Treasury Alliance Cash Pooling White Paper

Cash PoolingImproving the Balance Sheet

www.treasuryalliance.com n [email protected] n +1 630-717-9732


Introduction | 2

IntroductionEffective balance sheet management focuses on two areas: workingcapital improvement and cash optimization. Elements of the workingcapital cycle – receivables, payables and inventory are often not underthe direct control of treasury. Also, the process improvement approachthat is key to working capital management requires acceptance and input,not only from other areas of the company, but customers and vendors aswell; a time-consuming and expensive process. But when it comes tocontrolling the overall liquidity of the organization, “treasury rules”,as the assets to be managed are already monetized, and therefore atreasury responsibility.

In order to effect change in liquidity, treasury can implement specificmanagement techniques using banking and treasury systems. The mostcommon approach is through cash pooling – offsetting cash deficits in onebusiness entity or country with surplus cash in another entity or country.The benefits of pooling come from the elimination of the bid/offer spreadon these funds, improved visibility and control of cash, and often reducedadministrative and bank service charges. There are various approachesto pooling so understanding the nuances – and tax implications – isimportant. One thing is clear, if done correctly and with support fromeffective tax counsel, implementation of a pooling system can yieldsignificant ongoing benefits for the company as a whole, and can definitelyimprove the overall balance sheet.

TABLE OF CONTENTS

Introduction............................2

Background............................3

Pooling Mechanics ................4

Notional Pooling ..............4

Set Up Considerations ....5

Physical Pooling ..............6

Choosing an Approach ..........7

Pooling Service Providers ......8

Assessing the Costs ..............9

Tax Considerations ..............11

Basic Requirements ......11

Account Structure ........12

Tax Treaties ..................12

Domestic Tax Rules ......13

Withholding Tax ............13

Summary..............................14

Background | 3

BackgroundPooling is a common treasurytechnique that can improve thebalance sheet through efficientuse of internally generated fundsin order to reduce short termborrowing costs and maximizereturns on short-term cash. Cashpooling was originally used todescribe a notional technique foroffsetting cash deficits with cashsurpluses within a corporategrouping – a banking structure thatmimicked accounting treatment,but on a day-to-day basis. It nowrefers to the offset of deficits withsurpluses however it is achieved.Pooling can be accomplishedthrough physical or notionalmeans, and is usually handledthrough a banking arrangement.Either technique requires the useof a single bank, although multiplepools can be set up throughdifferent banks. Both approachesachieve the same objective, theuse of cash surpluses to fund cashdeficits. The main differences are:

Physical pooling must be done ona currency-by-currency basis andrequires the use of intercompanyloans for transactions to and fromthe pool accounts. Physical poolingis actually a form of cash sweepingor cash concentration with theaddition of multiple divisions orsubsidiaries. The separation ofdivisional or subsidiary activity isachieved through zero balancesub-accounts.

Notional pooling can be achievedon a currency-by-currency or on amultiple currency basis. However,the simplicity of the concept andstructure mask a number of taxand regulatory issues that must beaddressed. And it is often the casethat resolving the issues negatesthe benefit of the notional poolingstructure.

It is possible to operate a globalpooling system, but practicallyspeaking, pooling is most commonas a single country or regionalarrangement. Businesses operatein different time zones, usingvarying banking platforms and

with multiple cut-off times, makingit extremely difficult for a largemultinational company to manageall of its liquidity simultaneouslyon a global basis. Most companiesestablish sub-pools in key regionallocations that take advantage ofthe intra-regional bank rules thatfrequently favor local countries.Further, the rules of somecountries effectively restrictthe ability of local affiliates toparticipate in any sort of pool.

Pooling on a regional scale is mostcommon in Europe because ofthe Euro zone's reliable financialinfrastructure and a favorable taxand regulatory climate. It is lessused in Asia/Pacific, primarily forregulatory reasons and virtuallyunknown in Latin America due toFX restrictions and the withholdingtax implications of intercompanylending. In the US, pooling isachieved exclusively throughphysical means as IRS regulationsprohibit notional pooling, and isgenerally referred to as cashconcentration or zero balancing.


