In February 2020, the Organization for Economic Cooperation and Development ("OECD") released Transfer Pricing Guidance on Financial Transactions ("Guidance"). The Guidance is significant because it is the first time that the OECD's Transfer Pricing Guidelines have been updated to include guidance on the transfer pricing aspects of financial transactions. The use of a cash pool is popular among multinational enterprises as a way of achieving more efficient cash management by bringing together, either physically or notionally, the balances on a number of separate bank accounts. In a typical physical pooling arrangement, the bank account balances of all the pool members are transferred daily to a single central bank account owned by the cash pool leader. In a notional cash pool, some of the benefits of combining credit and debit balances of several accounts are achieved without any physical transfer of balances between the participating members' accounts. As cash pooling is not undertaken regularly, if at all, by independent enterprises, the application of transfer pricing principles requires careful consideration. According to the OECD, a cash pool is likely to differ from a straightforward overnight deposit with a bank in that a cash pool member with a credit position is not depositing money as a transaction with a view to a simple depositor return. Rather, the cash pool member is likely to be participating in providing liquidity as part of a broader group strategy, in which the member can have a credit or debit position. The appropriate reward of the cash pool leader will depend on the functions performed, the assets used and the risks assumed in facilitating a cash pooling arrangement. A cash pool leader may perform no more than a coordination or agency function with the master account being a centralized point for a series of book entries to meet predetermined target balances of pool members. Under these circumstances, the cash pool leader's remuneration as a service provider will generally be limited. Where a cash pool leader is carrying on activities other than coordination or agency functions, the pricing of such transactions would be adjusted appropriately. The remuneration of the cash pool members will be calculated through the determination of the arm's length interest rates applicable to the debit and credit positions within the pool. This determination will allocate any synergy benefits arising from the cash pool arrangement amongst the pool members and it will generally be done once the remuneration of the cash pool leader has been calculated.
Background. In February 2020, the Organization for Economic Cooperation and Development ("OECD") released Transfer Pricing Guidance on Financial Transactions ("Guidance"). The Guidance is significant because it is the first time that the OECD's Transfer Pricing Guidelines have been updated to include guidance on the transfer pricing aspects of financial transactions. The OECD expects that the Guidance should contribute to consistency in the application of transfer pricing and help to avoid transfer pricing disputes and double taxation.
The Guidance is divided into several parts. First, the Guidance elaborates on how "accurate delineation" analysis applies to the capital structure of a Multinational Enterprise ("MNE"), which was the subject of a prior post. Regarding accurate delineation, the Guidance makes clear that it does not seek to prevent countries from implementing approaches to address capital structure and interest deductibility under domestic legislation. Subsequent sections of the Guidance address specific issues related to the pricing of financial transactions, such as treasury functions, intra-group loans, hedging, guarantees and captive insurance. Those issues are the subject of separate posts. This post covers cash pooling.
Treasury Function. For MNE groups, the management of group finances is an important and potentially complex activity where the approach adopted by individual businesses will depend on the structure of the business itself, its business strategy, place in the business cycle, industry sector, and currencies of operation, among other factors. Different treasury structures involve different degrees of centralization. In the most decentralized form, each MNE within the group has full autonomy over its financial transactions. At the opposite end of the scale, a centralized treasury has full control over the financial transactions of the MNE group, with entities within the MNE group responsible for operational but not financial matters. A key function of corporate treasury may be to optimize liquidity across the MNE group to ensure that the business has sufficient cash available and that it is in the right place when it is needed and in the right currency. Other activities that treasury may have responsibility for include raising debt (through bond issuances, bank loans or otherwise) and raising equity, and managing the relationship with the MNE group's external bankers and with independent credit rating agencies. Generally, the treasury function is part of the process of making the financing of the MNE group as efficient as possible.
Cash Pooling Structures. The use of a cash pool is popular among multinational enterprises as a way of achieving more efficient cash management by bringing together, either physically or notionally, the balances on a number of separate bank accounts. According to the OECD, depending on the particular arrangements in place, a cash pool can help to achieve a more effective liquidity management, whereby reliance on external borrowing can be reduced or, where there is a cash surplus, an enhanced return may be earned on any aggregated cash balance. Cash pool arrangements are complex contracts which may involve controlled and uncontrolled transactions. For instance, one common structure is that the participating members of the MNE group conclude a contract with an unrelated bank that renders cash pooling services and each participating member opens a bank account with that bank.
