1. thecorporatetreasurer.com2 corporate treasurer June / July 2016 thecorporatetreasurer.com2 corporate treasurer June / July 2016
China liquidity
management
alchemy
China’s tax reforms may
not reduce tax burdens
on popular cash pools,
and might even increase
costs. The traditional zero-
balance cash pool structure
specifically suffers.
Ann Shi reports
thecorporatetreasurer.com2 corporate treasurer June / July 2016
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2. thecorporatetreasurer.com June / July 2016 corporate treasurer 2
cashpooling
thecorporatetreasurer.com June / July 2016 corporate treasurer 2
F
or treasurers managing
corporate cash pools in China,
the new nationwide value-added
tax (VAT) rules, which took
effect on May 1, offer little in the
way of perks.
Under the new tax system, four sectors –
construction, real estate, financial and the
consumer services industry – have joined
other sectors in China in adopting VAT
for their tax filings. Previously, they were
subject to business tax (BT), for which rates
vary within the range of 3% to 20%.
Even when a company does not fall into
those four sectors, as long as it provides an
entrust loan (also called entrustment loan
or entrusted loan) to its group companies
or affiliates, and obtains interest or similar
income from such loans, it is subject to 6%
VAT on interest income received, according
to Xiong Yi, a treasury consultant at
iSpan and former China head of cash
management and liquidity advisory at RBS.
The loan service falls under the scope of
financial services in the new VAT system.
In an entrust loan arrangement, a bank
acts as agent for an entrusted fund from a
corporate depositor and lends the funds on
to a borrower designated by the depositor.
This arrangement has formed the basis
of cash-pooling practices in China, and
for compliance reasons it is still the most
popular way to concentrate cash in China.
As much as its popularity and
effectiveness are cited by many treasurers
managing corporate liquidity in China,
cash pooling under the entrust loan
structure carries a major taxation pitfall. As
it’s considered a form of indirect lending,
the entrust loan was, before the reform,
subject to the 5% BT on interest income.
As The Corporate Treasurer reported
in May, China’s VAT reform may relax
corporate tax burdens by billions of dollars
annually as VAT is calculated on a net basis
for inter-company transactions, in contrast
to the BT system, under which such
transactions were taxed on a gross basis.
So, what are the tax implications of the
VAT reform on a renminbi cash-pooling
structure? Domestic renminbi cash pooling
is, in many cases, performed under an
umbrella zero-balance structure which
contains a parent account and a series of
corresponding sub-accounts. Since the
owners of sub-accounts and parent account
are not under the same legal entity, fund
sweeping between the parent account and
the sub-account must be recorded as the
drawdown or repayment of an entrust loan.
In addition, since fund sweeping usually
takes place frequently in a cash pool, the
company may need to leverage the cash
pooling report (including the daily accrued
interest amount) generated by its cash
management bank to further calculate the
output VAT.
Acording to Xiong, if sub-account A
swept Rmb10,000 to the parent account at
the end of the day, this would be recorded
as the one-day entrust loan drawdown by
the parent account. On the same day, the
parent account swept Rmb5,000 at the end
of the day to sub-account B, which similarly
would be interpreted as sub-account B
taking out a one-day Rmb5,000 entrust
loan from the parent account.
Xiong explained it as follows:
• Assume the cash-pool interest rate is 3%.
For example, for the parent account, the
output VAT of the daily accrued entrust
loan interest income is Rmb5,000 × 3% ×
1 ÷ 365 ÷ (1 + 6%) × 6% = Rmb0.0233.
• Since the outstanding entrust loan
amount in the cash pool fluctuates
every day, the parent account needs to
accrue the output VAT based on the daily
accrued entrust loan interest income,
then deduct the input VAT within the
same taxation period and pay the net
amount. In the same manner, sub-
thecorporatetreasurer.com June / July 2016 corporate treasurer 2
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3. thecorporatetreasurer.com30 corporate treasurer June / July 2016
Compare your pool
Cash management is a big focus of the
account A should calculate its output VAT
upon the corresponding daily accrued
interest income to be paid by the parent
account.