Pooling Mechanics | 4

Pooling Mechanics

NOTIONAL POOLINGNotional pooling refers to the offset of consolidated cash surpluses anddeficits that result from the varying positions in separate bank accounts.In the notional pool banking arrangement, each company participating inthe pool maintains its own account or accounts in the currencies beingpooled. The bank then creates a shadow or notional position from all ofthe participant accounts reflecting the consolidated cash position. Theconsolidated position achieved through this notional arrangement is theposition on which interest is paid or charged. Because there was nomovement of funds to calculate this position, the pooling is referred to asnotional and the legal and tax separation of the pool participants – thatultimately share a common parent – is maintained.

Because of its simplicity and ease of operation, notional pooling is thetechnique of choice for single currency pools within a particular country.Notional pooling is not permitted in all countries, notably the US andGermany, where tax authorities consider it to be a co-mingling of funds.Countries where notional pooling is most common such as the UK,Netherlands and Belgium, have minimal or no withholding tax on interestearned in a pooling arrangement, but there may be country-specificinterpretations that require a holding company to function as the poolmanager; this applies in the UK, for example.

Also, there is an issue of how a bank accounts for this pooling arrange-ment on its balance sheet, an important matter for regulatory authoritiesin the country where the pool operates. This may entail documentationrequirements, such as cross guarantees, for the pool participants. The logicbehind this is that deficit balances from pooling participants appear asassets on the bank’s balance sheet. But since the bank does not earninterest on these assets because of the notional offset with participant

NOTIONAL POOLING

Consider the case of three sub-sidiaries A, B and C operating inthe UK who want to pool US dollars.The credit interest rate offered bytheir common bank is 3.0% and theoverdraft, or debit rate of interestis 6.0%.

USD InterestPosition Earned or

(Paid)A 100 USD 3 USDB 40 USD 1.2 USDC (50) USD (3) USDUn-pooled NA 1.2 USDPooled 90 2.7 USD

In a notional pooling arrangement,A, B and C would open accounts atthe London branch of their UK bankand enter into a notional poolingarrangement with the bank.A, B, and C would operate theirbusinesses – and their accounts –independently while their accountswere pooled. The benefit of notionalpooling, as this example shows isthat while the company earned 1.2USD on its position before pooling,after pooling it earned 2.7 USD, abenefit of 1.5 USD.


Pooling Mechanics | 5

surpluses, they could be considered non-performing loans unless the bankhas a clear right of offset. The guarantees enable the banks to prove theright of offset and the right to use surplus funds to cover deficit positions.The requirement for cross guarantees does not apply in the Netherlands,which serves to explain the popularity of the Netherlands as a location fornotional pooling.

Notional pooling takes on significant complexity when it expands from asingle country to multiple-country arrangement. This is due to the crossborder and potentially cross currency nature of the pool.

When dealing with more than one currency, even within the samecountry, it is necessary to bring the currencies to a common base currency,usually the Euro or US dollar, before the pooling and interest offset cantake place. One technique for doing this is through a short-dated swap.Another is through a notional conversion to a base currency with the riskcovered through the adjustment of the interest rates paid or charged ineach currency. Either approach makes the process more problematic andless cost effective as the bank’s desire to be compensated for its risk takesplace at the expense of the corporate client pooling its funds.

Even the advent of the Euro, which simplified the FX component of theprocess, did not fully mitigate the difficulties of cross-border notionalpooling. There is still the need to accommodate multiple regulatoryregimes, demand deposit accounting (DDA) platforms, dealing roomsand cut-off times. The traditional clearing systems, such as TARGET,require a physical movement of cash to concentrate the Euro positionin one location. Even when a pan European bank substitutes its networkfor the clearing systems, managing the “book” takes effort.


SET UP CONSIDERATIONS

An important consideration in settingup a pooling arrangement on across-border basis, either physical ornotional, is the degree to which thepooling structure is integrated withthe local daily transactional activity.

If collections and disbursements arehandled outside of the pool, throughdifferent bank accounts, then thepool acts merely as an overlay.Funds will need to be transferred fromthe local in-country bank account tothe overlay bank’s in-countryaccount. Obviously, this arrangementis sub-optimal, it increases the overallnumber of bank accounts and theassociated charges. Inevitably fundswill be left in the unpooled localaccount to allow for clearingpayments.