Physical Pooling. In a typical physical pooling arrangement, the bank account balances of all the pool members are transferred daily to a single central bank account owned by the cash pool leader. Depending on whether there is a surplus or a deficit in the master account, the cash pool leader may borrow from the central bank to meet the net funding requirement of the pool or deposit any surplus as appropriate.
Notional Pooling. In a notional cash pool, some of the benefits of combining credit and debit balances of several accounts are achieved without any physical transfer of balances between the participating members' accounts. The bank notionally aggregates the various balances of the individual accounts of participating members and pays or charges interest according to the net balance, either to a designated master account or to all participating accounts under a formula. According to the OECD, in a notional pool, with minimal functions carried out by the pool leader, there may be little value added by the pool leader to be reflected in the intra-group pricing.
Accurate Delineation of Cash Pooling. As cash pooling is not undertaken regularly, if at all, by independent enterprises, the application of transfer pricing principles requires careful consideration. According to the OECD, a cash pool is likely to differ from a straightforward overnight deposit with a bank or similar financial institution in that a cash pool member with a credit position is not depositing money as a transaction with a view to a simple depositor return. Rather, the cash pool member is likely to be participating in providing liquidity as part of a broader group strategy, in which the member can have a credit or debit position. No member of the pooling arrangement would expect to participate in the transaction if it was made any worse off than the next best option. An advantage of a cash pooling arrangement may be the reduction of interest paid or the increase in interest received, which results from netting credit and debit balances. The OECD states that the amount of that group synergy benefit, calculated by reference to the results that the cash pool members would have obtained had they dealt solely with independent enterprises, would generally be shared by the cash pool members, provided that an appropriate reward is allocated to the cash pool leader for the functions it provides.
The OECD states that, before any attempt is made to determine the remuneration of the cash pool leader and participants, it is central to the transfer pricing analysis to identify and examine the economically significant risks associated to the cash pooling arrangement. These could include liquidity risk and credit risk. Liquidity risk in a cash pool arrangement arises from the mismatch between the maturity of the credit and debit balances of the cash pool members. Credit risk refers to the risk of loss resulting from the inability of cash pool members with debit positions to repay their cash withdrawals.
Rewarding the Cash Pool Leader Function. According to the OECD, the appropriate reward of the cash pool leader will depend on the functions performed, the assets used and the risks assumed in facilitating a cash pooling arrangement. A cash pool leader may perform no more than a coordination or agency function with the master account being a centralized point for a series of book entries to meet predetermined target balances of pool members. Under these circumstances, the cash pool leader's remuneration as a service provider will generally be limited. Where a cash pool leader is carrying on activities other than coordination or agency functions, the pricing of such transactions would be adjusted appropriately.
Rewarding the Cash Pool Members. The remuneration of the cash pool members will be calculated through the determination of the arm's length interest rates applicable to the debit and credit positions within the pool. This determination will allocate any synergy benefits arising from the cash pool arrangement amongst the pool members and it will generally be done once the remuneration of the cash pool leader has been calculated. Determining the arm's length interest rates for the cash pool intra-group transactions may be a difficult exercise due to the lack of comparable arrangements between unrelated parties. Banking arrangements involving the cash pool leader, taking into account functional differences between the bank and the cash pool leader, may inform the identification of comparable interest rates in the transfer pricing analysis. It is expected that cash pool participants will typically be at least as well off as in the absence of the cash pool arrangement. According to the OECD, cash pool participants might benefit from enhanced interest rates applicable to debit and credit positions within the cash pooling arrangement compared to the rates that they would expect to obtain from borrowing or depositing cash outside the pool.
Cash Pooling Guarantees. As part of the cash pooling arrangement, cross-guarantees and rights of set-off between participants in the cash pool may be required. This raises the question of whether guarantee fees should be payable. These cross-guarantees and set-off rights are a feature of an arrangement which would not occur between independent parties. Each guarantor is providing a guarantee for all members of the pool but will not have control over membership of the pool, has no control over the quantum of the debt which it is guaranteeing, and may not be able to access information on the parties for whom it is providing a guarantee. The practical result of the cross-guaranteeing arrangement may be such that the formal guarantee may represent nothing more than an acknowledgment that it would be detrimental to the interests of the MNE group not to support the performance of the cash pool leader and the borrower. Under such circumstances, the guaranteed borrower may not be benefitting beyond the level of credit enhancement attributable to the implicit support of other group members. If so, no guarantee fee would be due.
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