Magazine du Trésorier, April 2014
Luxembourg an attractive location for cash-pooling
Interview with Elmar Schwickerath, Partner, Business Tax Advisory, EY Luxembourg
Why is multinational cash-pooling a key component of international treasury management?
The implementation of multinational cash pooling creates a great opportunity to facilitate the management of, and overall visibility on a group’s net cash position. Companies that have opted for a cash pooling solution benefit from reduced external debt and consequently reduced interest expenses, through a better re-allocation of available liquid resources. This may in turn lead to a better credit rating through centralized net cash positions and a better return on excess cash balances. Beyond that, the centralization of cash management, as well as the management of interest and foreign exchange risks, may result in a reduction of operational costs through the elimination of local and regional treasury functions. In brief, for many multinational companies or groups (MNCs), multinational cash-pooling has become a core component of their global cash management strategy for several reasons:
- Improved, real-time visibility on the MNC’s global cash position enabling an enhanced group wide cash forecasting
- Reduction of external debt through a more efficient (re)allocation of cash available for the MNC
- Obtain an improved credit rating through a centralized net cash position
- Get access to better placement conditions for excess cash balances.
Why does tax impact the efficiency of multinational cash-pooling?
Even if in most cases taxes are not the original driver to implement a multinational cash-pooling, they may impact considerably on its overall efficiency. Thus, the overall efficiency of multinational cash-pooling is notably impacted not only by tax draw-backs such as withholding taxes on interest payments, limited deductibility of interest expenses, transfer pricing requirements, but also anti-avoidance rules and controlled foreign company (CFC) legislation restricting tax planning opportunities, as well as stamp duties and registration taxes. The actual impact of tax draw-backs depends to a large extent on the design of the cash-pooling solution and the locations where the cash-pool leader and the cash-pool members are established.
Example of a multinational cash-pool
Could you please explain how withholding tax can affect multinational cash-pooling?
Interest expenses paid in the frame of a cash-pool may be subject to withholding tax (WHT), ranging from 5% to 35% of the interest paid depending on the country of source. If WHT is applied, this generally leads to an immediate cash outflow. If WHT is neither recoverable nor creditable, it will generate a final cost and reduce the income earned by the recipient. This would negatively impact on the overall efficiency of the cash-pool.
What are the key benefits of establishing a multinational cash-pool in Luxembourg in that context?
First of all, based on Luxembourg domestic rules, interest paid out of Luxembourg, for instance by the Luxembourg pool-leader to the pool-members, should be exempt from WHT. Additionally, interest payments made by pool-members established within the EU, paid to a Luxembourg pool leader may be exempt from WHT based on the EU interest and royalty directive. In addition, Luxembourg has an extensive double tax treaty network providing at least for a reduced WHT on interest payments to a Luxembourg company.
What is the effect of a limited deductibility of interest in multinational cash-pooling?
Within a cash-pooling, the deductibility of interest expenses paid by the pool-leader to pool-members, or vice versa, might be limited for income tax purposes, whereas the corresponding income realized by the pool-members (or the pool-leader) would be taxable for the full amount.
The limited deductibility of interest expenses may be due to various reasons such as thin capitalization rules, interest barrier rules, CFC legislation and local anti-avoidance rules, or simply very stringent transfer pricing rules.
What is the benefit of Luxembourg in that respect?
Unlike some other European States, Luxembourg has not implemented interest barrier rules, local anti-avoidance rules or CFC legislation. Interest expenses incurred by a Luxembourg pool-leader should therefore be deductible for Luxembourg income tax purposes, to the extent that the interest expenses are at arm’s length.
Moreover, Luxembourg is a member of the European Union. As a consequence, CFC legislation or anti-avoidance rules existing in certain European States should not be applicable to interest payments made by pool-members located in these countries, to the extent the Luxembourg pool-leader has sufficient substance in Luxembourg.
Are there any planning opportunities to establish a cash-pool in Luxembourg?
Indeed. Establishing a cash-pool in Luxembourg might also give access to various planning opportunities. A pool-leader established in Luxembourg may for instance be refinanced through tax efficient debt instruments.
For example: tax losses carried forward by a Luxembourg company may, in principle, be used without any restrictions, except in certain abusive cases. Tax losses may also be carried forward indefinitely. As a consequence, by lodging the pool-leader of a multinational cash-pooling in a Luxembourg company that has tax losses, profits realized by the pool-leader may be completely offset with the tax losses available.
What is the future perspective of multinational cash-pooling in Luxembourg?
Luxembourg has been an attractive location for the centralization of intra-group financing activities of multinational companies for many years and aims to continue to do so in the future:
The new Luxembourg government aims at further developing Luxembourg as prime location for headquarters, fully in line with OECD and EU principles of taxation. A first step will be the extension of existing governance and substance rules.
The new government aspires to work out a comprehensive transfer pricing legislation and intends to further expand the existing Luxembourg tax treaty network
Additionally, the government refrains from participating to the introduction, of a European Financial Transaction Tax (FTT) currently proposed, but supports a worldwide FFT which would avoid any relocation of financial activities outside of the European Union.
Luxembourg has the ambition to develop itself as a center of excellence for headquarters of multinationals. An announced action plan is the introduction of a tax and legal framework for treasury activities (such as “cash pooling”).
In summary, Luxembourg is a very attractive location to establish the pool-leader of a multinational cash-pool. The Luxembourg tax framework in combination with the possibility of obtaining binding tax clearances provides a unique opportunity to enhance the financial and operational benefits arising from a multinational cash-pool.
Additionally, if cash management is combined with corporate finance, holding and even intellectual property management activities in Luxembourg, a multinational company may get the full benefit of Luxembourg’s tax framework.
Download the article (pdf, 139kb).