Using a single bank for both transac-tional banking and pooling in a regioncreates another set of issues, as thebanks capable of offering pooling donot necessarily having full branchingcapabilities in every market. Thus,there will be a reliance on correspon-dent banks, strategic partnerships orspecialized network arrangements.These can work very well or be asource of ongoing headaches andhidden costs, thus the design of theoverall structure must take intoconsideration not just the poolingitself, but how it integrates withthe day-to-day working capitalmanagement.

PHYSICAL POOLING

This example takes the samecorporate position as that shown insidebar 1 and illustrates the physicallocation of the cash before and afterphysical pooling. A, B, and C openaccounts with a common bank andarrange to have the accounts linkedin a sweeping/zero-balancingarrangement. A and B which are insurplus lend funds to the headeraccount of the pool which in turnlends some of these funds to Cwhich is in deficit. The benefit ofnotional pooling, as this exampleshows is that while the companyearned 1.2 USD on its position beforepooling, after pooling it earned 2.7USD, a benefit of 1.5 USD. The topdiagram in this example shows theaccounting treatment of each entryin the physical pool.

Physical Pooling | 6

PHYSICAL POOLINGPhysical pooling is often referred to as zero balancing. It can be achieved

on both a single country and cross border basis, but only currency-by-

currency. Zero balancing (ZBAs) and cash concentration have a long

history in the United States. The drivers behind efficient physical pooling

in the US were Regulation Q, which prohibited banks from paying interest

on demand deposits, and the large number of banks a company needed to

operate in the US before the repeal of restrictions on interstate banking.

As with notional pooling, each division or subsidiary maintains its

own bank accounts, which are normally sub-accounts linked to a main

or header account. These accounts can be maintained in any location

permitted by law and, more importantly, where efficient payment,

clearing and bank systems allow for rapid and inexpensive movement

of money between accounts.

Each division or subsidiary conducts its commercial operations, paying

and receiving money, ideally through the sub-accounts. At the close of

each business day, all funds in the divisional or subsidiary accounts are

physically transferred to the main account usually maintained in the

name of another legal entity, such as the parent, a regional subsidiary,

or a finance company – whatever is best from both a practical and tax

perspective. The net position in the main account is either invested or

funded through a centralized credit facility. The movements of money

to and from divisional or subsidiary accounts are generally treated asintercompany loans unless all movements take place within the samelegal entity.

A) USD 100

B) USD 40

C) USD (50)

A) USD 0

B) USD 0

C) USD 0

HeaderAccountUSD 0

HeaderAccountUSD 90

Lend to header

Lend toheader

Borrow from header


Choosing an Approach | 7


Choosingan Approach

Notional pooling, which relied onbank accounting systems was thepopular choice in the 1980’s andearly 1990’s. The advent of theEuro and systems improvements,both corporate and bank, alongwith more thorough scrutiny ofthe balance sheet implications ofnotional pooling techniques byregulators, have now shifted thispreference dramatically in favorof physical pooling. Major bankrespondents to a recent RFP admin-istered by Treasury Alliance Groupindicated that their client baseadopted physical pooling asopposed to notional pooling by amargin of more than 5 to 1.The specific factors driving thischange include:

n The Euro Zone – Countrieswithin the zone can behandled through a singlephysical pool. This dramaticallyreduces the number ofaccounts that need to bemaintained and the relatedaccounting and administrativerequirements.

n Cash Visibility – Virtually allcash is now visible throughweb-based solutions allowingnearly instant viewing andaccess to all accounts in thepooling arrangement.

n Corporate Systems – Mostcompanies now manage theiraccounting via an ERP system.This makes the booking ofintercompany loans –mandatory with a physicalpooling – a simpler task. Andwhere a corporate systemcannot, or is not used to per-form this function, third-partysystems can easily handle thebooking of loans.

n Bank Systems – The pan-European banks haveintegrated and consolidatedtheir operating platforms acrossthe region. In some cases,even if an account is nominallymaintained in France, thedemand deposit accounting(DDA) system supporting theaccount is physically located inthe bank’s European processingcenter, which could be in theUK or the Netherlands.

