Moving Cash Around the Group: Are You Tax Efficient?

Previous articles in this series have looked at securing tax relief for financing costs, tax issues associated with debt restructuring and opportunities for structuring intra-group lending. While these are important issues, each article focused on what amount to stand alone, or single financing transactions. This article takes a broader look at the treasury function and how it moves cash around the group.

In looking at the treasury function it seems to me that its primary role is that of the group bank, acting as lender of choice, managing risk(s) and minimising the group’s cost of funds. Therefore, at the simplest level, the group bank manages group liquidity with a view to ensuring that cash is available when and where it is needed, and manages this on a group/holistic basis.

But behind this high-level analysis is a much more complex position made up of a myriad of intra-group loans/balances and involving a large number of entities located in many jurisdictions.

What this means in practice is that, while the group bank may have plenty of cash available within the group, in terms of employing the cash within the various businesses it isn’t necessarily in the right place. Therefore, consideration has to be given as to how to move cash between legal entities.

But this should be relatively straightforward, yes? Well, it might be.

As a starting point, many multinational groups operate ‘regional’, e.g. European, US, Asia-Pacific cash pooling/cash sweeping arrangements. These are a common tool for moving cash around a group and securing the efficient management of the group’s day-to-day working capital requirements.

But while such arrangements may be relatively straightforward from a banking and commercial perspective, they give rise to a range of tax issues, including transfer pricing, thin capitalisation and related party rules relating to the deductibility of interest. In particular, as I mentioned in my article Issues with Securing Effective Tax Relief for Financing Costs, achieving tax neutrality for the intra-group balances that will be created with cash sweeping cannot be guaranteed.

Cash Management Options

What options are there for moving cash around a group outside of cash pooling/cash sweeping arrangements? If the funds happen to be located in the centre, i.e. group bank, then the most common technique will be one step on from cash pooling, i.e. the making of longer-term loans, and the tax issues here should be broadly as outlined above for intra-group balances arising from cash sweeping. While funding may also be provided to a group company in the form of equity, this isn’t typically undertaken by the group bank and so is outside the scope of this article.

But what if, as is more often the case, the funds aren’t located in the group bank? What if the funds are located in an offshore special purpose entity (SPE)? How do I move the funds out of the SPE? The starting point is having the SPE lend the funds either to the group bank or to the group company requiring the funds. This can, however, give rise to adverse tax consequences, e.g. irrecoverable withholding taxes, restrictions on relief for financing costs, etc, if the SPE is tax resident in an ‘unfavourable’ jurisdiction.

Next we look to the ‘other half’ of the balance sheet and consider if we can move/extract cash via equity-based transactions. So, for example, can we extract the funds by paying a dividend or by repaying share capital? Again, while both are viable options, consideration does need to be given to the tax consequences, with two of the initial issues to consider being:

• How much tax will be payable by the recipient on the dividend? Will the payer of the dividend have to deduct withholding tax from the payment?
• Will the repayment of share capital give rise to a tax charge? Could the receipt be taxed as a capital gain in the hands of the holder of the share capital?

The key point to note here is that if there is any taxation arising from such equity-based transactions then a significant amount of the cash may have been lost to the group. Therefore, while equity-based transactions may represent a good alternative to debt funding in that they remove the funds from the entity permanently, the associated tax cost may be prohibitive.

And where do we go after intra-group debt- and equity-based transactions?

Well, it then becomes much more complex, both from a tax perspective and a commercial perspective, with some of the options being:

• Migrate the tax residency of the SPE to a jurisdiction where debt- and equity-based transactions are more tax efficient.
• Have the existing SPE create a new funded SPE located in a jurisdiction where debt- and equity-based transactions are more tax efficient.
• Have the SPE acquire some income generating assets from within the group, e.g. via repo or stock lending arrangements.
• Engage in third-party structured finance transactions.

The key point to note here is that to seriously consider implementing one of these options, both the amount of funds involved and the potential tax charge being mitigated will need to be considerable, as such transactions will undoubtedly involve significant costs.

Conclusion

This article takes a high level look at how cash can be moved around the group and considers some of the tax issues that could arise when doing so. The key message for treasury and finance professionals is that moving cash around the group can be a complex and costly issue from a tax perspective and, furthermore, there are many pitfalls to be avoided. If, however, advice is taken upfront then in most cases the pitfalls can be avoided or alternatively another technique employed or transaction implemented.