Cash & Liquidity Management

Working my way back to you

Published: Jul 2014
Birds migrating in the sunset

It is all well and good making profit overseas, but from a treasury perspective this generally desirable commercial goal can bring with it a set of issues that must be tackled correctly or cash can become the subject of punitive taxation, risk-laden currency exposure and even reputational damage. Cash repatriation is rarely straightforward – and sometimes controversial.

A Bloomberg investigation published in December 2010 (‘Dodging Repatriation Tax Lets US Companies Bring Home Cash’) revealed the dark secrets of schemes such as ‘The Killer B’ and ‘The Deadly D’ used to help to soften the tax blow for a number of high-profile corporates.

The Killer B earned its name from section 368(a)(1)(B) of the US Internal Revenue Code. The technique, explained Bloomberg reporter, Jesse Drucker, involved a US company selling its shares to an offshore subsidiary, the offshore unit could then use the stock to make an acquisition, tax-free. This loophole was apparently shut down by the IRS in 2006. The Deadly D – also named after a section of tax law – allows a US company to buy a business and transfer ownership to an existing overseas subsidiary. The subsidiary then pays its parent a sum of cash up to the purchase price of the company which the parent can repatriate, tax-free. Moves are afoot to close this one down too.

With so much at stake, why and how do treasurers bring cash home?

The consultants’ view

Reduction of gross debt on the balance sheet is one of the most common reasons for cash repatriation, says Paul Cuddihy, Head of Treasury and Commodity Management Consulting, KPMG. But over the past few years, managing counterparty credit risk has joined the list: cash in an overseas domestic bank account, as opposed to a global relationship bank, is an exposure too far for many treasurers. A third driver, notes Cuddihy, is cash recycling. “Quite often cash is taken from developed markets and invested in emerging market projects, for example for a new production facility.”

Tax-efficiency is never far from the conversation too, adds Chris Morgan, Head of Tax Policy, KPMG. Where a corporate with surplus cash is located in a high tax jurisdiction, lending to subsidiaries will generate a high tax charge on the interest received. “That does not make much sense especially where lending is not that company’s business. It may be beneficial to repatriate funds to the head office or to a treasury operation in a low tax jurisdiction and lend it out from here,” he says. However, when repatriating cash by way of dividends, the company could incur high withholding tax (paid to the jurisdiction in which the cash was residing) and, depending on the jurisdiction in which the parent company is registered, dividends might be subject to double taxation (as in the US).

Locating accounts in corporate tax friendly countries – such as Ireland with a rate of 12.5%, Andorra at 10% or, better still, Bahamas or Bermuda at 0% – is not without issue, as Google, Amazon and Starbucks found to their cost. They were not doing anything illegal, but many saw their actions as ‘unfair’. Reputational risk should not be underestimated.

The heated media and political debate around the tax planning efforts of corporates is likely to move up a gear as the country-by-country reporting template that is being discussed by the OECD takes shape. “If it looks like a company is trying to strip out as much of the profits as possible – particularly from a developing country – it will attract attention,” says Morgan. “It is”, he adds, “a matter of balancing prudent cash management with “not being seen to push the envelope”.

Regulatory guidance must be followed too. In certain jurisdictions, for example, Morgan warns that over-zealous removal of local cash reserves may breach local ‘thin capitalisation’ rules (applicable to companies funded almost entirely by debt). These rules are put in place partly to ensure local entities are able to continue operating. Accurate forecasting thus becomes more important. “Organisations that put in place automated cash pooling and sweeping structures often have to put in place more sophisticated forecasting and liquidity tools,” notes Cuddihy. The involvement of the banks in this process is “critical”.

Despite what they may claim, no bank has a truly global footprint. “What corporates tend to do is select a regional bank – for Asia, for EMEA, for the Americas – and these will link with the local banking network,” he explains. Local banks are best-placed to provide local cash services such as payments and collections. A net amount may then be moved between the local and regional banks. It is, he explains, important to select a regional bank that has a network capable of satisfying requirements both at a local and central level, even if that means using partner banks. The current wariness of counterparty risk does however make careful bank selection critical.