Notwithstanding these points,the appeal of notional pooling as asimple solution remains – it is anexcellent approach for mitigatingthe costs of periodic fluctuationsbetween positive and negativepositions in short-term cash.Notional pooling is a convenientway for companies to capture thedeposit/borrowing spread earnedby financial institutions, but isnot a substitute for strategicintercompany financing orproactive investment strategies.

From a cross-border perspective,notional pooling also workseffectively if a company has justacquired overseas operations. Or,where treasury has limited controlover local banking arrangementsbut still wants to be able tomanage global liquidity aseffectively as possible. It allows anoverlay that will not disturb theexisting banking structure.

Locally, notional pooling is an idealtool in countries such as Brazil, wherethere is a debit tax levied on cashpayments from bank accounts.Physical pooling between separatelegal entities would trigger the tax; sonotional pooling is the logical choice.

Notional pooling is less effective asa solution when:

n The company has a long-termor permanent mismatchbetween cash positions. In thiscase, formal intercompanyloans would be used as themost appropriate balancingmechanism.

n All operating companies are ina long-term surplus cash posi-tion. With this positive liquiditysituation, the company shouldplace excess cash in higheryield investment instruments,by currency. In this case, usingZBA arrangements in order tobring up all excess cash tosingle currency pools is thepreferred option.

Pooling Service Providers | 8


Pooling ServiceProvidersFor single country, stand-alonepools, an indigenous bank can bethe preferred pooling provider.Their branch network, operatingcapabilities and likely roster ofexisting pooling clients give them apricing and experience advantage.Where the pool will be integratedwith other currency pools, oroperate on a cross-border basis,pooling services are typicallyobtained from the large globalbanks. Because the global banks donot have in-country infrastructurecomparable to the indigenousbanks, it is quite possible that theglobal bank may partner with oneor more local banks to provide therequired services.

This is because the most cost-effective pooling solutions link theliquidity management benefitsoffered by pooling with thetransactional services for receiptsand disbursements required tooperate a business in each country.The simple addition of a pool bankas an overlay, without any changeto the local banking structure, addsconsiderable cost due to the extralayer of accounts required, transac-

tion costs in moving funds to andfrom the pool bank and potentiallyloss of interest on funds that are“in-transit”.

While the regulations governingpooling systems are the same foreach bank the global banks tend totake slightly different approachesfrom each other reflecting theirdifferent operating systems andtechnology infrastructure. It istherefore advisable to solicitproposals from more than onebank. Finally a word of caution,the old saying “if your only toolis a hammer, then every problemis a nail” applies to the selectionof a pooling provider. Theirproposal should represent anaccurate response to your requestfor proposal or an improvementbased on their understanding of thecircumstances.

Following are brief abstracts ofservice offerings from the globalbanks.

ABN Amro offers in-country,regional and global pools throughbranches and strategic partners inEurope, Asia/Pacific and NorthAmerica.

Bank Mendes Gans (ING Bank)offers niche cash management solu-tions including regional and globalpooling facilitated through corre-spondent banks or the company’sexisting banking network.

Bank of America offers in-country,regional and global pools throughbranches and strategic partners inEurope, Asia/Pacific and NorthAmerica.

Citibank offers in-country, regionaland global pools through branchesand strategic partners in Europe,Asia/Pacific, North America andLatin America.

Deutsche Bank offers in-country,regional and global pools throughbranches and strategic partners inEurope, Asia/Pacific and NorthAmerica.

HSBC offers in-country, regionaland global pools through branchesand strategic partners in Europe,Asia/Pacific and North America.

JP Morgan Chase offers in-country,regional and global pools throughbranches and strategic partners inEurope, Asia/Pacific and NorthAmerica.

Assessing the Costs | 9

Assessing the Costs

The cost of pooling systemsvaries widely depending on thecomplexity and scope of thestructure, the financial institutionsinvolved, and the degree to whichthe pooling structure can make useof existing arrangements such asbank accounts, information report-ing and treasury managementsystems. Broadly speaking there arefour categories of cost to evaluate:implementation, maintenance,transactional and opportunity cost.

