In these unprecedented times, it is more crucial than ever for asset managers to maintain flexible business operations and adequate cash positions. This may include monitoring cash closely and onboarding innovative solutions to manage cash efficiently. An adequate cash management/treasury activity should also consider the impact on existing tax strategies and potential tax risks in cash management policies.

There is no-one-size-fits-all solution, as it can depend on the investment strategy of a particular investment fund/asset manager; for example, there are different cash needs for income funds versus long-term capital-growth focused funds. Treasury models, the use of external/internal financing and repatriation routes should align with guiding principles and pain points while also considering the related tax implications.

The proper management of cash in an asset management/investment fund context is highly important, as it can have an enormous impact if not properly addressed; prompting the payment of late interest and penalties, and sometimes even falling within default considerations with stakeholders.

Among other considerations, maintaining good cash flow management is key for fluid cash (re)deployment, funding cost management, mitigation of foreign exchange and tax risks and, ultimately, internal rate of return (IRR) preservation or increase.

Despite the importance of cash management, many asset managers are still using manual/less sophisticated solutions (e.g., manually inserting data into Excel spreadsheets) when managing positions within a fund structure. While this has already been slowly changing in the past couple of years due to the emergence of various FinTech/banking solutions, the phenomenon has now accelerated with the impact of the COVID-19 pandemic.

We have been living in unprecedented times that have far-reaching effects for all segments of the global economy, including the asset management industry. More than ever, asset managers must gain any edge they can to stay ahead in this increasingly competitive and volatile environment. Asset managers may need to rethink their existing cash management model to stay afloat and embrace the “new normal” in a COVID-19 context.

The management of an efficient treasury function has various commercial, tax, legal and regulatory pain points that should be addressed in an adequate treasury model. For example, these could be:

• Cross-border banking: not all credit institutions have the global reach to cover all countries where an investment fund has a presence (e.g., fund, holding and investment jurisdictions). Therefore, even though banks have started partnering up, the current environment may create fragmented banking relationships across countries and hinder visibility on global cash flows and balances (e.g., due to different platforms and cost schedules applied by different banks across countries).
• Loan covenants: external financing could heavily affect the method and frequency of cash extraction and shareholder debt levels. These constraints could include setting loan-to-value (LTV) ratios, restricting certain corporate actions, pledging accounts/assets, and requiring a certain level of cash balances leading to a cash trap.
• Negative interest rates: the current market environment further penalizes cash left on bank accounts if assets have not been consolidated (e.g., negative interest rates and multiplication of costs), while the absence of cash pooling implies the need to have cushions everywhere, preventing treasury optimization.
• Timing constraints: greater efficiency could be achieved if cash deployment and placement could be streamlined across multiple funds and jurisdictions. This may be subject to legal, tax or operational constraints. For example, the structuring of investments may lead to timing constraints in cash movement and cash traps. Cash repatriation may sometimes be delayed due to a lack of operational readiness or postponed to minimize operational costs related to distributions.

Asset managers should also consider the relevant tax impacts when navigating the above constraints, most of which should be addressed as part of the tax structuring of the fund or a particular investment. The key tax areas to address as part of a cash management/treasury activity are:

• Thin-capitalization/debt-to-equity requirements: the choice between equity, internal and external financing may not be straightforward. While internal financing can be tempting and could facilitate efficient cash repatriation strategies, certain jurisdictions are increasingly conscious about the potential tax base erosion effect of such practices (e.g., via claiming interest tax deduction). Therefore, some jurisdictions may set a certain minimum level of equity (safe-harbor) and/or expect debt financing to be aligned with OECD transfer pricing principles (e.g., a quantum of debt to be at arm’s length).
• Withholding tax: cross-border cash repatriation begs the evergreen question of withholding taxes. Withholding tax considerations may depend on the investment jurisdiction (e.g., some Member States do not levy withholding tax on dividends, while others do). Furthermore, EU Directives, domestic exemptions and double tax treaty benefits may raise questions on the level of substance, beneficial ownership and economic rationale of the structure that must also be addressed and navigated.
• Transfer pricing: transactions between related parties should (in most countries) be concluded in alignment with the arm’s length principle. Therefore, various transfer pricing considerations could arise depending on the intra-group transaction. This could include setting the arrangement at arm’s length (e.g., interest rates on shareholder loans, remuneration of the cash-pooling leader or guarantees) and having appropriate transfer pricing documentation/policies in place.

For example, the OECD recently released new transfer pricing guidelines (Chapter X) that provides guidance on using the arm’s-length principle to analyze the debt-to-equity ratio of a borrowing entity, intra-group financing, and cash pooling arrangements. The impact of Chapter X on these areas may be significant and should be carefully considered.

• VAT: although most financial transactions can be VAT exempt, VAT must still be taken into consideration as part of the overall treasury activities to mitigate any unintended VAT cost. In addition, granting shareholder loans to EU borrowers may entail a change in the lender’s economic profile from a VAT perspective and could trigger the leading entity’s VAT registration and ongoing compliance in certain situations (regardless of whether this flow could be VAT exempted or not). Therefore, VAT could impact the overall compliance burden of the structure and imply additional costs.

Many different variables must be factored in when preparing (or reviewing) the relevant financial model and IRR/cash-yield calculations. Some of the above concerns may be managed or mitigated by making sufficient plans upfront, for example by:

1. Considering the use of internal shareholder debt financing together with alternative external debt finance providers (e.g., debt fund lending with more favorable covenants);
2. Using short-term diversified cash-equivalent investments (to counter negative interest rates); and/or
3. Partnering with FinTech/banking service providers to implement cash pooling solutions (some of which are already available on the market).

It goes without saying that these considerations, despite being key during the initial transaction structuring process, do acquire further relevance on existing structures and are prone to surviving tax law evolution; therefore, they are perfect crash test dummies for new cross-border tax legislation. In this sense, a consistent review of adopted cash management solutions is highly recommended and can also be key to ensure a profitable exit is done.

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