• However, the interest expenses of
the parent account arising from the
Rmb10,000 entrustment loan from
sub-account A is not applicable for tax
deduction according to the new VAT
rules. It means the new VAT rules do not
address the issue of the historical tax
burden inherited from BT.
• It is clearly stated that the loan interest
expense could not be part of input VAT
for deduction purposes and the entrust
loan interest income is still taxable.
As a result, the tax burden associated
with the traditional zero-balance cash
pooling structure in China is not changed
materially.
“If the corporate has not done so, it is
highly recommended to transform the
traditional zero-balance cash pooling
structure into some type of tax-saving
cash-pooling structure (e.g., sweeping
on demand, or without a parent account
structure…) to reduce the overall tax
expense for the group,” warned Xiong.
“It is highly
recommented
to transform
the traditional
zero-balance...
structure into
some type of
tax-saving
structure”
Xiong Yi
account, which reflects the overall group-
level liquidity onshore. However, net
outflows from cross-border cash pools
remain suspended, and the new VAT
rules are posting higher tax charges for
ZBAs than under the business tax system.
If corporates have not done so, they are
advised to transform the traditional ZBA
cash-pooling structure into a system that
offers more tax savings (see structures 2,
3 and 4 below).
Structure 2: Sweep as required
Summary: Carries low tax costs; offers
poor cash concentration on a group level;
inefficient when it comes to sweeping across
borders.
The sweep-as-required arrangement is
similar to the traditional ZBA structure,
in that there is a header account and each
member company has a bilateral loan
relationship with the header account’s
holding entity. But unlike the ZBA
structure, sub-accounts can lend to each
other, and not all the balances at the sub-
account have to be swept to the header
account. As a result, the overall inter-
company transaction size and volume are
smaller than structure 1, which means
lower tax costs for the company.
However, as not all the balances in
the sub-account have to be swept to the
header account, this structure provides
a relatively poor reference to group-level
liquidity, hence does not work well with
cross-border pooling arrangements,
which are more often linked to a single
header account.
Structure 3: Centralised,
tax-efficient cash pool
Summary: Carries low tax burdens; offers
good cash concentration on a group level;
works well for cross-border arrangements; a
lot of corporates favour and are shifting to
this structure.
Unlike structures 1 and 2, each sub-
account company in this structure has
a bilateral loan relationship with other
sub-account companies. Besides a header
account, which absorbs all positive sub-
account balances, there is also a dummy
account owned by the agent bank via
which the header company can cover
negative balances in sub-accounts.
The overall outstanding entrust loan in
this structure is smaller than in structure
A, meaning fewer tax expenses.
daily responsibilities of many treasurers
and CFOs, and provides some of their best
opportunities to add value.
That is especially the case for foreign
multinationals whose China operations
are a key revenue generator, and Chinese
companies that need to fund overseas
expansion. The need to manage excess and
deficit cash positions across borders makes
cash pooling in China the tool of choice to
transfer funds out of the country.
And VAT reform is not the only recent
policy change that may have steered
treasurers towards rethinking how their
cash pools are designed.
To name one, earlier this year, China
made a U-turn on its well-publicised
cross-border renminbi cash-pooling policy
and suspended net outflows of money
from treasury cash pools. To date, the
suspension is still in force.
To cope with these changes, it is critical
to understand the nuances of different
cash pool designs. Some structures bear
heavy tax costs, while some others deliver
less optimal visibility of group-level
liquidity.
Again, with the invaluable help of Xiong,
The Corporate Treasurer has provided a
guide to managing liquidity in China via
cash pools, pinpointing their merits and
pitfalls.
Structure 1: Traditional ZBA
Summary: The zero-balance account
(ZBA) carries high tax burdens; offers great
cash concentration on a group level; works
well for cross-border arrangements; now at
risk from the ban on cross-border renminbi
outflows from cash pools and VAT rules.