1. Implementation costs assessedby banks include setup chargesfor the basic pooling system,out-of-pocket reimbursementfor certain types of on-sitetechnical support and licensefees for any bank systems used.Depending on the bankrelationship, these charges maybe waived. But as they are realcosts to the bank, the bank willbe careful to recoup costs inother areas to ensure thatoverall profit targets are met.

2. Maintenance costs may includeaccount maintenance, state-ment rendition and softwareservicing/upgrading.

3. Transactional costs includewire and book transfer charges.The number of possiblecharges is limited only by thecreativity of the bankers assess-ing them and the trick is toworry less about specific itemsand focus on the “run cost”of the pool. To do this, thebidding banks should be askedto prepare an estimated monthly“run cost” based on theproposed pooling structure andvolumes. This will go a longway to eliminating pricingsurprises once the pool is upand running.

4. Opportunity cost is much moredifficult to manage. Opportunitycost arises because in virtuallyany pooling arrangement thebank will have use of use ofthe company’s funds for aperiod of time. The bank mayprovide account services fora nominal fee in return forproviding pooling services. Theopportunity costs in an embed-ded compensation scheme likethis can be difficult to measure.For example:

a. The rates applied tobalances may be slightlybelow the rates a companycould achieve in themoney markets.

b. A spread may be taken inthe notional conversion ofpooling currencies to thebase currency of the pool.Where conversion isachieved through the useof interest rate differentialsthe interest rates may beless competitive than whata company could obtainotherwise.

c. The type of instrument forinvesting surplus funds andits tenor is selected by thebank, not the company.

d. If the pooling bank doesnot provide the basicoperating accounts used bythe participants, anotherlayer of bank accounts isrequired. This may necessi-tate a manual transfer tothe pool accounts or a lossof value.

e. If there is a currencymovement against thepooled currency, theparent company will haveto purchase currency inorder to bring the poolback to the “zero” level.


Assessing the Costs | 10

More significantly, if the bank performing the pooling is not a member ofthe payment and clearing systems within a given country, the cut-off timesfor investment may reflect the bank’s need for an intermediary. This canchange a late-afternoon cut-off time to the midday which, for a Europeanpool means the loss of a full day’s interest for US balances and about halfa day for European balances.

With physical pooling, pricing is typically more transparent. The bankscharge fees and do not need to take a portion of the interest spread, thusinvestment rates applied are usually higher. Also, the charges can beassessed on the sub-accounts, a monthly fee for the sweeping or acombination of both. Thus, funds can be pooled on a daily basis at a fixedcost with no idle balances remaining in the accounts. Finally, the companymay already be paying fees for web-based reporting and other ancillaryservices. As these may be used for ongoing treasury operations, theyshould not necessarily be considered incremental costs of the poolingstructure.

However, physical pooling places additional requirements on the treasurymanager. Specifically:

n Funds remain in local currency and there is no notional FX conver-sion. If there are positive/negative positions between currencies,treasury can make the decision to offset through a series of short-dated swaps.

n There can be two levels of investment. The pool header accountsshould earn a competitive rate of interest on an overnight basis, buttreasury may choose to move funds into higher yielding investmentsas required.

n All balances are by currency, allowing treasury to clearly view the FXrisk profile and make logical and cost-effective hedging decisions.


RESTRICTIONS ANDBEST PRACTICES

In-country Regional Best

Country Pooling Pooling Practice

Argentina No No NoneAustralia Yes Yes NotionalBelgium Yes Yes NotionalBrazil Yes No NotionalCanada Yes Yes PhysicalChina No No NoneFrance Yes Yes NotionalGermany Yes Yes PhysicalIndia No No NoneItaly Yes Yes PhysicalJapan Yes Yes PhysicalMexico Yes No PhysicalNether- Yes Yes Notionallands

Singapore Yes Yes NotionalTaiwan No No NoneUnited Yes Yes NotionalKingdom

United Yes Yes PhysicalStates

Tax Considerations | 11

Tax Considerations

Regardless of the pooling approachselected, tax considerations are ofcritical importance. For example,there can be deemed dividendissues in any pooling arrangement– notional or physical. Deemeddividends arise when the allocationof the interest benefits, or cost, ofthe pool to each participant takesplace at arbitrary rates with theeffect of avoiding taxation. Becauseintercompany loans are in placewith a physical pooling arrange-ment and arm's-length interestis charged, paid and documented,there is a high degree of trans-parency in the pool. With anotional pool, the situation froma tax perspective is more ambigu-ous and therefore is a source ofconcern to many company taxdirectors and their advisors.

