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Pricing financial transaction #1: Cash pooling arrangements

In the volatile economic climate caused by successive COVID-19 pandemic waves, businesses have been scrambling for cost-efficient funding schemes. Where available, many multinational enterprises (MNEs) are opting for intra-group funding as internal liquidity pools allow group members to support each other financially before seeking (costly) external funding.

Despite the lack of precedent TP audit cases related to financial transactions in Thailand, a blueprint has already been laid out for the Revenue Department (RD), with specific guidance in the OECD TP Guidelines (2022).

PwC Thailand’s FSTP team will be exploring the key controversies surrounding financial transactions through notable court cases in OECD countries related to the pricing of interest under cash pooling arrangements, pricing of interest for intra-group term loans, as well as the pricing of guarantee fees.

Our first deep dive is exploring issues related to base rates used for cash pooling transactions.

What is cash pooling?

Cash pooling allows group companies to centralise funds at one designated entity, the ‘pool leader’, who pulls the separate balances into one ‘central account’.[1]

There are two types of cash pool:

1) Physical pools, where balances are physically swept into/out of the central account resulting in inter-company loans,[2] or

2) Notional pools, where the deficit/surplus positions of participants are recorded nominally at the central account without physical transfers of balances.[3] 

Although notional pooling is an interesting option, physical cash pooling remains the most common in Thailand.

Pricing interest on cash pooling – current practice

It has been observed that many Thai companies choose to set the interest rate for lending free cash or excess working capital to the pool by referring to commercial bank deposit rates and following tax rulings on inter-company borrowing.

Because those tax rulings were issued before the enactment of TP laws in 2019 and focus on the lender’s perspective, that the lender should earn interest not lower than the lender’s cost of fund, without considering other factors that commercially impact interest rate (e.g. credit worthiness of the borrower, lending period), this leads to a question whether such a bank deposit rate could still be acceptable under the arm’s length principle or not.

Given that Thailand’s specific transfer pricing provisions are based on the arm’s length principle and are broadly consistent with the OECD TP Guidelines, the potential issues and risks can be seen in real disputes on the arm’s length principle in OECD countries.

TP disputes on cash pooling in OECD countries

A real-world example is the case of Bombardier Group versus Danish tax authorities, where subsidiaries deposited funds into (and received funds from) an overseas pool leader’s central account. The depositor was compensated with an overnight inter-bank (risk-free) lending rate (the ‘base rate’) of -0.5%, while the borrowers pay interest at a base rate of +1.15%.

Bombardier Group viewed the arrangement as being at arm’s length as all subsidiaries benefited from favourable rates compared to the deposit or overdraft rates offered to them directly by financial institutions.

The Danish tax authorities viewed the arrangement through a different lens: deposits made to commercial entities are not comparable to bank deposits as the pool leader’s creditworthiness is weaker than that of a financial institution. Thus, the Danish company which was a lender to the pool account assumed a higher credit risk compared to having its funds securely maintained by a financial institution.

It was also viewed that the pool leader was overcompensated, as it earned a substantive spread while performing routine administrative functions. With this, the tax authorities viewed that the Danish company should be entitled to higher returns to reflect the relative contributions and risks of the pool members.

The position of the tax authorities was upheld by the Danish Administrative Court, which reaffirmed that the spread earned by the pool leader needs to be reduced to reflect the routine administrative functions performed while the interest earned by the Danish company (lender) needs to be uplifted to reflect the credit risk of the pool leader which is higher than those of commercial banks.

Another notable case where this view applied was the case of Vodafone versus Hungarian tax authorities. The tax authorities challenged that the function and credit risk of the pool leader were not comparable to those of deposit transactions conducted with commercial banks and successfully won the case as the court agreed to reclassify cash pool deposit transactions from bank deposit rates to short-term or long-term lending rate, depending on the lending period.

Managing TP risks on cash pooling

Unlike the interpretation under Thai tax rulings, foreign tax authorities have also considered factors beyond realistically available alternatives of the lender and exploring the creditworthiness, contributions, functions performed and risk assumed by the pool leader and each pool member.

These developments, amongst others, could result in increased tax risks for Thai cash pool participants. Given that Thailand’s transfer pricing rules are based on the arm’s length principle, the RD could refer to the arm’s length principle and follow the blueprint laid out by tax authorities in OECD countries when it comes to the review and assessment of financial transactions.

Companies participating in cash pooling are recommended to revisit and maybe revise their TP policy for financial transactions and support transactions with substantial documents to manage risks. For lending and borrowing from the cash pool account, the market interest rates should be considered in connection to the creditworthiness, terms and conditions of the loans, as well as activities performed and risks borne by the pool leader and pool participants.

Upcoming articles will explore interest rate setting for short-term and long-term intra-group loans, and guarantee fee pricing. Please stay tuned!

Authors:

  1. Nopajaree Wattananukit
    Associate Partner, Tax and Legal
  2. Vasoontaree Chanyatipsakul
    Senior Manager, Tax and Legal

 

[1] Paragraph 10.109-10.111, OECD Transfer Pricing Guidelines (Revised 2022)

[2] Paragraph 10.112, OECD Transfer Pricing Guidelines (Revised 2022)

[3] Paragraph 10.113-10.114, OECD Transfer Pricing Guidelines (Revised 2022)

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