The most traditional form of
physical pooling, the ZBA requires the
establishment of a header account at
group level to absorb or release liquidity
to the sub-accounts held by member
companies. Each member company has a
bilateral loan relationship with the header
account’s holding entity. After end-of-day
(EOD) sweeping, each sub-account should
have a zero balance.
As the entrust loan is subject to
VAT, using ZBA cash pooling – which
generates the biggest inter-company
transactions by size and volume among
the four options – would be the most
expensive structure in terms of tax costs.
A ZBA system does provide good
support for cross-border cash pooling,
due to the establishment of a header
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4. thecorporatetreasurer.com June / July 2016 corporate treasurer 31
Cashpooling
This is the option recommended most
highly for companies that intend to save
tax while desiring centralised liquidity
management, such as those looking to
sweep cash offshore.
Structure 4: Tax-efficient cash pool
Summary: Carries the lowest tax
cost; offers no cash concentration on a
group level; inefficient for cross-border
arrangement
Unlike the other structures, there’s
no header account. Sweeping is through
a dummy account by the agent bank,
and each sub-account retains its own
balances. Like structure 3, each sub-
account company has a bilateral loan
relationship with other sub-accounts.
The overall outstanding entrust loan in
this structure is the smallest among the
four structures, meaning it is the most
cost effective option in terms of tax. But
due to the lack of a header account, it
offers no cash concentration on a group
level and works badly for cross-border
arrangements. n
Comparison
Daily outstanding
Entrust loan amount
When aggregated balance
of whole pool is positive
When aggregated balance
of whole pool is negative
Structure 1 140 80
Structure 2 90 50
Structure 3 90 50
Structure 4 50 30
Assumption: entrust loan interest rate is i% (VAT inclusive). VAT rate is 6%
The daily accrued output VAT=daily outstanding entrust loan amount *i% *1 /365 / (1+6%) *6%
Daily accrued output
VAT amount
When aggregated
balance of whole
pool is positive
When aggregated
balance of whole
pool is negative
Tax saving
benefit
Structure 1
=140* i% *1/365/
(1+6%)*6%
=80* i% *1/365/
(1+6%)*6%
None
Structure 2
=90* i% *1/365/
(1+6%)*6%
=50* i% *1/365/
(1+6%)*6%
Good
Structure 3
=90* i% *1/365/
(1+6%)*6%
=50* i% *1/365/
(1+6%)*6%
Good
Structure 4
=50* i% *1/365/
(1+6%)*6%
=30* i% *1/365/
(1+6%)*6%
Better
Please note: L is lender, B is borrower. A, B, C and D are sub-accounts, E is the header. We assume the header account has a balance of Rmb10
before cash sweeping when the overall pool runs a surplus, and –Rmb10 when in deficit. Source: Xiong Yi
Centralised tax efficient cash pool (by percentage)
l Before EOD sweeping: Overall pool surplus
l All subs become ZBA after EOD sweeping
l Header keeps remaining balance
l Before EOD sweeping: Overall pool deficit
l All subs become ZBA after EOD sweeping
l Header incurs extra OD
E
A B C D
10
50
(before EOD sweeping)
(after EOD sweeping)
L/B E A B C D Ʃ
E
A 26.67 16.67 16.67 60
B 13.33 8.33 8.33 30
C
D
Ʃ 40 25 25 90
L/B E A B C D Ʃ
E 10 10 20
A 10 10 20
B 5 5 10
C
D
Ʃ 25 25 50
O/S Entrusted loan = 25+25+40=90 O/S Entrusted loan = 25+25=50
60
0
30
0
-25
0
-25
0
40
60
30 25
25
E
A B C D
-10
-30
(before EOD sweeping)
(after EOD sweeping)
20
0
10
0
-25
0
-25
0
20
10 25
25
20
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