Tax Issues Related to Financing and Cash in Times of Crisis

The health crisis linked to the coronavirus epidemic has plunged all countries worldwide into the unknown. Paralyzing a large portion of the population and of companies, the health crisis gives way to a major economic crisis, which will be the most important since the Second World War according to estimates. Against this backdrop, companies first focused on liquidity. Indeed, with a sudden drop in sales, the cash flow generation slows down or even stops as companies are unable to slow down their cash outflows at a similar pace. Companies end up depleting their cash reserves and, as a result, their borrowing lines.

As from the start of the crisis, corporate treasurers have therefore been strongly focussed on several topics: anticipating immediate liquidity needs, ensuring a smooth flow of cash, analysing whether external and internal funding were adequately addressing the requirements of subsidiaries, considering the opportunity to refinance or restructure their company’s debt, studying the possibilities offered by governments to benefit from guaranteed loans and the conditions attached to these, identifying the needs of subsidiaries in terms of financial guarantees in order to secure financing or, more broadly, to provide support to the business, monitoring ratings agencies actions and impact, in particular on companies’ access to financing or to their eligibility for governmental or European Central Bank support programmes, not to mention managing the increased volatility of hedging instruments and derivatives. This is a long list and each topic requires considering different possible options for dealing with these questions. The tax consequences are among the key elements to factor in the analysis of each of the scenarios.

First, from a tax point of view, the challenge is to ensure an optimal allocation of financial charges to secure their deductibility both applying the various limitation rules resulting from the EU Anti-Tax Avoidance Directives (“ATAD”) and complying with the OECD “arm’s length principle”. The answer is bound to differ from one group to another depending on its general situation and the specificities of its financing structure.

However, as a general principle, it would be inefficient to increase the financial charges of a subsidiary with a tax loss through an increase in the interest rate applied for example.

In addition, it is important to ensure that each type of funding is used appropriately. For example, a cash pool is appropriate if it is used to finance very short-term needs and not to cover a longer-term structural financing requirement, which should then carry a higher interest rate. The requalification of a cash pool into mid or long-term cash advances, which already was a topic that tax inspectors liked to challenge during pre-Covid tax audits, is likely to occur more frequently and with a greater magnitude in the context of this crisis.

Likewise, with regard to intragroup financing, changes in market conditions under which the parent company is financed, the deterioration of the company’s ratings, the increase in the risk of default of subsidiaries, will require a review of interest rates applied on existing intercompany loans and of the background economic analyses justifying these rates. The increased use of guarantees should also give rise to a tax analysis of their remuneration.

Therefore, setting the appropriate, so-called “arm’s length” interest rate and justifying it will once again be central issues that corporate treasurers will necessarily have to discuss with their tax expert.


Marie-Charlotte Mahieu
Partner
Taj Deloitte