What is Cash Pooling?

Cash pooling is typically used by large corporations since the technique requires a sophisticated level of structuring and many internal resources. That said, technically, any organization comprising several companies can use the technique.

Cash pooling allows the holding company (or parent company) to act as a central unit to distribute liquidity. This type of central cash management allows for the interests of each subsidiary to be served more efficiently.

What are the Types of Cash Pooling?

There are two primary types of cash pooling: notional cash pooling and physical cash pooling.

Notional Cash Pool

A notional cash pool allows a multinational group to combine the ending balances of each company’s accounts into a net balance recorded at the bank. Essentially, it centralizes all of the companies’ balances across multiple bank accounts and jurisdictions to one net balance. This does not mean the cash is transferred into one main account, but the balances are concentrated and recorded by the bank in a centralized fashion.

Physical Cash Pool

A physical cash pool is where the balance of an individual company’s bank account (a “sub-account") “sweeps” to a centralized account (the “header account”) periodically. This transfer may occur daily, weekly, or monthly, and the header account takes ownership of the cash.

Cash movement between accounts is viewed as an intercompany loan between the header entity and its subsidiaries. Since the holding entity is designated as an agent for the entire group, any interest paid and earned is viewed as bank interest and not subject to withholding tax.

Each sweeping entry is documented via the bank transactions, and “arm’s length” interest is either paid or charged on a periodic basis. The bank transaction paper trail provides sufficient documentation in case of a corporate tax audit. Many view physical cash pooling as a transparent and efficient liquidity management tool.

With both types of cash pooling, an arrangement must be set between the companies involved and a third-party bank. With physical pooling in particular, loan documentation outlining the pool structure must be prepared in advance.

While some entities may choose one type of cash pooling, combinations and variations can be used to optimize cash management for each business’s unique needs. Take, for example, multinational organizations, which may employ several physical pools – one for each currency under which the business operates. Those individual currency pools could then be combined into a notional pool.

Is Cash Pooling Allowed in the U.S.?

Different countries have different regulations and laws regarding cash pooling, including the U.S. For U.S. entities that are considering joining either a physical or notional cash pool, there are broad tax implications to consider. These tax rules differ depending on whether the U.S. entity is depositing to or drawing on a cash pool and include items like interest deductions, withholding tax issues, cross-border payment issues, potential re-characterization of debt​​, and many others.