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An Overview on Cash Pooling in China

2 December 2020

Cash pooling enables corporate groups to minimize banking facilities expenditure through economies of scale. However, cash pooling agreements must be carefully structured in order to minimize the risks of liability of the participating group companies and their officers and to make sure that they are in line with regulatory requirements. Below is an overview on the current cash pooling regulations in China.  

1. General Legal Framework

In past years, China took a step-by-step approach to liberalise foreign exchange control, but the cross-border inflow and outflow of funds, in particular those under capital account items, are still heavily regulated. Cross-border cash pooling arrangements are subject to the administration and supervision of the State Administration of Foreign Exchange and its local counterparts.

In addition, it is not possible to implement the structure among companies within China where funds are not actually moved and instead the bank offsets the debit and credit balances of the accounts of companies participating in the cash pooling in order to calculate the net interest position of the pool. This is because banks in China are not allowed to engage in such offsetting, i.e. they must charge loan interest and pay deposit interest separately.

2. Arrangement within Chin

a) RMB Cash Pooling Arrangement within China

There are no specific regulations on renminbi (RMB) cash pooling within China. The banks offer their own RMB cash pooling products for group member companies incorporated in China. All of these products are designed in the form of entrustment loan arrangements via the bank.

Under the PRC General Provisions of Lending (the “GPL”), entrustment loans refer to loans for which the funds are provided by an entrusting party. The use of the loans is supervised and the recovery is assisted by the lender (being the entrusted party) in accordance with the purpose, amount, term, interest rate, etc. determined by the entrusting party. The lender (being the entrusted party), i.e. the bank in this context, only receives a handling fee but does not bear the loan risk.

Under such arrangement, one company will act as the “Concentration Leader” which will open a head account with the bank and the other participating companies will also open their own accounts with the same bank. At the closing of each business day, the balances or any funds over a certain value in the accounts of the participating companies will be swept to the head account of the Concentration Leader by way of an entrustment loan. If there is any debit balance in one of the accounts of the participating companies at the end of a business day, the bank is instructed to transfer the amount equalling such debit balance from the head account of the Concentration Leader to the account of the concerned participating company via the entrustment loan arrangement.

b) Foreign Exchange Cash Pooling Arrangement within China

The Provisions on Administration of Centralised Management of Foreign Exchange Funds between Internal Members of Enterprises in China issued by the State Administration of Foreign Exchange (the “SAFE”) on 12 October 2009 (the “2009 SAFE Provisions”) allow the eligible members of the group companies incorporated in China to participate in foreign exchange cash pooling through the entrustment loan structure via a bank or the group’s own finance company in China.

Eligible member companies under the 2009 SAFE Provisions include:

  • the parent company,
  • subsidiaries in which the parent company holds more than 51% of the equity interests,
  • companies in which the parent company and the subsidiaries individually or jointly hold more than 20% of the equity interests,
  • companies in which the parent company and the subsidiaries individually or jointly hold less than 20% of the equity interests, but the parent company or the subsidiaries or both jointly are the largest shareholder in the companies, and
  • public institutions or social organisations with legal person status under the parent company and its subsidiaries.

The bank is only allowed to sign the cash pooling agreement with the participating companies if it has received approval from the competent SAFE. However, finance companies do not need to obtain the approval of the SAFE before signing the cash pooling agreement.

c) Direct RMB Loans

Direct inter-company lending is prohibited by the GPL. In the past, any lending between companies in China had to be structured as an entrustment loan arrangement. On 6 August 2015, the PRC Supreme People’s Court promulgated the Provisions on Several Issues concerning the Application of Law in the Trial of Private Lending Cases (the “2015 SPC Provisions”), which for the first time allow direct intercompany loans. Article 11 of the 2015 SPC Provisions stipulates that for contracts concluded between companies for the purpose of production and business operation, where the parties concerned claim that the loan contract is valid, such claim shall be upheld by the People’s Court. 2015 SPC Provisions have been revised on 20 August 2020 (the “2020 SPC Provisions”) but this Article 11 keeps unchanged and is still valid. Overall, although the GPL is still in place, we consider the risk that the People’s Bank of China may still impose fines on the lender for intercompany loans to be very remote, i.e. nowadays direct intercompany loans are possible.

Further, according to the 2020 SPC Provisions, if the interest rate is four times higher than the loan prime rate (“LPR”) quoted for one-year loans at the time when the loan contract is concluded, it will not be protected by PRC law. The term “LPR quoted for one-year loans” means the LPR for one-year loans issued monthly by the National Interbank Funding Center as authorised by the People’s Bank of China (“PBOC”). Currently the LPR quoted for one-year loans is 3.85%.

