If a group has several current accounts in one or more countries, it is sometimes advantageous to avoid having credit balances in certain accounts when other accounts are overdrawn. There are two main ways of achieving this objective: target balancing and notional pooling.

Target balancing involves periodically achieving a zero balance or another target balance in sub-accounts by transferring the surplus to a principal, collecting account, or covering amounts overdrawn on sub-accounts by debiting the principal account.

The customer group can thus automatically pool its cash and negotiate better financial terms rather than spending a great deal of time managing several accounts with small balances.
In addition, target balancing makes it possible to reduce the number of credit lines and the outstanding amounts, which enhances the balance-sheet structure and financial results.

Notional pooling, on the other hand, involves calculating the virtual balance by adding together the balances of several accounts (in credit or overdrawn) so that the bank only considers the net group balance when calculating credit or debit interest. In this way, the customer will recoup the interest margin resulting from the difference between the credit and debit rates on the balances offset. In financial terms, the result is similar to that of target balancing, but no active management is required on the part of the customer group.

Target balancing and taxation

In the event of target balancing between different legal entities, cash pooling results in a series of loans and interest payments between the pooling company and other companies involved in the target balancing system.

The collecting account should be located in a country where credit interest paid by banks is not subject to deduction at source, or in a country that does apply deduction at source but where the pooling entity is exempt from withholding tax on interest it receives when investing the group's surpluses or pays when borrowing from a bank.

The country of domicile of the pooling company also plays a role here, since it is better if interest on lending and borrowing between the pooling company and members of the pool is not subject to deduction at source.
For instance, if a French company pools the cash for its group in a non-resident account held in Belgium, French tax law applies to intercompany loans generated by the target balancing.

Common European taxation system for interest and charges

In Europe, many Member States levy a deduction at source on intercompany loans. The rates vary from one country to another. Bilateral treaties may be concluded to limit the effects of this and to avoid double taxation. However, to benefit from these treaties, companies have to take a series of very time-consuming administrative measures.

A Directive of 3 June 2003 establishes a common system for the payment of interest and charges between associate companies domiciled in various Member States. Such interest payments are no longer subject to deduction at source. However, this exemption is restricted to loans between a parent company and direct subsidiaries or between direct associate companies without any intermediary.

The target-balancing system developed by Fortis Bank not only makes target balancing possible within a country, but also internationally, at five successive levels. This system can be used to extend the scope of the exemption, by setting up a series of direct target balancing transactions between parent companies and subsidiaries or between associate companies.

Notional pooling and taxation

Under the system of notional pooling, taxation is less important but is still a delicate issue. The service provided by the bank consists of optimising the terms for the accounts involved (by reducing the debit interest rates and increasing the credit interest rates), without generating new financial transactions. No new loans or deposits are set up.

There is no change to the tax treatment as a result of the cash pool. The tax status of a company does not change: if the bank interest it receives is subject to deduction at source when there is no pool, it is also subject to such deduction within the pool.

With notional pooling, the basic aim as regards tax is to ensure that the improved financial terms do not give rise to a transfer of profit among the members of a pool or among the participating banking establishments. A fortiori, where the pools have an international dimension, it is advantageous to reduce the taxable profit in one country by transferring all or part of that profit to another country.

Fortis Bank has set up a method for calculating interest that spreads the profit resulting from the notional pooling system on the basis of the contribution by each participant to the generation of a profit margin for each of the banking units involved.

Notional pooling ultimately provides each party with more advantageous credit or debit interest. This amount is communicated to the local accounting units to be applied to the respective accounts, on the basis of the tax status of each participant in the notional pooling scheme.