Cash & Liquidity ManagementCash ManagementCash Management RegionalThe Advantages of a Notional Cash Pooling Structure in the Netherlands

The Advantages of a Notional Cash Pooling Structure in the Netherlands

Cross-border cash pooling is like the economics of international trade. It makes perfect sense in theory. Its advantages are crystal clear until you consider taxes, transaction costs and regulations of the countries involved (beyond the pure economics of the scheme, it is also a fantastic idea until you realize you may have to give up your cosy relationship with your friendly local banker). As this article will demonstrate, these difficulties can be overcome.

This article will cover the main benefits of cash pooling for multi-national corporations (MNCs). The primary advantages of the Dutch tax regime and regulatory environment will be discussed, concluding what sets the Netherlands apart from other potential pooling locations. The impact of pooling on bank relationships will also be addressed.

The Case for Pooling

Personal-finance advisors recommend paying off credit-card debt first, because it carries the highest interest costs. Cash pooling is a corporate-level solution to a similar problem. It permits a company to offset overdrafts in some bank accounts with positive cash balances in others, thereby reducing overdraft charges and interest costs associated with short-term borrowing while optimizing the use of idle cash. The working-capital efficiencies captured by this type of scheme can be significant; it raises the return on capital employed, thereby increasing shareholder value. Assuming critical mass and the right structure in the right location, setting up a cash-pooling system will pay for itself almost immediately.

In broad terms, this is achieved either by cash concentration, i.e. ‘physically’ transferring the cash balances of a corporate’s different entities to a main concentration account in a suitable location, or through ‘notional’ pooling, in a sense treating a group of accounts as one for the purposes of interest calculation. Notional pooling is often favoured over cash concentration as the latter gives rise to higher transaction costs. With notional pooling, cash does not move or change ownership. Most pooling arrangements are typically hybrids, due to local restrictions on notional pooling. A typical example of such hybrid pool is the ‘cross-border notional pool’ whereby the balances of the different corporate entities are transferred (cross-border transfers) to accounts participating in a domestic notional pool. This domestic notional pool then functions as an overlay pool.

MNCs are, for strategic, legal and tax reasons, comprised of multiple types of entities in multiple jurisdictions. The larger and more geographically and organizationally diverse the firm, the more likely that it will show significant cash-balance variances between the entities. Organizational complexity will also create difficulties for the treasury to control and make best use of the cash.
While a detailed discussion on all issues impacting pooling is beyond the scope of a single article, some issues to be addressed, when considering a cash pool, include:

  • Do the company’s cash balance pattern and volumes warrant pooling?
  • What countries will be involved in the pool, i.e. what are the account currencies, where are the different entities’ bank accounts domiciled, and are those jurisdictions suitable to pooling?
  • Under what circumstances, such as company structure, do these countries permit cash concentration or notional pooling?
  • What do tax regulations require and what does the company itself prefer with regards to the movement and change of ownership of cash, inter-company loans and mirror accounts?
  • Are the entities and/or the treasury profit centers?
  • Are cross-guarantees implied in the law or negotiated in contracts?

The Dutch Regulatory Environment

A key issue in the pooling argument is the domicile of the notional pool. Not all jurisdictions are suitable, primarily because of taxes and limitations on non-resident account holders. In France, for example, interest is not paid on current accounts, while in Germany, non-resident account holders are often subjected to lifting fees.

To operate a pooling scheme effectively, the corporation’s entities, regardless of residency and currency, must be able to ‘share’ their cash. Cross-entity offsets permit ‘sharing’ between legal entities, cross-border offsets allow sharing between entities in different jurisdictions, and with cross-currency offsets cash can be actually or virtually converted to a base currency for interest calculation and application. The availability of all three types of offsets is one reason why the Netherlands is among the most advantageous pooling locations. From a Dutch regulatory standpoint, both cash concentration schemes, such as zero-balancing and target-balancing, and notional pooling, including the overlay pool, are permitted and assisted by the regulations surrounding bank accounts and, consequently, offsets and interest payments.

