In the current economic environment, liquidity management is a key function for multinational corporations. Many multinationals operate some form of group treasury structure, such as centralized or regional treasury centers; in-house banks; foreign exchange (FX) centers; and payment factories, which are central units that execute payments on behalf of one or more subsidiaries. Through these various treasury structures, multinationals undertake activities like centralized lending, payment management, risk management, and FX hedging.
For short-term cash management, cash pooling is often the most effective way to optimize both excess and deficit cash positions within a group of companies. By allocating internal funds, rather than depending entirely on external sources, a large business can minimize its interest costs overall. Moreover, cash pooling can lead to significant savings when the group marshals its combined market power in dealing with external banks and through centralization of cash management, which may lead to economies of scale.
Determining arm’s-length terms and conditions can be challenging, since we generally cannot observe cash pooling systems among unrelated parties. Nonetheless, that is the standard by which multinationals must evaluate their internal transactions. The primary issues around which a multinational needs to hold its transfer pricing at arm’s length are:
How to Allocate Cash Pooling Benefits
In practice, netting and volume benefits are often considered in tandem as “total cash-pool profits.” For transfer pricing purposes, these benefits have to be allocated among all participants in the cash pool, including the CPL and/or parent company, in a way that reflects each entity’s contributions in terms of function, assets, and risks. If the CPL is responsible for the entire risk related to the cash pool, by way of an overall guarantee agreement, it is entitled to a larger part of the netting and volume benefits than it would be if it were operating only as an administrative service provider (as it may in the case of a notional cash pool, particularly if individual participants receive and pay close to market-level interest rates in their dealings).