Favorable tax treatment is anotherimportant factor in deciding whetherto use notional or physical pooling.In this case, it is not the merits of aparticular pooling technique thatare at issue – assuming they areboth permitted. Instead, it is thecontent of the underlying agencyagreement in place between theowner of the main pooling accounte.g. a corporate treasury, a BV, aBCC or an IFSC, and the poolparticipants that will determine the

tax treatment. This explains whytwo companies with outwardsimilarities may take differentapproaches to pooling.

Of course the presence or absenceof withholding taxes in the countryor countries where pooling iscontemplated is influential on thechoice of pooling method. Thevery nature of pooling with itsimplicit or explicit charging andpaying of interest makes withhold-ing tax treatment one of the mostimportant considerations in estab-lishing a pooling arrangement.

BASIC REQUIREMENTSVirtually all liquidity managementstructures, whether physical ornotional must comply with threebasic requirements from a taxperspective.

1. Arm’s-Length InterestAllocation – All financialarrangements betweenparticipants, such as creditlines, cross-guarantees andinterest rates should reflect anarm’s-length, or “market”price. While the pool managermay have discretion in allocat-ing the interest income andexpense among participants,this interest allocation cannotbe arbitrary. The concern isthat the pool may be used to

shift income from one jurisdic-tion – or entity – to another inorder to reduce the tax burden.

2. Business Purpose – The entirestructure must have a validbusiness purpose other thantax avoidance or the circum-vention of non-tax regulatoryrestrictions. Pooling structurestypically meet this requirementas the net lending and netborrowing positions of theparticipants are of a short-termnature and comparatively smallamounts, and the primarypurpose of the structure isthe efficient management ofliquidity.

3. Economic Substance – Theparticipants must have formal,legal responsibilities surround-ing their participation in thepool including the need to payinterest, suffer interest rate riskand the risk of default by acounterparty. Cross-guarantees,cross-indemnities and otherrights of offset – protectivemeasures used by banks – alsoserve to establish economicsubstance and need not be aconcern as long as all partici-pants are legitimate and solvent.Intercompany compensation atarm’s-length rates with respectto guarantees providesadditional support.



ACCOUNT STRUCTUREA key consideration with accountstructure is whether or not theowner of the main pooling accountis acting as the principal for thegroup or as an agent on behalf ofthe participants. When the owneracts as a principal then interestearned or charged will be consid-ered to be intercompany interest.If the main account owner is actingas an agent for the participantsthen similar interest will beconsidered to be bank interest –and taxed accordingly. Thereforethe definition of interest is a keydeterminant of tax treatment andthe type of interest will affect theallocation back to the participantsand how they are taxed in theirrespective tax jurisdictions.

Two other issues to be aware of are:

n Many companies set up afinance vehicle in theNetherlands or elsewhere withminimal capital, and this maydictate that they cannot chargemanagement fees. However,when they act as an agent ina pooling arrangement thisgives the finance vehicletreasury functionality. And,this may raise concerns aboutthin capitalization and itsconsequences.

n If the main account owner isthe treasury of a US parent,then subpart F restrictions willlikely trigger treatment of poolearnings as deemed dividends.This effectively precludesdirect participation by the UStreasury in any non-US poolingarrangement.

In selecting the best location forthe treasury center – from a taxperspective – there are four areasthat require careful considerationby companies and their tax advi-sors. They are: account structure,tax treaties, domestic tax rules andwithholding tax.

