Notional pooling definition
/What is Notional Pooling?
Notional pooling is a mechanism for calculating interest on the combined credit and debit balances of accounts that a corporate parent chooses to cluster together, without actually transferring any funds between the accounts. It is ideal for companies with decentralized organizations that want to allow some autonomy to their subsidiaries, including their control over bank accounts.
Tax Impact of Notional Pooling
Once a company earns interest on the funds in a notional pooling account, interest income is usually allocated back to each of the accounts comprising the pool. For tax management reasons, it may be useful for the corporate parent to charge the subsidiaries participating in the pool for some cash concentration administration expenses related to management of the pool. This scenario works best if the corporate subsidiaries are located in high-tax regions where reduced reportable income will result in reduced taxes.
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Advantages of Notional Pooling
The advantages of notional pooling are noted below:
Single liquidity position. Notional pooling allows each subsidiary company to take advantage of a single, centralized liquidity position, while still retaining daily cash management privileges.
Local allocation of interest income. Each account in the pool receives an allocation of interest income at the end of each month that is based on the contribution of the account to the total balance being invested during the investment period.
No inter-company loans. Notional pooling avoids the use of cash transfers to a central pooling account, so there is no need to create or monitor inter-company loans for tax purposes.
Short-term commitment. A notional pooling arrangement does not require a long-term commitment with a bank; on the contrary, it is relatively easy to back out of the arrangement.
No cash transfer fees. There are no bank fees related to cash transfers, since there are no transfers between accounts that would normally trigger fees.
No overdraft lines. It largely eliminates the need to arrange overdraft lines with local banks, since cash is retained locally.
Increased interest income. Interest earnings tend to be higher under a notional pooling arrangement than if investments were made separately for smaller individual accounts, since pooled funds can be invested in larger instruments that generate higher returns.
Agreeable to minority owners. It offers a solution for partially-owned subsidiaries whose other owners may balk at the prospect of physically transferring funds to an account controlled by another entity.
Reduced foreign exchange transactions. Where global notional pooling is offered (usually where all participating accounts are held within a single bank), the pool offsets credit and debit balances on a multi-currency basis without the need to engage in any foreign exchange transactions.
Local autonomy. If a parent company wants to preserve the operational independence of its subsidiaries, notional pooling allows them to retain cash balances in their local bank accounts. This also makes it easier to conduct bank reconciliations at the local level, since there are no cash transfer transactions to a central account, as would be the case with a cash sweeping arrangement.
Reduced interest expense. Notional pooling allows a company to reduce its interest expense to the minimum level, since debit and credit positions are offset.
Disadvantages of Notional Pooling
The main downside of notional pooling is that it is not allowed in some countries. It is difficult to find anything but a large multi-national bank that offers cross-currency notional pooling. Instead, it is most common to have a separate notional cash pool for each currency area.