Daily Tax Report: International

INSIGHT: Impact of Negative Interest Rates on Intra-Group Treasury Structures

Dec. 13, 2019, 8:01 AM

As of June 2014, the European Central Bank (ECB) applies a negative interest rate in connection with euro deposits that banks hold with the ECB. Consequently, as of this date banks must pay to deposit their money with the ECB. Likewise, banks in the eurozone apply negative interest rates in connection with financing transactions on the interbank market.

The three-month Euribor—an important benchmark rate consisting of average interest rates at which eurozone banks offer unsecured three-month lending on the interbank market—turned negative for the first time on April 21, 2015. As of 2017, the three-month Euribor curve has been fluctuating between -0.25% and -0.5%. In addition to the ECB, central banks in other jurisdictions (including Switzerland, Denmark, Sweden and Japan) allowed interest rates in connection with their respective domestic currencies to drop below zero.

Considering the above, it is fair to say that over the last few years negative interest has become a common market phenomenon. The substantial period during which interest rates have been negative, and the lack of specific signals that this phenomenon will disappear in the short run, will increasingly require multinationals to take appropriate action.

In this article, we will discuss how negative interest rates may affect multinationals’ treasury structures from a tax and transfer pricing perspective. Furthermore, we discuss what actions multinationals may take to avoid or mitigate adverse tax and transfer pricing consequences caused by negative interest. We will illustrate this by using the example of a physical cash pool, which is an arrangement that many multinationals apply to manage liquidity within their group.

Mechanism of a Physical Cash Pool

Under a typical physical cash pooling arrangement, group companies with excess cash “sweep” their surplus cash to a single bank account (the “master account”) of another group company. Conversely, group companies with a cash deficit may draw on the funds in that account to satisfy their own cash need. A company facilitating this process, called the cash pool “header” or “leader,” typically holds the master account.

Depending on the type of cash pooling arrangement, the participating companies may transfer either their entire cash surplus (“zero balancing”), or cash exceeding a certain surplus level (“target balancing”) into the master account. Cash sweeps to and from the master account create intra-group receivables that the cash pool header owns and intra-group payables that the cash pool header owes to the participants.

Key Transfer Pricing Implications

Arm’s Length Interest Rates

Under Organization for Economic Co-operation and Development (OECD) guidance and transfer pricing rules in most jurisdictions throughout Europe, transactions between the cash pool leader and the cash pool participants should in general be governed by arm’s length terms and conditions, including arm’s length interest rates.

Typically, multinational groups use pricing policies by applying an interest margin plus or minus the applicable short-term interbank offered rate (IBOR) (e.g. three-month Euribor rate) for lending and deposit transactions. The individual interest margins applicable to cash pool loans and deposits are usually bench marked based on short-term market interest rates, and include comparability adjustments where required.

With negative interest rates on the market, the question arises how arm’s length interest rates should be determined and appropriately applied in intra-group cash pool pricing policies. First, depending on the specific transfer pricing policy in place, the deposit interest rates used in the cash pool structure can be negative. This may result in the cash pool leader charging interest on cash deposits to cash pool participants. Furthermore, with market interest rates declining further, even cash pool lending transactions may be priced at negative interest rates.

Theoretically, this may result in a situation in which a cash pool leader owes interest to cash pool participants in connection with a loan granted by a cash pool leader. In practice, the latter is a particular issue for multinational groups with a strong creditworthiness (e.g. investment grade credit rating) and low interest credit margins applicable for euro-denominated transactions.

It is important to actively monitor market developments and assess applicable transfer pricing policies on a timely basis to avoid undesirable interest developments in cash pool structures. From an operational and administrative as well as a transfer pricing perspective (e.g. options realistically available—as emphasized by the OECD in its discussion draft on financial transactions; see section B.1.19) the use of negative interest rates may not be preferable.

In this respect, it is essential to review existing pricing policies and interest benchmarks applied, considering current market developments. This further entails assessing the comparability of interest credit margins, taken into account for purposes of the benchmark analyses as well as the comparability adjustments performed (e.g. on creditworthiness and maturity). Furthermore, it can be justified from a treasury perspective to avoid using negative interest rates on an intra-group level, for instance by applying “floored” (e.g. at least 0%) interest rates in the pricing policy. Whether such measure is appropriate should be assessed on a case-by-case basis.

Remuneration of the Cash Pool Leader

The remuneration of the cash pool leader should be at arm’s length taking into account functions performed and risks assumed with respect to the cash pool. In general, the remuneration of a cash pool leader follows from the transfer pricing policy as applied by the group with respect to the transactions entered into. This further depends on the risk profile of the cash pool leader, which may—depending on the specific cash pool arrangement—range between (i) a full risk financing entity earning the effective interest spread between lending and deposit interest, to (ii) a limited-risk service provider earning a fixed remuneration.

Due to the existence of negative interest rates on the market, transfer pricing policies in cash pools may be under pressure with respect to the remuneration of the cash pool leader. The interest spread as earned by the cash pool leader may be limited or negative following the evolvement of market interest rates (e.g. Euribor) impacting the pricing policy.

Furthermore, in favorable business conditions, the cash pool leader may be managing a significant amount of cash deposited by the cash pool participants on which it is currently unable to earn a positive spread on the market (e.g. on third party bank deposits). At the same time the need for additional cash in the group through lending transactions may be limited (on which the cash pool leader may earn a positive interest spread). As a result of this, the effective margin booked by a cash pool leader can be negatively impacted and result in a too low (even negative) arm’s length remuneration.