The basic framework for operating an overlay pool in the Netherlands consists of the following elements. First, both resident and non-resident entities can open EUR and foreign (convertible) currency accounts in the Netherlands. Second, the central bank generally does not require reporting of movements to and from the accounts held in the Netherlands. Third, it is possible to include different convertible currencies in the cash pool. Last but not least there is no withholding tax on bank interest payments in the Netherlands.

Thin Capitalization Rules

One consequence of cash concentration and pooling is that, as soon as more than one legal entity is involved, inter-company loans arise during the pooling cycle. This affects the debt-to-equity ratios of each of the entities involved, and may result in ‘thin capitalization’, i.e. high debt-to-equity ratios on a temporary but recurring basis. New thin-capitalization rules introduced in the Netherlands in 2004 limit the deductibility of interest cost on ‘excessive’ related-party debt financing, where loans include bank deposits. Thin capitalisation rules differ widely across Europe. While a 3:1 debt-to-equity ratio exists in the Netherlands, a 1.5:1 applies in France and Germany. In France, interest can be deducted if the loan does not exceed 150 per cent of French subsidiary’s capital. In Belgium, a 7:1 ratio applies if the creditor operates under the Belgian Co-ordination Centre regime.

THIN CAPITALISATION RULES
Country Debt/equity ratio
Austria The Administrative Court has established certain broad and rather liberal guidelines that are used to determine whether the equity for commercial purposes is adequate for the purpose of taxation.
Belgium 7:1 in case the creditor enjoys a favourable tax regime ( e.g. the Belgian Coordination Centre).
Denmark No specific rules.
Finland No specific rules.
France 1,5:1 (deductibility of interest provided that the loan does not exceed 150% of the French subsidiary’s capital).
Germany As from January 1, 2004 : general ratio of 1,5:1.
Greece No specific rules.
Ireland No specific rules but interest paid to a 75% non-resident affiliated company is deemed to be a dividend in certain cases.
Italy As from January 1, 2004 : 4:1 for related companies (10% direct or indirect shareholding).
Luxembourg No general rules but in practice tax administration applies a certain debt/equity ratio ( 6:1 ).
Netherlands As from January 1, 2004 : a ratio of 3:1 applies either on an individual or group basis.
Norway No general rules, but in practice a debt/equity ratio of 4:1 is a guideline.
Portugal 2:1 (general rule).
Spain 3:1, but as from January 1, 2004 not applied in the case of EU resident lenders.
Sweden No specific rules.
Switzerland the debt/equity ratio results from the maximum indebtedness for all types of assets held by a company; in some canton a debt/equity ratio of 6:1 is applied.
U.K. no fixed debt/equity ratio but a ratio of 1:1 is normally acceptable for the tax authorities

 

Day-to-day amounts for an MNC could add up to significant volumes, in the aggregate perhaps higher than some long-term loans. The implications for cash concentration are higher after-tax interest costs, a heavier burden on the treasury systems, and an increase in transaction reporting and charges from the bank. Via adequate intra-company loan management (either by using mirror accounts, or by control mechanisms offered by banks to protect against excessive intra-company financing) banks may help prevent this. Avoidance of intra-company lending is also possible with an appropriate account structure. In such structure, each subsidiary maintains its own account in the overlay pool (The diagrams below illustrate structures with and without inter-company loans).


Central Bank Reporting, Capital Adequacy and Cross Guarantees

In contrast to Belgium, where gross reporting is always required when more than one legal entity is involved, a Dutch bank is permitted to report a notional pool’s debit and credit balances on a net basis, provided the accounts belong to the same legal entity or joint- and several liability is established. Reporting balances gross incurs higher capital adequacy charges. These costs – which are passed on to the customer – do not incur in the Netherlands.

Notional pooling requires a way to offset balances in the event of a default of one of the pooling participants. In the Netherlands, this requires the establishment of joint- and several liability. Joint- and several liability is to be contractually agreed between all cash pool participants and the bank. Without the establishment of joint- and several liability, true notional (overlay) pooling between different legal entities is not possible, and regulatory capital requirements must be fully met. Otherwise, the bank’s capital adequacy restrictions, which are imposed by the central bank, would be violated.

