Are you capturing the cash pool dynamics in an arm’s length context?

Explore how Multinational enterprises (‘MNEs’) can navigate the essential transfer pricing considerations when determining arm’s length pricing of cash pool arrangements.

Amidst a volatile economic climate over the last years, businesses have actively been seeking cost-efficient funding solutions. MNEs explore funding opportunities, namely by leveraging internal liquidity pools to facilitate support among group members before resorting to (more costly) external financing.

This trend has, amongst others, led to the implementation of cash pools, where cash flows from multiple affiliates are consolidated to efficiently manage short-term working capital needs for the groups, and reduce financing costs accordingly.

Following the release of the Transfer Pricing Guidance on Financial Transactions (FT TPG) on February 11, 2020, which resulted in Chapter X of the OECD Transfer Pricing Guidelines 2022 (OECD TPG), the Belgian Tax Authorities (‘BTA’) have intensified their scrutiny of cash pool arrangements within MNE groups. Below, we delve into the essential transfer pricing considerations when operating cash pools, with a particular emphasis on proactive measures to anticipate potential scrutiny.
 

Key considerations when determining arm’s length pricing of the cash pool arrangements

From a transfer pricing perspective, a critical question arises: how should the cash pool reflect arm’s length conditions, considering, in essence, its sole intragroup nature? This type of transaction typically does not exist in the market, but is rather specific to MNEs, which makes the cash pool a type of transaction that is more technical to benchmark. Despite the arrangement involving a third-party bank, ensuring the application of arm's length intercompany interest rates between the cash pool leader (CPL) and the participants (CPP) is paramount, given that interest rates offered by external banks do not ensure a proper allocation of the synergetic impacts of the cash pool. To ensure compliance with arm's length principles, the following steps are essential to consider:

• Accurately delineate the transaction
  
  Evaluate whether the cash pool is effectively functioning as a short-term financial instrument as it is supposed to, or whether a potential requalification of short-term vs. structural positions is applicable. In Belgium, cash pool balances held longer than 12 months may be subject to requalification and this may directly impact the applied interest rates. Beyond this aspect, consider the overall arm's length framework of the cash pool setup, including assessing realistic options available to CPP, applicable terms and conditions, and debt capacity.

• Determine the functional profile of the CPL
  
  OECD TPG identifies two predominant types of CPLs based on functions, assets, and risk assessment: a service provider role (involving limited functions and risk – by default position of OECD and most tax authorities, except if it can be supported that the entity experiences more full fledge characterization) where the CPL receives a routine remuneration (typically a cost plus); or an in-house bank role (involving significant functions and risk) where the CPL retains part or all of the spread between borrowing and lending positions.

• Determine and allocate cash pool synergies
  
  Allocate synergy effects derived from cash pooling equitably among CPPs and CPL. Typically, an arm's length return based on the CPL's functional profile is deducted, in case of CPL routine qualification. In this context it is of particular interest to note that residual benefits / synergies derived from the cash pooling arrangement are expected by the BTA to be properly allocated to CPPs. The cash pool should offer better conditions to the participants than the ones the affiliates would have obtained on a standalone basis, which would typically come from volume and netting synergies created via the cash pool.

• Determine the arm’s length pricing of the transaction (i.e., deposit and credit rates)
  
  Ensure that interest rates applied to cash pool transactions accurately reflect inherent risks and facts. This involves considering and reconciling various factors, including the terms and conditions of the external cash pool agreement, the credit risks associated with both the CPL and CPPs, CPL functional profile, currency, etc.

• Develop a consistent transfer pricing financing policy and secure a proper documentation
  
  We observe that the BTA and other tax authorities expect MNEs to maintain detailed documentation supporting financing policies, including cash pool transactions. It is crucial that the financing policy accurately reflects the implemented cash pooling arrangements. Robust documentation of the TP financing policy should encompass providing sufficient support of the parameters, processes and approaches relevant to the applicable cash pooling arrangements. Additionally, keeping track of and monitoring daily / monthly cash pool balances per CPP is key.

The above outlined considerations can mitigate transfer pricing compliance risks and enhance transparency in cash pool management, supporting MNEs in effectively addressing potential scrutiny from tax authorities.