Cash pooling: short term and long term balances held in the cash pool
Applying the arm’s length principle to transactions within the cash pool should not differ from any other transfer pricing analysis. Using the basic principles of transfer pricing, we should look at the functions, assets and risks of each of the parties to the arrangement, and consider which one of the OECD methodologies is the most appropriate method to be used to calculate an arm’s length return for the UK party.
Determining whether the arm’s length principle is adhered to in respect of cash pooling arrangements is a complex task, with the following factors adding complexity:
- Multiple currencies may be used.
- Balances may be fluctuating on a daily basis.
- External funding/investment of surplus funds externally may affect the financial results (and risks) of the cash pool header.
- The cash pool header may also be a pool participant in respect of other activities it carries out.
- The return to the cash pool header may be difficult to determine in a treasury company with many activities.
- As money is fungible, it is not easy to determine when all or part of a balance should be viewed as “long-term” rather than “short-term”.
These arrangements tend to be put in place principally for commercial purposes, in order to facilitate short term liquidity or to increase the security of the funds. When used as a tool for accessing short-term funding and depositing surplus cash on a short term basis, there is normally little tax risk arising from these arrangements.
However, as a result of the group relationship, in certain cases the cash pool header and participants may not act as independent enterprises would in similar circumstances. For example:
- The cash pool header may not be applying the same level of monitoring and the use of safeguards/limits and active management that would take place if the participants were independent parties. For example, whilst most third party banks would have limits on overdraft facilities, for some borrowers using the cash pool, there may be no limit. Or there may be no criteria being applied contemporaneously to determine when a balance goes from being “short term” – repayable on demand and charged short term borrowing rates – to “long term”, where at arm’s length the debt would likely have been restructured into a loan on a long term rate, the legal structure and reward of which would reflect the substance of what is happening in practice.
- The non-arm’s length cash pool depositor may be happy having long term deposits earning short term rates, despite the fact that at arm’s length, one of a company treasurer’s key roles, aside from security and liquidity, is to get yield on cash balances. If large balances are being held on overnight deposit, we would expect contemporaneous documentation to be available giving the commercial reasons that explain why the money is being held on a short term basis.
There is a risk that the contractual arrangements of short term deposits, and borrowing on short term rates, may not represent the substance of the arrangements, which in reality could be long-term for both depositors and/or borrowers. See INTM501040 regarding the importance of looking at what happens in practice, as well as what is written down in the legal documentation.
When the balances being deposited/borrowed become more long term structural balances, the arrangements need to be reviewed in detail, to consider whether the arm’s length principle is being applied with respect to the UK participant’s transactions. There may not be a tax motive in respect of balances building up in the cash pool (both positive and negative) - there may be commercial convenience of using the cash pool for funding or a lack of management oversight regarding the cash pool - but both reasons lead to increased tax risk for the UK, the nature of which depends on which role the UK participant takes, as discussed in INTM503150 and INTM503160.