Bank reporting of resident/non-resident transactions to the central bank has been abolished and, since 2003, corporates are responsible for their own reporting. However, only companies with high-volume resident/non-resident transactions are required to do so, which has reduced the number of companies reporting to less than a tenth of those previously required to report. In contrast, in many Euro countries (Spain, Italy, France, Belgium, Germany, Luxembourg, Greece, Austria, Portugal) reporting is required for all transfers exceeding 12,500 EUR.

The Dutch Tax Regime

The interest payments generated by cash concentration and pooling schemes are subject to withholding taxes in some countries which eliminates them from the list of suitable pooling locations. In the Netherlands, interest payments are generally exempt from withholding tax. The Dutch also have a large number of tax treaties with other countries which reduce or eliminate withholding taxes on cross-border interest payments.

The Netherlands is not alone in the EU as a jurisdiction in which no withholding tax is levied. As well as tax efficient regimes in Belgium and Ireland (Belgian co-ordination Centres and IFSC-based companies), countries including Denmark, Switzerland and Luxembourg do not apply withholding tax. Complications arise however in the most benign jurisdictions depending on the location of the lender. If the lender of the inter-company loan is located in Italy, Portugal or Belgium, withholding tax may arise. The rate of taxation applied is the lower of the double tax treaty rate and the domestic tax law.

Local Entities and their Banking Relationships

In general, companies are not change-resistant; the people in them are. Change is treated with suspicion, particularly when the benefits for the individual entity are not large or apparent. Another major issue is the control over and access to the entity’s own cash. A country manager may be neither willing nor have incentive to see his cash balance ‘disappear’ across the border every night for the global good of the company. This barrier might be overcome when the account in the overlay pool is held and thus controlled by that same country manager.

Creating a pooling structure for an MNC may also result in a significant overhaul of existing banking relationships. When the MNC has an overview of the ebbs and flows of its bank balances, worldwide or in a particular region, it may conclude that an entirely new banking structure is in order. This may seem to require dismantling long-standing relationship with a local banker in favour of a network bank with presence in all the relevant business locations.

It may however well be that the MNC concludes that it wants to maintain local bank relationships, for instance because the network bank cannot fulfill all local needs everywhere. In that case, pooling may still be worthwhile. There are basically three options:

  1. ‘Do-it-yourself’ solution: the MNC installs its overlay pool with one of the local banks and manages the movements in and out of the cash pool itself;
  2. Hybrid solution: Identical to option 1, however the overlay cash pool runs within a network/cash management bank that can and is willing to set up, manage and monitor automated sweeping arrangements with the local banks;
  3. Outsourcing the solution to cash management providers specialized in multi-bank solutions. The multi-bank cash management specialist performs the information reporting, interest calculation and payments to and from the entities’ local bank accounts, which allows customers to maintain existing banking relationships. This type of multi-bank solution pays off for MNCs with an annual turnover equivalent to at least EUR1bn in various currencies.

How a treasurer’s performance is measured plays a significant role in whether a new cash management tool will be implemented. There is little incentive for a treasurer measured on traditional balance-sheet indicators to go through the cost and pains of setting up a system that will enhance cash-flow performance. However, these measures are increasingly seen as important indicators of shareholder-value creation, and ways to improve them are of growing interest to the Boards of Directors.

Conclusion

A pooling structure will make sense for large MNCs that have regular variances in cash balances in their major subsidiaries, entities or countries of operations. A cost-benefit analysis will show if there is critical mass to justify the cost of establishing a cash pool as well as the ongoing transaction costs and bank fees. Careful study of the regulatory environment will determine if the company is permitted to take advantage of pooling. If these two criteria are fulfilled, the Netherlands offers sophisticated banking solutions in an advantageous regulatory and tax-law environment. Several Dutch banks have long experience in the area of pooling, either using overlay structures or network-bank set-ups.

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