Cash Pooling

What is a cash pooling arrangement?

Cash pooling is a financial management technique used by multinational companies to optimize their liquidity and reduce the cost of borrowing. It involves the consolidation of cash balances of various subsidiaries or business units into a single account or in a few accounts, typically held by a parent company or a designated treasury entity.

Such centralization of cash enables companies to gain a comprehensive overview of their cash position and make better use of surplus funds. When managed efficiently, it can reduce reliance on external borrowings and the associated costs.

Broadly, there are two basic types of cash pooling arrangements:

• Physical pooling: Actual cash from multiple subsidiary accounts is transferred into a single central account. This central account aggregates the funds, allowing for better liquidity management and interest optimization.
• Notional pooling: Cash balances in various subsidiary accounts are combined virtually for the purpose of calculating interest and managing liquidity. No physical movement of funds occurs; instead, the aggregation is done on paper to optimize cash flow and interest calculations.

Applying the Arm’s Length Principle to Cash Pooling arrangements

Cash pooling arrangements involve transactions between related parties, making it crucial to align these arrangements with the Arm’s Length Principle. The compensation for a cash pool leader should reflect the specific facts and circumstances, including the functions performed, the assets used, and the risks assumed in managing the cash pooling arrangement.

Typically, a cash pool leader handles routine tasks such as coordination, forecasting, reporting, and basic analysis, and should be remunerated accordingly as a routine service provider.

In more complex cash pools, where responsibilities may include risk management, interest optimization, and external banking relationships, the leader’s compensation may be higher to reflect these additional duties. The level of remuneration should be directly related to the activities and services, assets, and risks involved. The appropriate transfer pricing method should be selected based on a thorough analysis of these factors.

For cash pool members, remuneration is determined by applying the arm’s length interest rates to the debit and credit positions within the pool. This process allocates the benefits of the cash pooling arrangement among the members and is typically carried out after calculating the compensation of the cash pool leader.

Key takeaways

Cash pooling is unique to multinational enterprises (MNEs). Further, even though a third-party bank may be involved, it is essential to apply the arm’s length intercompany interest rates between the cash pool leader and the participating entities. External bank rates alone do not fully capture the synergistic benefits of the cash pooling arrangement. The key aspects to ensure compliance with the arm’s length principles include:

• Defining the transaction accurately.
• Assessing the functional profile of the cash pool leader.
• Identifying and allocating the synergies generated by the cash pool.
• Determining of the arm’s length pricing.
• Implementing the applicable transfer pricing policy and documentation.