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Home > Cash Flow Management Best Practice > How Taxation Impacts on Liquidity Management

Cash Flow Management Best Practice

How Taxation Impacts on Liquidity Management

by Martin O’Donovan

Withholding Taxes

WHT is a tax that is deducted at source on earnings, which include employment income, dividends, and interest payments, and can also include intangible services. It is a charge on the recipient. It is not tax that is charged on the remitter and has no effect on tax payable by the latter. This tax is withheld by the remitter and is paid over to the domestic tax authority in which the income arose. A tax treaty may lower the withholding rate between certain countries—sometimes to zero. Double tax relief may also be available to offset WHT against a domestic tax liability. It may be necessary to apply in advance in order to obtain the reduced rate. As there are considerable differences in WHT rules between countries, companies need to carry out due diligence at the country level first and then look at the tax treaties that are available in order to obtain a full appreciation of the impact of WHT on their activities.

From a liquidity perspective, the major areas where withholding taxes can be an issue are:

  • Dividends and royalties.

  • Bank interest applied at source: The company may, or may not, be able to reclaim or deduct the WHT from income when the corporate tax return is filed, but there is inevitably a cash flow delay.

  • Deemed bank interest applied by the corporate treasury, for example when reallocating interest on deemed bank interest arising from a notional pool. In some countries, such as the United Kingdom and the Netherlands, banks pay corporate interest gross, i.e. without deduction of WHT. This is one of the reasons why these countries are popular as cash pool centers.

  • Interest on intercompany loans applied by the corporate treasury or created by cash concentration sweeping.

  • Payments considered “in lieu of interest,” such as guarantee and arrangement fees. The tax is due irrespective of whether or not an actual payment was received or a charge made for the service.

The WHT tax paid may become a final tax burden for the lender if it cannot be refunded or claimed as a tax credit or deduction. In some countries the WHT can be offset against corporate taxes due.

Tax Treaties/Double Tax Relief

Tax treaties (also known as double taxation treaties) are a set of bilateral agreements between two countries that set out the taxation rights of each country in respect of tax charged in the other.

When a company receives income from overseas that has been taxed at the local level there are three options in dealing with the potential for double taxation. In order of most advantageous to the company:

  • If the tax treaty calls for participation exemption (which prevents the same income from being taxed twice), the income may not be taxed again at the shareholder level.

  • The overseas tax is used to offset and reduce any domestic tax liability, i.e. the amount of the tax already paid reduces the amount of the tax due at home by an equal amount.

  • The overseas tax may simply be allowed as a tax deduction against domestic tax liability, i.e. the tax paid overseas is used as a deduction against income, thereby reducing taxable income.

Tax Implications of Notional Pooling

Notional pooling means that credit and debit balances of various companies are notionally aggregated and netted by the group’s bank, without actual transfer of ownership of the funds taking place. The following issues are associated with notional pooling:

  • Notional pooling is usually considered to be a form of bank lending and treated as if interest is paid to the bank, although in fact the interest may actually be paid through intercompany transactions.

  • Transfer pricing regulations require that any interest paid as an intercompany transaction is reallocated to the subsidiaries on an arm’s-length basis.

  • Transfer pricing will also look into the issues of pricing for the value of cross-guarantees that would normally be paid to a third party.

  • There may be withholding tax (WHT) on the interest paid through intercompany transactions.

  • A debit balance in a notional pool may also be used to calculate thin capitalization ratios.

  • Notional pooling requires cross-guarantees and a legal right of offset to secure the position of creditors. Strictly, both these should be charged for.

  • Legal constraints, such as not allowing cross-border legal right of offset, prohibiting the co-mingling of resident and nonresident accounts or requiring central bank reporting and reserves to be maintained on a gross basis, render pooling unviable or difficult in some countries.

Tax Implications of Cash Concentration

With cash concentration, the funds move physically into the concentration account, with a resulting change of ownership. These are the major issues that arise from cash concentration:

  • It creates intercompany loans and is taxed accordingly.

  • No cross-guarantees or legal right of offset are required.

  • Transfer pricing regulations require that any interest paid as an intercompany transaction is reallocated to the subsidiaries on an arm’s-length basis.

  • There may be WHT on the interest paid through intercompany transactions.

  • Thin capitalization is likely to be an issue.

  • It may attract deemed dividends.

  • In some countries there may be additional stamp duties on cross-border intercompany loans (for example Austria, Italy, Portugal).

  • Regulations prohibiting cross-border transfers will restrict participation in an overseas concentration scheme.

  • Reference accounts are a way to pool cash without transfer of ownership.

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