Following current market developments, the remuneration of the cash pool leader should be reviewed on a timely basis. In general, current transfer pricing policies, not taking into account the negative interest rate environment (sufficiently) may result in a non-arm’s length remuneration at the level of the cash pool leader. In this respect it is recommended that appropriate measures are taken, which may for instance consist of including a year-end pricing adjustment mechanism in the corporate legal documentation to adjust the income booked to an arm’s length measure. This includes reviewing whether, from the perspective of the cash pool leader, charging other fees—such as commitment fees or line of credit fees—may be warranted.

Other potential measures may be reviewed from a treasury perspective, for instance by converting cash pool funds to positive interest rate currencies (e.g. U.S. dollars).

Furthermore, the functional profile of the cash pool leader should be reviewed to ensure that it is aligned with the transfer pricing policy as applied. In cases where the cash pool leader may in fact not be able to manage the market (interest rate) risk, the entity could be more appropriately characterized as a financial service provider to the cash pool arrangement, earning a fixed remuneration. This is further emphasized by current market developments in the financial services industry where third party banks in the eurozone are facing difficulty in earning a positive spread on lending activities.

Key Tax Implications

Deductibility for Corporation Tax Purposes

In most jurisdictions, arm’s length interest costs are regarded as a deductible business expense. Conversely, arm’s length interest income is regarded as a taxable source of income.

If the arm’s length interest in connection with an intra-group loan is negative, the arm’s length interest that the creditor owes to the debtor will in most jurisdictions likely also constitute a deductible business expense for the creditor, and taxable income for the debtor.

The question arises whether the deductibility of arm’s length interest due by the creditor participating in the cash pool may be limited under an interest deduction limitation. In many jurisdictions, interest deduction limitations will not provide for specific rules dealing with negative interest.

(Denmark is one of the exceptions. On February 27, 2015, the Danish tax authorities issued guidelines concerning the Danish tax treatment of negative interest rates. In the guidelines, the Danish tax authorities state: “Under section 6e of the Danish State Taxation Act, interest expenses on debt are deductible from the taxable income. Based on its wording, the provision is not limited to the debtor’s interest expenses on debt. The right of deduction is also considered to be available where the interest expense is incurred by the creditor.” According to the Danish tax authorities, negative interest paid by a creditor to a debtor is deductible by the creditor as interest expenses and is taxable for the debtor as interest income.)

Thus, it is important to analyze this matter on a case-by-case basis. In this respect, it is also worthwhile to note that in some instances interest deductibility limitations provide for an algebraic mechanism. In other words, the rule may limit the deductibility of interest and other costs (e.g., foreign exchange losses) in connection with a loan, but potentially also exempt income in connection with this same loan (e.g., Article 10a of the Corporation Tax Act 1969 in the Netherlands).

Hence, in certain instances an interest deductibility limitation may possibly exempt arm’s length interest income in the hands of the debtor, resulting in a tax benefit. Needless to say, this outcome becomes even more beneficial to the group as a whole if the creditor may claim a deduction for the corresponding arm’s length interest due.

Withholding Tax

If a country levies withholding tax on interest under its domestic laws, the question arises whether negative interest due by the creditor qualifies as interest for withholding tax purposes. Other options would be to view negative interest as a commission or a service fee for acting as the custodian of the funds or as a penalty. If one were to compare an intra-group loan with government bonds bearing a negative coupon, negative interest may also in a way resemble a bond premium, or—since upon repayment of the position the creditor receives less than deposited initially—as a capital loss.

Since the applicability of withholding tax heavily depends on this qualification, it can be quite fundamental to analyze how negative interest must be viewed under domestic tax rules. Yet only a few countries provide for guidance in this respect. An example of such a country is Switzerland, where negative interest rates have occurred before. In the 1970s, the Swiss National Bank imposed negative rates on foreign depositors, as a measure to temper the appreciation of the Swiss franc. In those years, the Swiss Supreme Court decided that negative interests were commissions. It is unclear if this view would be upheld today.

If the conclusion is that negative interest also qualifies as interest for withholding tax purposes under domestic laws, the counter-intuitive situation may occur that under the given country’s domestic laws, withholding tax may be due by the creditor participating in the cash pool. The question that then arises is whether the EU Interest & Royalties Directive as transposed into domestic legislation, or an applicable tax treaty, provide for a withholding tax exemption or reduction. Determining this will generally require an analysis on matters like beneficial ownership and—if the taxpayer will invoke a tax treaty—possibly the principal purpose test.

A creditor owing interest and failing to withhold and remit any withholding tax due within the required time limits may face various sanctions, such as missed interest charges (computed on a compounded basis), penalties and director’s liability. Therefore, where negative interest occurs, multinationals should carefully review their cash pool and/or other treasury arrangement from a withholding tax perspective on a case-by-case basis.


The above-mentioned qualification may also be relevant from a value-added tax (VAT) perspective. Interest payments are generally not subject to VAT. Depending on the countries involved and the direction of the fund flows, contrary to an interest payment a service fee payment may very well be subject to VAT. If the service fee is subject to VAT, the question arises if and to what extent the VAT is recoverable. A failure to comply with VAT obligations may similarly give rise to the above-mentioned sanctions, meaning that a case-by-case analysis is recommended.

Kuba Grabarz is Senior Associate, Tax, and Andre Dekker is Senior Economist, Transfer Pricing, with Baker & McKenzie Amsterdam N.V.

The authors may be contacted at: kuba.grabarz@bakermckenzie.com; andre.dekker@bakermckenzie.com

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners

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