Cash Pooling - Are you Managing the Tax Issues?

London, 12th January 2010

Cash pooling tools, such as notional pooling and zero balancing, are used to move cash around a group and manage working capital, but different tools have different tax implications that treasurers need to be aware of.

In my previous article Moving Cash Around the Group: Are You Tax Efficient?http://www.mavenpartners.co.uk/recruitment_news/moving_cash_around_301109.html, 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 both 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 was 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 on 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 effect a previously neutral tax position

Conclusion

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

1. Notional pooling, or interest compensation, where there is no physical transfer of funds and where banks will require a legal right of off-set
2. 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

Martin Bardsley, Senior Director with Alvarez & Marsal Taxand UK, serves as head of the firm's Treasury & Financing Tax practice and also leads Taxand's Global Financing service line. Taxand is a global network of leading tax advisors from independent firms in nearly 50 countries

Martin brings over 20 years of experience in providing corporate and international tax advice to a wide range of multi-national clients and has significant experience in advising on Treasury and Financing transactions, both in the corporate and financial industry sectors. Prior to joining Alvarez & Marsal, Martin spent 17 years with the tax groups of PricewaterhouseCoopers and KPMG, 13 of which were spent in London focusing on Treasury and Financing Tax. Martin also completed a long-term secondment to a major FTSE 100 multinational firm during 1998 and 1999 where he was tax adviser to the Treasury, Corporate Finance and Asset Management teams.

For more information contact Rob Stephenson, Managing Partner of Maven Partners on 0207 061 6421.