Pooling, the practice in which treasuries consolidate funds from subaccounts into a central account, provides companies with better visibility into their cash. But pooling can be challenging to implement across national borders, in large part because of tax regulations.
Susan Hillman, a founding partner at Treasury Alliance Group, a Chicago area-based treasury consulting firm, cautioned that the tax issues involved in cross-border pooling are “very complex and need to be vetted by each company’s tax counsel.
“You’re not just dealing with U.S. tax law, you’re dealing with country-by-country tax considerations,” said.
Pooling can be either physical or notional. In physical pooling, bank accounts maintained by various units of a company are linked to a master, or header, account. Cash is automatically swept from accounts with a positive balance and moved from the master account into accounts with a negative balance. In notional pooling, no funds actually move between accounts. Instead, the bank administering the pool makes accounting entries on a set of virtual accounts.
Treasury Alliance Group estimates that physical pooling constitutes about 80% of the pooling structures set up by companies. “Physical pooling has to be a single currency,” Hillman said. “In Asia Pacific, cross-border physical pooling is commonly U.S. dollars, which are used for trade in many countries in the region.”
“The one definitive thing that you can say is cross-border pooling is a short-term cash management technique,” she added. “It should not be used to manage any long-term cash deficit or surplus cash positions between entities,” he said.
While there has been a greater use of cash pooling over the last six years, according to Jeffrey Olin, a managing director with Alvarez & Marsal Taxand, until recently, companies’ tax departments were often “a little bit in the back seat” when pooling was implemented. “The trend we are seeing now is tax and treasury teams working more closely together to address the cross-border issues on the front end,” Olin said.
That’s a positive development since “we’re in a world where tax authorities are going after multinational businesses. Putting in the correct documentation around any type of a cash pooling arrangement or any type of cash management system continues to be important,” he said.
Visibility isn’t the only thing companies gain from pooling. Since banks charge more to lend than they pay in interest, offsetting the negative balances in some of the company’s accounts with the cash swept from its other accounts saves the company money.
“Pooling benefits include reduction of idle cash balances and offset of short-term borrowing costs,” Hillman said, adding that pooling also “allows treasury to reduce the number of bank accounts and banks they’re dealing with,” which can cut costs.
Layne Albert, a managing director with Alvarez & Marsal Taxand, cites the advantages that pooling can provide to companies that hedge their foreign exchange exposure or use other types of derivatives.
“You’re able to offset sometimes a lot of counterparty risk within your own cash pool before you have to go outside and hedge further,” he said, and noted that pooling can also play a role in the posting of collateral. “We’ve seen a lot of situations where these cash pools can be relied upon for multiple collateral purposes just because of the sheer size.”
Still, tax considerations are a problem.
Joseph Calianno, a partner at Grant Thornton, noted U.S. federal tax issues that could come into play.
“Some of the issues that may need to be considered include certain anti-deferral rules, such as the subpart F rules of the Internal Revenue Code,” Calianno said. “These anti-deferral rules may require the U.S. parent of the foreign subsidiaries to include in income the interest income earned by the foreign subsidiaries even if such income is not repatriated in the form of an actual dividend.”
Transfer pricing is one of the top issues, said Olin of Alvarez & Marsal Taxand, pictured at left. “Transfer pricing has an impact on a cash pooling arrangement because it asks: what are the proper interest rates set between pool members? The transfer pricing rules apply to the setting of the interest rates within a cash pooling structure.”
“The other open question in transfer pricing is how do you allocate the benefits of a pooling arrangement,” he said. “That has to be at an arm’s-length standard.”
Another possible area of concern in transfer pricing is how companies’ business units charge for the treasury department’s services. “A U.S. multinational might have a fairly sophisticated treasury management team based in the United States,” Olin said. “If you’re doing regional cash pooling that just addresses Europe, how do you charge out the treasury management services being performed in the U.S., such as foreign currency hedging?”
The deductibility of interest and withholding taxes is another consideration in cross-border pooling, Olin said. “There are issues about the location of your pool leaders and how you structure the pool arrangement,” he said. “These could come under the umbrella of what we in the tax world call permanent establishment. And indirect taxes—there may be other stamp taxes, business taxes that apply.”
Tax considerations come into play when a company decides where to set up the pooling arrangement’s header bank accounts. “It is preferable to be in a location that has no withholding tax on interest and has minimal or no reserve bank charges,” Hillman said. “The common locations for cross-border pool headers are London, Amsterdam and Singapore, but New York is sometimes used for USD pooling.”
One criterion for the location for a header account is the extent of the country’s treaty network, Olin said, since such treaties generally cut the amount of withholding tax that’s due.
“If the statutory withholding rate on interest payments is 30%, a treaty will normally reduce that to zero, or potentially 5%,” he said. “You get less withholding-tax drag on any of your pooling payments that are going across borders.
“The UK is an excellent location because it has so many treaties among the various countries. Netherlands is another example, with a vast treaty network, and Singapore, too,” Olin said.