Cash & Liquidity ManagementCash ManagementNetting/PoolingCash Pooling: Are You Managing the Tax Issues?

Cash Pooling: Are You Managing the Tax Issues?

In my previous article Moving Cash Around the Group: Are You Tax Efficient?, I took a high-level look at how groups move cash around and the associated tax consequences.

In terms of the techniques available, I referred to cash pooling/cash sweeping arrangements, stating that these are common ways for moving cash around a group as well as securing the efficient management of the group’s day-to-day working capital requirements.

While such arrangements may be relatively straightforward from a banking and commercial perspective, they do give rise to a range of tax issues, including transfer pricing, thin capitalisation and related party rules relating to the deductibility of interest.

But isn’t cash pooling straightforward from a tax perspective? Well, it may be.

Ultimately the complexity from a tax perspective depends on both the type of cash pooling arrangement and the jurisdictions involved. While there are many variations, in essence there are two main forms of cash pooling: notional pooling and zero balancing.

Notional pooling

In the case of notional pooling, the debit and credit balances kept by the various members of the pool are added up and interest is calculated onthe basis of the net result. The balances themselves are, however, not transferred to one separate central entity, but remain with the individual member companies of the pool.

Zero balancing

In the case of zero balancing, also known as sweeping, the balances of the pool members are physically transferred (i.e. swept) to one central entity (the pool leader). At the time of the sweep (normally at the end of the day), positive balances will be transferred to the pool leader. The pool leader will also provide the necessary cash to those entities that are in an overdraft position resulting in the individual companies having a zero balance at the end of the day.

Notional Pooling Versus Zero Balancing

While economically the same, these two forms of cash pooling have substantially different tax aspects. In this regard, the key point from a tax perspective relates to the fact that, while with notional pooling the pool members retain their existing balances, with zero balancing intra-group balances are created between the pool members and the pool leader.

What this means in practice is that with notional pooling, issues relating to interest deductibility, thin capitalisation and withholding tax remain the same. While some consideration does need to be given to such issues as the interest rates applied within the pool and the transfer price for any financial guarantees, in general, notional pooling is relatively straightforward from a tax perspective.

With zero balancing, however, new intra-group balances are created and so the rules relating to interest deductibility, thin capitalisation and withholding taxes will all have to be revisited. This is firstly because the rules for intra-group funding may be different from those applying to external funding and secondly because a previously in-jurisdiction balance may have become a cross-border balance. Consideration will also need to be given to the transfer pricing consequences of any financial guarantees associated with the zero balancing arrangements.

In summary, therefore, the tax consequences associated with zero balancing are complex and could adversely affect a previously neutral tax position.

Conclusion

Cash pooling arrangements exist in many forms and in this article I have focused on:

  • Notional pooling, or interest compensation, where there is no physical transfer of funds and where banks will require a legal right of offset.
  • Zero balancing, where funds are physically transferred and each member of the pool has only one counterparty – the pool leader.

The key message for treasury and finance professionals is that there will always be tax issues associated with both the establishment of a new cash pool and the addition of new members to an existing cash pool.

From a tax perspective, the most important piece of initial information your tax colleagues will need will relate to the type of arrangements being used, i.e. notional pooling or zero balancing, as this will determine both the nature and extent of the tax issues that need to be addressed.

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