Cash Pooling—the Pros and Cons

The latest issue of the Tax Planning International Forum addresses cash pooling, a common arrangement entered into by multinational enterprises (“MNEs”) to retain internal control over financing. Cash pooling is essential to reducing financing costs for many MNEs, but is subject to increasing uncertainty in light of recent cases and regulatory changes.  Some of these are discussed briefly below.

What is Cash Pooling and How Does it Work?

Cash pooling is a way for multinational enterprises to manage short term liquidity issues and keep their financing costs to a minimum. Generally they work as follows: An MNE will have several subsidiaries, located in several different countries. If it wants to pool the finances of those entities, it will set up a company, which need not be in the same country as the parent company, which will act as the Cash Pool Leader (“CPL”). Each of the participants will have a bank account. The pool is managed using either zero target balancing or notional cash pooling.

Zero Target Balancing

In the Zero Target Balancing arrangement, participants with a cash surplus transfer that surplus from their bank accounts to the account of the CPL. The CPL, in turn, transfers necessary funds to any participant that is in deficit.

This can happen on a daily basis. So every day, a participant that is in credit will have its surplus transferred to the CPL.

Notional Cash Pooling

In the other kind of cash pool, known as Notional Cash Pooling, surpluses are not transferred. Instead, the CPL’s bank will assess the balances and deficits in each participant’s account, add them up, and, if the overall balance is in credit, will pay interest to the CPL, and if it is in debit, it will charge interest to the CPL.

Advantages of Cash Pooling

Key advantages are that:

  • Most short-term financing can be carried out within the pool.
  • It’s cheaper—there are fewer financing costs from external loans.

That doesn’t mean that cash pooling is costless. The CPL will pay interest to participants which pay in their surplus, and will generally charge a higher interest to those that are in deficit and need an injection of funds. The calculating and documenting of these transactions, in turn, incurs costs of its own.

However, the CPL can enjoy a low interest rate from the third party lender as a result of carefully managing the pool, which can then be passed on to other participants. This spread, the “coordination benefit”, has given rise to transfer pricing issues in the past and has been challenged by the judiciaries and regulatory agencies of a number of countries. Below we include brief reviews of these developments.

Norway: ConocoPhillips Skandinavia AS / Norske ConocoPhillips AS v. Oljeskattekontoret (Norwegian Court of Appeals, 2010)

The ConocoPhillips cash pool, which was a Zero Target Balancing cash pool, consisted of 150 participating companies, including the parent company. The participants were jointly and severally liable, but the parent company provided a guarantee to the bank for the cash pool liabilities.

The two participating Norwegian companies were always in credit, so their surpluses were always transferred over to the CPL.

The cash pool itself was managed actively to ensure that it, to, was always in credit. Consequently, the bank paid the London Interbank Bid rate (“LIBID”) minus 25 basis points (“bps”) to all 150 accounts, whether they were in credit or not.

The Norwegian tax authorities criticized this, arguing that LIBID -25 was too low a rate. They pointed out that all the participants in the pool received this rate, regardless of their financial performance, and argued that the two Norwegian members of the pool should be getting a better interest rate than poorer-performing participants in the pool, something that they would have received had the transaction with the bank been at arm’s length. Their accounts were always in credit, and those surpluses contributed to the CP leader’s account always being in credit, which in turn influenced the favorable interest rate that all participants enjoyed. 

In the eyes of the tax authorities, this situation therefore gave the Norwegian participants disproportionate power over the pool and, from that, the right to share in that coordination benefit more than other participants, such as those which might end each day with a negative balance. They therefore decreed that the two Norwegian subsidiaries should instead be receiving LIBID +25 bps in interest.

The participants replied that this was irrelevant, as cash pools do not happen between unrelated entities at arm’s length from one another.

The court dismissed ConocoPhillips’ arguments, siding with the tax authorities, resulting in the upward adjustment of the Norwegian participants’ incomes and, consequently, a higher tax bill. 

The case was not given leave to appeal to the Supreme Court.

Denmark: Bombardier (DK: Admin. Tax. Ct., 21 Oct. 2013, Case 12-0189459.)

A Danish subsidiary of the Canadian Bombardier group was in a zero-balancing cash pool. It transferred its surpluses to the cash pool leader in an unsecured transaction and received interest at the daily overnight bank rate -50 bps. Occasionally it needed to borrow at the daily overnight rate +115bps.

The cash pool maintained a positive balance throughout.

However, because the amounts deposited with the cash pool were unsecured, the Danish Tax Authorities argued that the interest rate that the subsidiary had been receiving did not reflect the fact that the amounts on deposit were unsecured, and instead calculated that the Danish subsidiaries should be earning the daily overnight bank rate +118 bps.

The court agreed, although it set the rate at the daily overnight bank rate+115 bps.

United States: Earnings Stripping Rules

The latest threat to cash pools comes from the United States, where the proposed update to the earnings stripping rules (REG-108060-15, deadline for comments: July 7, 2016) will mean that loans between different companies within an MNE will be treated as stock, rather than debt. This will mean, in turn, that payments will not be treated as including interest, which means that interest deductions will not be applicable to such transactions/ Payments will instead be seen as cross-border dividends, which are taxable to the recipient, do not carry a right to a deduction by the payor, and are generally subject to withholding taxes under treaties, whereas interest payments are generally treaty-exempt. 

All of this, on the one hand, fits in with the OECD’s battle against base erosion and profit shifting, in the guise of Action 4, Limiting Base Erosion Involving Interest Deductions and Other Financial Payments. But on the other hand, it threatens the viability of cash pools as an easy and cheap way for MNEs to ensure liquidity. The U.S. government is being lobbied to consider a carve-out for cash pools but already companies are exploring external financing alternatives. We will await the next twist with interest.

To find out more about the International Forum, visit the homepage.

By Alex Miller, Managing Editor, Bloomberg BNA.

Thanks to Joanna Norland of Bloomberg BNA for her assistance.

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