The auditors have been and gone, the results have been announced, the Easter break is coming soon and so it‘s time to return to a more normal routine. But is it?
You have the feedback from the auditors on the treasury function’s activities and have the issues in hand – but what about the tax impact? Have you addressed that?
To illustrate the issues involved, I will examine two areas that I come across on a regular basis in the current economic environment:
- Recapitalising group companies.
- Managing group companies’ current/cash pooling accounts.
Recapitalising Group Companies
It isn’t uncommon for a subsidiary to need recapitalising after an audit. From a commercial perspective, this is relatively straightforward exercise in that all we need to do is to convert some of the existing debt into shares and no cash needs to be moved. But this not straightforward for tax purposes.
While this might work in some jurisdictions, e.g. the UK and many European jurisdictions, such an approach is likely to result in a tax charge arising on the amount of debt capitalised. Given this, it is often necessary to actually subscribe for new share capital, have some/all of the existing debt repaid and to actually flow the cash for each step.
Managing Group Companies’ Current/Cash Pooling Accounts
Generally speaking, a group company has a current account with treasury in order to manage its working capital position/requirements and the account limit is set accordingly. So you wouldn’t normally expect the current account to show a structural borrowing position, but in the current climate working capital volatility, e.g. irrecoverable debtors, it is much more likely to be the case
So what’s the tax issue? Current account debt is treated in exactly the same way as other debt and so there is no immediate rush to fix this, is there?
Generally speaking, this is the case but in recent years tax authorities have become much more sophisticated when looking at the interest rates charged on intra-group debt. In particular, the interest rate applied to a current account is likely to be significantly different to the interest rate for a longer-term loan.
The other issue to be mindful of is that some jurisdictions, such as the UK, only apply the withholding tax on interest rules in circumstances where the loan is expected to be for a term of more than 12 months. What this means in practice is that withholding tax on interest is not relevant to current accounts, but if a structural borrowing position exists then this will no longer be the case.
What Action Should Treasurers and Finance Professionals Take?
The two areas above show that there are significant tax issues associated with resolving any treasury issues which the auditors have raised during the audit.
When recapitalising companies, the standard approach could give rise to a tax charge on the amount of debt capitalised. Therefore, the message for treasurers and finance professionals is to ensure that tax advice is sought from the relevant jurisdictions before confirming the methodology for the recapitalisation.
When fixing the current account, tax issues can arise around both interest rates and withholding taxes. So the message for treasurers and finance professionals in this regard is don’t leave it too long to fix the current account, as a tax cost could be accruing until the issue is fixed.
These two suggestions are equally relevant for any other post-audit work: first, always confirm the methodology even if it looks straightforward; and second, don’t leave it too long. Failure to do so is likely to lead to a tax cost.
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