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Capital Markets / Country-Level Treasury

No Tax-Reform Impact on Notional Pooling

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January 04, 2019

Still, treasurers need to be aware of potential risks.

Accounting-MoneyUS tax reform still prompts questions about its impact on pooling and particularly operationally appealing notional pools. While regulators have stated the new law does not affect pooling, corporate treasuries should consider notional pools’ potential risks.

Several members of the Assistant Treasurers Leadership Group (ATLG) sought answers in a recent meeting to questions related to pooling, including whether the year-old Tax Cuts and Jobs Act of 2017 impacts notional pooling. The short answer is no, according to Susan Hillman, partner at Treasury Alliance Group. She noted that the US Treasury Department clearly stated that the new law would not impact short-term treasury arrangements such as physical and notional pooling.

However, tax reform did nothing to resolve notional pooling ambiguities that have existed for decades and recently came under further scrutiny with the arrival of Basel III, since banks providing the pooling services could see their liquidity ratios impacted.

Ms. Hillman said the red flags notional pooling raises typically stem from the intercompany nature of the arrangements. There is no physical movement of funds between entities, but the purpose of the service is to offset credit and deficit positions between participating entities across multiple jurisdictions and currencies. Such activity usually is not labeled specifically as a loan, or intercompany payable or receivable, with the appropriate arm’s length pricing, and that lack of clarity can raise regulatory concerns.

Physical pooling—also called zero balancing or sweeping—instead label funds movement as intercompany loans, and participating subsidiaries are charged or paid interest based on their net positions at the end of the month or quarter. Information on cash positions and interest is normally provided through the bank’s electronic banking platform and can be downloaded into a company’s treasury management system (TMS) or enterprise resource planning (ERP) system for correct interest allocation, Ms. Hillman said, thus providing the audit trail necessary for tax reporting.

“In a notional pool, the subsidiaries, which are separate legal entities, are not charged or paid interest, because the arrangement is not between the subsidiaries but between the bank and the entities,” Ms. Hillman said. However local tax authorities in a subsidiary’s country of domicile may view these changes as intercompany transactions and want to see arm’s length pricing.

Ms. Hillman added that the Netherlands is a common location for notional pool domicile because cross guarantees are not required. By contrast, London as a notional pool location does require cross guarantees. Some countries, notably the US and Germany, do not permit notional pooling.

Ms. Hillman said that notional pooling requires minimal daily input from corporate treasury, and hence its appeal. But treasury is essentially outsourcing liquidity management, one of its traditional functions. Complications arise because notional pools are much less transparent than physical pools, which may raise regulators’ concerns in any country where an operating subsidiary is domiciled. US corporate subsidiaries, for example, can participate in offshore pooling arrangements as long the subsidiary’s position is always positive. If a negative position occurs at any time, for whatever reason, the company risks an IRS fine.

Another pooling consideration: “If one of the pool participants is tagged with a tax issue, that could cascade to all of the intercompany borrowing in the pool and then interest expense may be considered non-taxable and potentially would have to be treated as a deemed dividend—or Subpart F income,” the Treasury Alliance Group wrote in a recent report titled “Treasury and US Tax Reform.”

For that reason, Ms. Hillman said, many corporate tax departments view notional pools as too opaque, and while large global banks can offer notional pooling, most companies prefer physical pooling. However, notional pool “collars” across the physical pool header [or lead] accounts are common, and there are no intercompany issues since the notionally pooled accounts are held by the same entity.

A robust TMS allows an overall view of various currency balances and can simulate notionally pooled positions, Ms. Hillman said.

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