When companies set up a Zero Balancing Cash Pools structures, tax authorities scrutinize in-house bank solutions and apply interest spreads. To support this, a number of countries are working together through the OECD organization. They aim to streamline economic market forces and have defined guidelines accordingly. This measure aims to prevent tax base erosion and profit shifting resulting from non-realistic spreads applied in in-house bank structures. The guidelines are known as OECD BEPS.
Understanding OECD BEPS Guidelines
In short, the OECD BEPS guidelines specify that in-house banks must provide solid and realistic justification for the spreads they apply. In addition, local tax authorities may interpret a solid and realistic substantiation of the applied spread differently. This interpretation suggests that spreads should differ per legal operating entity. It is akin to how external commercial banks assess terms and conditions for customers legal operating entities individually.
Challenges and Solutions
Corporate Treasury and Tax departments tend to “keep things simple.” This is because of the workload involved when differentiating interest spread per operating entity. Interest spreads on InterCompany loans are rather easy to differentiate as:
- IC loans do not occur very often (compared to daily sweeps in Zero Balancing solutions), and
- IC loans require individual documentation, which makes it easy to set different terms for different legal operating entities.
Compliance and Documentation
This may potentially be sustainable for companies with little history of cash pool structures. However, for mature companies, there is an increased tendency for local tax authorities to scrutinize in-house bank structures. They aim to understand whether interest spread settings comply with OECD BEPS Transfer Pricing guidelines. To further comply with transfer pricing principles, with an increased focus on OECD BEPS, more companies are implementing methodologies. These methodologies aim to differentiate interest spreads based on the individual balance sheets of legal entities.
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Preparedness for Tax Authority Reviews
External banks run a risk analysis for each company that wants to bank with them and is additionally looking for financing (part of the Know Your Customer requirements). Similar to external commercial banks, an in-house bank may be required to apply larger spreads for legal entities that have a financially stable balance sheet.
Assessing each individual operating unit and applying a separate risk related interest spread can be too labor intensive and counterproductive. A more practical and accepted approach to this is to introduce a limited number of “risk” classes, e.g., A-level means a healthy financial balance sheet, B-level means the balance sheet is on the watch, and C-level is technically bankrupt. In-house bank spreads will need to be differentiated according to risk classes. Periodically, e.g., once a year, legal entities are reviewed to reassess the risk class (and potentially apply a renewed interest spread).
In Conclusion…
Any risk class review and assessment will be required to be documented. The better the documentation (including the rationale behind the applied interest spread), the more likely it is that local tax authorities will be less inclined to scrutinize legal entities. Documenting the rationale behind interest spreads and the review methodology can be included in the cash management agreement. (See white paper “Legal Aspects of In-House Banking” 2024, March Maarten Steyerberg, Solutius.). Many treasury management systems will be able to support this approach.
When an operating entity or the in-house bank is under review by the local tax authorities, Treasury and Tax will need to be prepared to provide answers on why the current methodology for interest spreads has been applied and how that matches transfer pricing principles. The better the rationale behind the current methodology is explained and documented, the fewer discussions are expected with local tax authorities and, therefore, fewer tax consequences.
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