Cash pooling is a valuable treasury tool for practical, day-to-day cash management. Cash pooling allows a multinational group to centralize its internal financing arrangements, allowing more control, efficiency, and synergy across the members of the group. It has become clear in recent years, however, that cash pooling arrangements can also create certain transfer pricing risks. Such risks manifest themselves in non-deductible interest expense, double taxation or penalties, that can ultimately outweigh the benefits. This article focuses on the transfer pricing risks associated with cash pooling arrangements, and follows our previous article on "Intra-group Loans - 10 Things to Consider".

There are two broad types of cash pooling arrangements: notional cash pooling and physical cash pooling. Notional cash pooling allows a multinational group to net balances of different accounts across jurisdictions without physically moving cash. Physical cash pooling (also known as zero or target balancing) sweeps excess cash out of individual bank accounts to a central account on a daily basis. Both types of cash pooling arrangements give rise to transfer pricing considerations.

The OECD and tax authorities of some countries have published transfer pricing guidance on the treatment of cash pooling arrangements. For instance, HM Revenue and Customs (HMRC) updated their Inspector’s Manual guidance (INTM503110-503200) on cash pooling in 2017, stressing key themes that are also at the core of the OECD’s BEPS work. Last year, the OECD published a discussion draft on financial transactions that was opened up for public consultation, and further guidance from the OECD is anticipated.

Below, we highlight ten important considerations which will assist in the structuring of cash pooling arrangements in line with the arm's length principle.

  1. Ensure the functional profile of the Cash Pool Leader (CPL) is consistent with its characterisation - The remuneration of the CPL depends on its functional and risk profile. At one end of the spectrum, a CPL can be characterised as a financial services entity (with limited functions and risks), at the other end, it can be characterised as an in-house bank (with significant functions and risks). Financial services entities earn a lower return as compared to in-house banks and, therefore, an inappropriate characterisation of the CPL can lead to incorrect remuneration and significant transfer pricing risks. A robust functional analysis will ensure that an appropriate transfer pricing policy is adopted.
  2. Consider options realistically available to each Cash Pool Participant (CPP) - From a CPP's perspective it is important to understand what other options are realistically available to being a CPP. In the event that there is at least one realistically available option that is clearly better for a CPP, cash pool transactions involving the CPP might not be supportable as arm's length.
  3. Determine the credit risk - The credit rating of the CPL and the standalone credit ratings of the CPPs need to be determined to estimate their credit risk, as this will influence the arm's length interest rates for the cash pooling transactions. An assessment of creditworthiness should also take into account the explicit, implicit and cross guarantees (see item 9 below).
  4. Ensure cash pooling transactions are characterised appropriately - Transactions within a cash pooling arrangement are generally of a short term nature (less than a year) and are entered into for managing working capital requirements (liquidity management). Thus, interest rates should be set accordingly. Where a cash pool transaction remains outstanding for a longer term, or the funds are used for a different purpose, then there is a risk that tax authorities may re-characterise the transaction.
  5. Ensure interest rates are arm's length - Interest rates applicable to cash pool transactions should reflect the risk inherent in them. Therefore, it is important that the terms and conditions of the legal agreement, credit risk of the CPL and the CPPs, and currency of the transactions are taken into account when determining the credit and debit interest rates.
  6. Consider withholding taxes - Withholding taxes may apply to cash pool transactions. When they do apply, it is important to consider which party (CPL or CPP) will bear the economic burden of these withholding taxes and the impact on the interest rates. That treaty protection is only available for the interest component that is consistent with the arm's length principle should be kept in mind when considering withholding taxes.
  7. Ensure cash pool advantages are allocated appropriately - A cash pool advantage refers to the synergies and cost savings generated by cash pooling arrangements. This advantage needs to be quantified and allocated to the CPL and/or the CPPs based on their relative contributions.
  8. Ensure terms and conditions documented in legal agreements are at arm's length - Legal agreements are the starting point for any transfer pricing analysis, but the economic and legal realities must be synchronized. If the terms and conditions documented in legal agreements do not reflect third-party behaviour and genuine economic circumstances, there may be a risk of re-characterisation by tax authorities.
  9. Consider the impact of guarantees - It is important to account for explicit, implicit and cross guarantees from entities within a cash pooling arrangement, as well as those outside it. These guarantees affect the risk profile of the CPL and CPPs and are likely to have an impact on the pricing of cash pool transactions. An assessment of whether a guarantee fee is payable or not and which party(s) benefit from the guarantee also needs to be undertaken.
  10. Develop a consistent transfer pricing policy - A transfer pricing policy for cash pool arrangements should be developed and followed. Such a policy needs to define the parameters, processes and approaches to cash pooling from a transfer pricing perspective. Developing this policy provides an opportunity to involve and align all internal stakeholders from treasury, legal, tax and operations. A consistent policy is essential, as a description of the overall financing policy of a multinational needs to be included in the Master File documentation.

As the global tax environment changes and financing arrangements within multinationals are subject to greater scrutiny by tax authorities, it is essential that transfer pricing aspects are taken into account in order to reduce tax controversy risk. In order to proactively manage the transfer pricing risks, it may be worthwhile to explore the use of Advance Pricing Agreements or Mutual Agreement Procedures, which strengthen the overall financing policy of multinationals.