“The best corporate structure to facilitate the efficient repatriation of cash depends on many factors,” says Morgan. To enable a business to take dividends out with minimum withholding tax, for example, may require it to set up regional holding companies. It may be desirable to locate these in jurisdictions with favourable tax treaties, just as it may be equally beneficial to establish treasury centres in these locations, bearing in mind the reputational element. But with cash sweeping and pooling in the main free market areas already in place within most sophisticated organisations, Cuddihy notes that leading-edge organisations (notably in the pharmaceutical industry) are now implementing payments and receipts factories. “These structures remove the need for cash to be paid or received locally at all,” he explains.

The banker’s view

Treasurers are under increasing pressure to demonstrate the depth and rigour of their risk management, notes Paul Taylor, Managing Director, Regional Sales Head, GTS EMEA at Bank of America Merrill Lynch (BofAML). He believes few treasurers will today tolerate having cash spread across multiple jurisdictions for just this reason. “Whether it is counterparty risk, country, reputational or systemic risk, repatriation often feels like an easier way to manage and mitigate that risk.”

In particular, emerging market volatility and the advent of certain so-called ‘Black Swan’ events are a deep concern for treasurers who may not be on the ground as events unfold. Being able to respond quickly, diverting cash without closing down these markets is essential and international banks argue that they have the infrastructure to facilitate the essential visibility and access for effective cash repatriation.

For Taylor, repatriation is thus often based on “the intelligent management of cash pools”. A business may be managing cash in multiple pools, across multiple jurisdictions, but that cash can still be concentrated in markets where the greatest return and control can be achieved. A corporate with a multi-currency notional pool, he argues, can “optimise cash accessibility and return”.

The strategic need to manage cash and exposures may be driven by the CFO (and possibly the chief risk officer) but it is the treasurer who will most likely devise the solution. “This is where bank relationships play an important role,” says Taylor. The traditional banking service for repatriation is the sweeping and pooling of accounts. “As a business becomes more multi-national, it is required to put in place treasury structures and middleware to support that expansion. For a bank, the ability to support pooling, where the corporate objective is to optimise working capital management, is critical.”

Actual or notional pooling (combining account balances without actually transferring funds), either on a single or multi-currency basis, is necessarily driven by technology. It relies upon the bank having the access tools, infrastructure and reach to meet its clients’ needs. But Taylor believes the move into emerging markets and thus the increased threat of trapped cash is driving treasurers to look for “more intelligent” in-country solutions too. The global banks are responding by offering clients access to a variety of local short-term funds either on an entity- or country-specific basis, he says. “Where repatriation is not possible, this is a way in which treasurers can start to make more localised decisions on how to get the best possible return.”

A business should establish its repatriation strategy in advance of moving into a new territory. “A treasurer will be looking at ways in which that strategy can be supported by finding a solution that can get the cash to the right place,” says Taylor. Once past the investment phases, and assuming it has cash coming in, each entity will need a collections facility, an ability to manage that cash in the most effective way, and a well-defined approach to risk management, he explains. “Treasury won’t necessarily want to open accounts with domestic banks where the relationship is minimal,” he says. “The need is typically for something that is in step with how they manage the rest of their cash, which gives them the same visibility, control and scalability as they have for the majority of the business, which offers the same return, and which enables them to move the cash intelligently or deploy it back into that market if the business is not yet fully matured.”

The treasurer’s view

There are two main reasons for bringing cash back to headquarters for Corina Keller, Head of Cash Management for Germany-based global specialty chemicals group, ALTANA: security and efficiency. This means all of the company’s core banking panel are highly-rated and that the structure of the business facilitates easier redeployment of funds from cash-rich entities to where it is needed. But Keller acknowledges that repatriation is rarely straightforward.

