Cash Pooling and Intercompany Transactions

A company with multiple entities might have one subsidiary cash-rich while another is borrowing from the bank. That's inefficient—you're paying interest while excess cash sits idle elsewhere in your own organization.

Cash pooling and intercompany financing solve this by treating the enterprise as one cash pool, moving money where it's needed. Done right, it reduces external borrowing, improves visibility, and optimizes liquidity. Done wrong, it creates tax problems, documentation gaps, and audit issues.

When You Need Cash Pooling

Cash pooling becomes relevant when you have:

• Multiple legal entities: Parent company with subsidiaries, holding structures, or acquisitions
• Uneven cash distribution: Some entities cash-rich, others cash-poor
• External borrowing while holding cash: Paying interest while cash sits in another entity
• Cross-border operations: Cash trapped in different countries

If you operate a single legal entity, cash pooling isn't relevant—your cash is already consolidated.

Types of Cash Pooling

Physical Cash Pooling (Zero-Balance Accounts)

Cash physically moves between accounts daily to concentrate in a master account.

• How it works: Subsidiary accounts sweep to zero each day, with all cash moving to a master account
• Benefits: Maximum liquidity concentration, simplified external borrowing, clear cash visibility
• Considerations: Creates intercompany transactions that must be documented, may have tax implications

Notional Cash Pooling

Balances remain in separate accounts but are "notionally" combined for interest calculation.

• How it works: Bank calculates interest on the net combined balance across all accounts
• Benefits: No actual cash movement, no intercompany transactions to document, maintains entity separation
• Considerations: Not all banks offer it, may not satisfy all liquidity needs, complex accounting

Which to Choose

• Physical pooling: Better for domestic operations, when you need actual liquidity concentration
• Notional pooling: Better for cross-border operations, when you want to avoid intercompany complications
• Hybrid: Physical pooling domestically, notional across borders

Intercompany Loans

When cash moves between entities (physically or through pooling), it creates intercompany balances. These must be properly documented as loans.

Why Documentation Matters

• Tax compliance: IRS requires arm's-length terms on intercompany transactions
• Transfer pricing: Interest rates must be justifiable to tax authorities
• Legal liability: Undocumented loans could be recharacterized as equity contributions
• Audit requirements: Auditors will test intercompany balances and documentation

Required Documentation

• Loan agreement: Written agreement specifying principal, interest rate, term, repayment schedule
• Board resolutions: Both lender and borrower entity boards should approve
• Interest rate support: Documentation showing rate is arm's length (comparable loans, plus reasonable spread)
• Cash flow tracking: Record of actual cash movements

Setting Intercompany Interest Rates

Intercompany loans must charge arm's-length interest rates—what unrelated parties would charge for a similar loan.

Methods for Setting Rates

• Comparable transactions: What rate would a bank charge this subsidiary?
• Reference rate plus spread: SOFR + spread based on credit quality
• Cost of funds: Parent's borrowing cost + margin

Practical Approach

Recording Interest

• Interest should be calculated and recorded monthly
• May be paid in cash or added to principal (if agreement allows)
• Creates intercompany income/expense that must be eliminated in consolidation

Tax Implications

Cash pooling and intercompany financing have significant tax implications. Get tax advice before implementing.

Key Tax Issues

• Interest deductibility: Borrower may deduct interest paid (subject to limitations)
• Interest income: Lender must recognize interest income
• Transfer pricing: Rates must be arm's length or adjustments may apply
• Thin capitalization: Some jurisdictions limit deductions if debt-to-equity is too high
• Withholding tax: Cross-border interest payments may be subject to withholding

US-Specific Considerations

• Section 163(j): Limits business interest deductions to 30% of adjusted taxable income
• Section 385: Recharacterization of debt as equity for related party loans
• Transfer pricing documentation: Support for arm's-length pricing required

Multi-Entity Cash Management

Beyond pooling, managing cash across multiple entities requires visibility, forecasting, and coordination.

Visibility

• Consolidated daily position: Single view of cash across all entities
• Entity-level detail: Ability to drill down to individual entity positions
• Intercompany balances: Track what entities owe each other

Forecasting

• Entity-level forecasts: Each entity projects its cash flows
• Consolidated forecast: Roll-up showing enterprise-wide position
• Intercompany flows: Planned transfers between entities

Cash Coordination

• Funding decisions: Which entity needs funding? From where?
• Investment decisions: Where should excess cash be held?
• External borrowing: Which entity borrows externally?

Common Structures

Centralized Treasury

Parent company or designated treasury entity manages cash for all entities.

• All external borrowing at parent level
• Parent on-lends to subsidiaries as needed
• Subsidiaries sweep excess cash to parent
• Maximum control and efficiency

Decentralized with Coordination

Entities manage their own cash with central oversight.

• Each entity maintains its own bank relationships
• Central treasury monitors positions and coordinates
• Intercompany funding on request
• More autonomy, less optimization

Hybrid

Centralized for domestic operations, decentralized for international.

• Domestic subsidiaries participate in pooling
• International entities manage locally with central oversight
• Periodic repatriation of excess foreign cash