TAX TREATIESEvery country has a network oftreaties with its trading partners,providing different levels of taxconcessions for international trans-actions. The level of concessiondepends on the treaty partner.Certain countries have a highlydeveloped treaty network thatfacilitates operation of a treasurycenter. Their treaty networkprovides benefits such as low orno withholding tax on cross-borderinterest, dividends and capitalgain payments.

The simple existence of a treatynetwork does not automatically

guarantee treaty benefits to allparticipants. For the treasury centerof a multinational to qualify forthe treaty benefits, it must be aresident company in each of thetreaty countries. That is, it musthave a substantial business pres-ence in the treaty country. Taxtreaties contain rules to protectagainst sham operations, nominallyresident in the country, but actuallyset up to take advantage of afavorable treaty benefit. Forexample, some rules attemptto determine the true identity ofthe true party-in-interest, orultimate beneficiary, from a seriesof intercompany loans or othertransactions. Advance planning isimportant in getting the most outof tax treaties.

This would include the use of“capital blockers” in which fundsare contributed as equity and with-drawn as loans. These rules mustbe reviewed in detail and appliedto a company’s particular situation.

When evaluating a number ofattractive locations for the treasurycenter, factors extending beyondtax may ultimately tip the balance.Human resources must be consid-ered; does one location have moreactivity or more financially skilledpersonnel? Would the treasuryoperation require relocation of



qualified employees or the hiringof experienced local staff? And,particularly for US multinationals,does the specific location requirethat financial management anddecision making be made by localnationals, such as is the case forthe UK.

It is important to recognize thatthe domicile of the bank accountssupporting the treasury center doesnot need to be in the same locationas the entity that is controlling theaccounts. Simply put, it is notnecessary to physically locate thebank accounts supporting a Swisscompany in Switzerland when thebanking infrastructure in the UK ismore suitable. The Swiss companywill hold a non-resident accountin the UK. Tax and other logisticaldrivers determine the location ofthe pooling entity.

DOMESTIC TAX RULESIn addition to their network of taxtreaties, countries have taxationrules applicable to the treasurycenter and other business activitiesof the company within the country.For example, some countries offerreduced local income tax rates toattract foreign investment. Equally,

others impose “thin capitalization”rules that deny interest expensedeductions if local operations arehighly leveraged – generatingsubstantial interest deductions andminimizing the capital “at risk” inthe country. These rules can applyeven if the intent of the localborrowing is to be part of aconduit, pass-through treasuryoperation. Also, if the company isconsidered non-resident, somecountries will limit or forbid its par-ticipation in a local pool.

WITHHOLDING TAXCross-border treasury managementinvolves the payment or receiptof fees for services and interestpayment or receipt on lending orinvestment activities. Theserevenue and expense streams areoften subject to withholding taxeswhen the recipient of the servicepays money to a treasury serviceprovider located in anotherjurisdiction.

The withholding tax “leakage”will depend on the income taxtreaty network between these twojurisdictions. If there is a tax treaty,the withholding tax on the interest

payment can be reduced oreliminated. For example where aUS Company pays interest expenseto a European treasury center,the withholding tax can bereduced from 30% to zero in manyinstances – because there is a taxtreaty in place between the US andthe European country in which thetreasury center is located.Conversely, similar payments toan Asian or Latin American treas-ury center will result in highertaxes, in many instances at the full30% rate.

Treasury service fees can also besubject to a withholding taxdepending upon the location of theservice recipient and whether ornot a treaty exists with the treasurycenter’s jurisdiction. Any profitrepatriations from the treasurycenter to its shareholder in theform of a dividend will be subjectto withholding tax considerations.For dividends, the withholdingtaxes could be reduced eitherunder the domestic tax legislationof the treasury center’s jurisdiction,or under the tax treaty betweenthe treasury center’s jurisdictionand the jurisdiction of theshareholder.


Summary | 14


Summary

The management of a poolingarrangement is relativelystraightforward once the analysisof pooling benefit, technicalapproach to pooling and locationof the pool has been determined.Implementation is the biggestchallenge. A notional pool/overlayusing existing banking arrangementsis easier and less disruptive toimplement than a physical pool;all that is required is the opening ofa few accounts and execution of therequired banking documentation.