“The first consideration is whether the cash is in a currency and location that allows transfers out of the country,” she says. If not, it may be possible to exchange it in-country into euros or dollars and then remove it. However, she comments that the exchange rate is often quite unfavourable and, in China for example, there are restrictions on how much foreign currency may be held at one time. Even if cash is removed, it may be subject to a ‘fee’ in the originating country as is the case for example in Russia or China. Although not officially a tax, this is a cost nonetheless. “But tax is always a reason to think about how you might get the cash out,” Keller says. If, for example, the intention is to declare a dividend, the threat of double taxation – withholding tax paid at the point of origination and receipt – must be considered. “It is not a restriction in that we won’t do it, but we must bear in mind the level of withholding tax.”

Wherever possible, ALTANA requests SWIFT MT940 customer statements from each bank account held by its overseas entities to know the balance on each account. But just as there are some banks that technically cannot comply, some charge “horrendous” fees for this service. If ALTANA cannot find a way to get the money out, at least at an acceptable cost, it may grant the relevant local entity special leave to open an additional account with a branch of one of the group’s core banks. “At least then we know the funds are safe and that we have a good level of control over the cash.” All non-core banks are subject to group treasury’s ‘bank monitoring’ programme where it takes a weekly look at the ratings and outlook of each. It will then make decisions on what the highest acceptable positive balance limit should be, explains Keller. In some instances instructions have been issued to close an account and select another bank from a short-list of corporate treasury-approved institutions.

Operations in China require a different strategy. Because ALTANA has more than one entity in-country it has established an ‘entrusted loan’ structure. Similar to a cash pool, it means one entity will deposit cash with a bank, that bank then lends the cash to other ALTANA group entities. “It does reduce the need to send additional funds into a trapped-cash environment, but it still doesn’t solve the problem of getting cash out of the country,” admits Keller.

Cash may be removed in the form of an inter-company loan to HQ but the asset remains on the books of the foreign entity. This has major implications for the security of those funds. Keller marks the distinction between cash and assets. With the retention of the asset, if for some reason the economy of the country in which that asset is booked collapses and the government then seizes control of the company, that government could legally force the parent company to repay the loan.

“In a volatile world, should the need to extract cash from a country become urgent there is but one real option, says Keller, and that is to get the funds out in the form of a dividend.” By declaring a dividend the cash and the asset are no longer on the books of that entity. But, as mentioned above, this can be expensive: “Sometimes you have to take a deep breath and swallow hard when you hear how much you must pay on withholding taxes.” Another way to remove the funds is by merging the company into another within the group. This, notes Keller, “takes even longer to do and there are more fees involved than paying a dividend.” And obviously, this is only an option if the local entity is no longer needed.

Under ‘normal’ circumstances, where repatriation is possible, ALTANA relies upon its core banking partners to connect into a traditional cash pool. Cash is automatically swept every day to a header account. But even in this scenario there may be legal restrictions on what can and can’t be moved; cross-border pooling or participation by certain company structures is not permitted by some jurisdictions, for example.

The main instrument used by ALTANA to disperse cash is the inter-company loan. “We might instruct an entity to grant a loan to HQ and it will send us the cash for us to invest, pay-down debt or lend it to another entity,” explains Keller. If making an internal loan, interest rates must be set at ‘arms-length’, reflecting the kind of rate achievable by the borrowing (or lending) entity in the open market and based on treasury’s similarly arms-length assessment of the entity’s credit risk.

“About the only good thing about the current low interest rate environment is that through inter-company lending we can repatriate most of the funds for next to nothing,” comments Keller. However, she adds, “it is not necessarily the main goal of corporate treasury to repatriate all funds”. The first view a treasurer has of in-country cash is usually an amount in a bank account. This is not necessarily the amount that can be repatriated, she warns. Given the complexities and anomalies likely to be faced, and given that treasury may not be aware of every in-country need for funding (eg. pension payments, ongoing legal processes, licence or tender applications and so on), it is possible that a multi-functional review may be required, consulting, for example, with the controlling, tax and legal teams. “There are always exceptions or reasons as to why it makes sense to leave some funds in-country.” But with more than 60 subsidiaries and associated companies around the world, and over 80% of group sales derived outside of Germany, the movement of ALTANA’s cash is never taken lightly.

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