Cash pooling: UK company as the cash pool header and the arm’s length principle
It may be the case that the cash pool header appears to be making a very good profit on its activities as a whole, of taking in deposits and lending out cash short term. However, there are actually potentially four separate transactions which can be priced (i.e. it will not necessarily be viewed as a “series of transactions”):
Short term deposits
Long term deposits in practice
Short term borrowings
Long term borrowings in practice
The issue of whether balances are short term or long term is discussed at INTM503140.
If the balances being deposited into the cash pool become more long term, structural balances, in order to consider whether the arm’s length principle is being applied, the arrangements need to be reviewed in detail. A UK cash pool header should have a monitoring system in place, which periodically reviews the material balances held within the cash pool, assesses the volatility of such balances, and records contemporaneously the reason for the balances being held on a short term basis, using for example, cash flow forecasts, narrative around business purpose etc. This monitoring also provides audit evidence to a tax authority regarding the arm’s length nature of arrangements.
To the extent that there is no commercial rationale for retaining funds on a short-term basis, the deposit/borrowing should be rewarded on a the basis of a longer-term arrangement (reflecting the substance of the arrangements over the legal form), and one should also consider any withholding tax implications (see INTM503160). The easiest way to achieve this will probably be to pull these funds out of the cash pool and put on term deposits/loans, as opposed to using multiple interest rates within the cash pool.
It is very important to ensure that any “long term” borrowings within the cash pool are correctly priced for tax purposes based on the arm’s length principle, and that the return reflects the risk that the cash pool header is assuming by lending out to the borrower on what is in practice a long term basis. This may involve changing the pricing of the transaction to reflect its substance.