Physical pools require a morecomplex implementation. This isbecause the most cost-effectivepools combine the operatingaccounts used by the businesses

with the accounts required forphysical pooling. The result is thatthe existing in-country accountstructure may need to be modifiedand accounts shifted from existingbanks or branches to new banksor branches.

Ongoing operation requires theadministration of intercompanyloans from an accounting perspec-tive and active involvement on thepart of treasury to insure active,effective oversight of investment,debt and related risk management.

In the case of both physical andnotional pooling, implementationcan take between six monthsand one year depending on thecomplexity and the dedicatedresources supplied by the company

and the bank performing thepooling. A mutually agreed projectplan with an experienced projectmanager is essential.

Pooling is a smart way for treasuryto improve the balance sheetwhere there is the need to manageliquidity across multiple legalentities. Such an arrangementrequires an initial assessmentand cost benefit analysis, closecollaboration with tax, an evalua-tion of overall banking requirementsand a focused project approach toselecting the correct structure andbanking services. It’s not easy, butthe benefits are clearly worth thetrouble as more and more compa-nies review and implement cashpooling arrangements.

TERM DEFINITIONCurrency Swap An agreement to swap a series of specified payment obligations denominated in one currency

for a series of specified payment obligations denominated in another. Used to convert positionsin different currencies into a common currency for pooling purposes.

Header Account The main, or top-level account in a pooling arrangement. The net balance in the header accountis used to determine the interest paid to, or due from the pool.

Mirror Account An accounting/banking arrangement where the entries made into one account are actuallybooked in an offsetting account leaving the original account remains in a zero balance position.

Multilateral Netting A treasury management technique in which the payments and receipts among a group ofparticipants, typically within the same company, are consolidated on a periodic basis, usuallymonthly, and participants then settle the net balance of their obligations to the otherparticipants with a single payment, or receipt in their local currency.

Notional Pooling The offset of interest income and expense that results from the varying cash positions in bankaccounts maintained by different divisions or business entities of the same company. In anotional pool banking arrangement, each company participating in the pool maintains its ownaccount or accounts in the currencies being pooled. The bank then creates a shadow ornotional position from all of the participant accounts reflecting the consolidated cash position.

Overlay A banking arrangement set up for liquidity management purposes that holds the net cashpositions for all participants. The bank accounts in the overlay may or may not be the sameaccounts that participants use for their principal collection and disbursement activity.

Physical Pooling The offset of interest income and expense that results from the varying cash positions in bankaccounts maintained by different divisions or business entities of the same company. Thisoffset of positions is achieved through the physical movement of money from one account toanother. Physical pooling is often referred to as zero balancing.

Sub-Account A bank account that is subordinate and linked to a principal account. Typically held by partici-pants in a pooling or zero balancing arrangement, they are automatically linked to the headeraccount.

Sweeping The physical and automatic transfer of funds from one account to another. Typically used tomove money from sub-accounts to header accounts.

Zero Balance Account ZBAs are sub-accounts in a physical pooling arrangement linked to a header account. Balances(ZBA) are never maintained in the accounts, having been swept to the header account.

Glossary | 15


GLOSSARY

ABOUT THIS WHITE PAPER

This White Paper was written by Treasury Alliance Group and is for the use of our clients and friends.We gratefully acknowledge the expert tax advice provided by William Zink of Grant Thornton International.Your use of the White Paper is subject to the following terms and conditions: You may display this documenton a computer or other electronic display, print it on paper, email it to others and store it in electronic form.You may not modify this document in any way. The document is for your general information and doesnot constitute any form of advice, recommendation or arrangement by Treasury Alliance Group LLC.The information in this document is provided “as is” and there is no guarantee as to accuracy, completenessor fitness for a particular purpose.

ABOUT TREASURY ALLIANCE GROUP LLC

Since 1981, Treasury Alliance Group and its predecessor firms have provided treasury consulting servicesto more than 400 clients in 42 countries. Our experience delivers practical, realistic solutions that meet eachclient's unique requirements. We welcome the opportunity to discuss how our consulting can help meet yourtreasury challenges. Contact us by email at [email protected] or call +1 630-717-9732 forfurther information.

Documents

Treasury Alliance Cash Pooling White Paper