3. Cross-border Arrangement

On 15 March 2019, the SAFE issued the Administrative Provisions on Centralised Operation of Cross-border Funds by Multinational Corporations (the “2019 SAFE Provisions”), which has replaced the Administrative Provisions on Centralised Operation and Management of Foreign Exchange Funds by Multinational Corporations issued by the SAFE on 5 August 2015 (the “2015 SAFE Provisions”). Before the promulgation of the 2019 SAFE Provisions, in China, the cross-border foreign change cash pooling is under the administration of the SAFE, while the cross-border RMB cash pooling is under the administration of the PBOC. After the 2019 SAFE Provisions came into effect on 15 March 2019, cross-border cash pooling of multi-currencies, i.e. RMB and foreign exchange, is under the unified administration of the SAFE. However, since the Circular on Further Facilitating Cross-border Bilateral Renminbi Capital Pooling by a Transnational Group Company issued by the PBOC on 5 September 2015 (the “2015 PBOC Circular”) is still valid, currently the cross-border pure RMB cash pooling will still under the administration of the PBOC as before.

a) Cross-border Cash Pooling of Multi-Currencies

Under the 2019 SAFE Provisions, cross-border cash pooling of multi-currencies is possible. One member company of a transnational group company shall act as the concentration leader of the cross-border foreign exchange cash pooling arrangement between the domestic and overseas group member companies. A transnational group company shall mean a consortium linked by capital and comprising the parent company, subsidiaries and other member enterprises or organisations. Please note that according to the 2019 SAFE Provisions, currently only the companies that have direct or indirect shareholding relationship with each other or held by the same parent company can be member companies. Variable interest entities, i.e. entities controlled by the investor via contracts, or those companies under management of the group but without any shareholding relationship cannot participate in the cash pooling. Before the implementation of the cross-border cash pooling, the consolidated cross-border RMB and foreign exchange payment and receipt amount of domestic member companies in the preceding year shall exceed USD 100m.

Compared to the 2015 SAFE Provisions, the 2019 SAFE Provisions expressly stipulate that financial institutions (except for finance companies acting as lead enterprise), local government financing platforms, and real estate companies are not allowed to participate in the centralised operation of cross-border funds by multinational corporations as lead or member enterprises.

A bank in China shall be involved in the cash pooling arrangement. The cross-border multi-currencies cash pooling arrangement shall be filed with the competent SAFE in advance and a recordal notice shall be obtained from the competent SAFE.

b) Cross-border RMB Cash Pooling

Under the 2015 PBOC Circular, cross-border RMB cash pooling is possible. One member company of a transnational group company shall act as the concentration leader of the cross-border RMB cash pooling arrangement among the domestic and overseas group member companies. Before the implementation of the cross-border foreign exchange cash pooling, the aggregate turnover of domestic member companies in the preceding year shall not be less than RMB 1bn and the aggregate turnover of overseas member companies in the preceding year shall not be less than RMB 200m.

A transnational group company shall mean a consortium linked by capital and comprising a parent company, subsidiaries and other member enterprises or organisations, including

  • the parent company,
  • subsidiaries in which the parent company holds more than 51% of the equity interests,
  • companies in which the parent company and the subsidiaries individually or jointly hold more than 20% of the equity interests,
  • companies in which the parent company and the subsidiaries individually or jointly hold less than 20% of the equity interests, but the parent company or the subsidiaries or both jointly are the largest shareholder in the companies.

An agreement between the group member companies participating in the cash pooling shall be signed with a bank in China. Such bank shall file a recordal of such cash pooling arrangement with the competent branch of the PBOC.

c) Granting Foreign Exchange Loans Abroad

According to the Circular (Hui Fa (2014) No. 2), a PRC entity (except financial institutions) is allowed to grant foreign exchange loans to those offshore companies with which it has an equity relationship. The PRC entity shall apply for registration of such loans with the competent SAFE.

d) Granting RMB Loans Abroad

According to the Circular (Yin Fa (2016) No. 306), a PRC entity can grant RMB loans to its overseas affiliates with which the PRC entity has an equity relationship, i.e. overseas third party borrowers are not allowed.

e) Cap of Loans

According to the Circular (Yin Fa (2016) No. 306), the amount of loans a company in China can grant to its offshore operations can only be up to 30% of its owners’ equity (i.e. net assets). This 30% cap applies to the aggregated amount of both RMB and foreign exchange loans.

4. Liabilities and Restrictions

a) Liabilities of Directors, Supervisors and Senior Management Personnel

Under the PRC Company Law, if a director, supervisor or senior management personnel violates laws, administrative regulations or the company’s articles of association in the course of performing his or her company duties, thereby causing the company to incur a loss, he or she is liable for damages. In the context of the PRC Company Law, senior management personnel refers to a company’s general manager, deputy general manager, financial officer, the secretary to the board of directors of a listed company and other persons specified in the company’s articles of association. Given the above, directors, supervisors and senior management personnel of a company will ensure that setting up the cash pooling arrangement has been duly authorised by all necessary corporate actions of the company and that no other action or proceedings are necessary.

In addition, according to the PRC Enterprise Bankruptcy Law, if a director, supervisor or the senior management personnel of an enterprise commits a breach of his/her obligation of loyalty or obligation of due diligence, thereby causing the enterprise that he/she serves to go bankrupt, he/she will bear civil liability in accordance with the law. Such person may not serve as a director, supervisor or senior management personnel of any enterprise for three years from the date of conclusion of the bankruptcy procedure. Therefore, before entering into the cash pooling arrangement the director, supervisor and the senior management personnel of a company will make an appropriate assessment to reach a conclusion that the benefits of the cash pooling arrangement outweigh any risks and that such an arrangement will not jeopardise the liquidity and solvency of the company. The appropriate assessment will be made in order to avoid being blamed for failure to completely perform his/her due diligence obligation, if the cash pooling arrangement causes a problem with the liquidity or solvency of the company.

b) Restrictions for Listed Companies

Under the Circular (Zheng Jian Fa (2003) No. 56) issued by the China Securities Regulatory Commission and the PRC State-owned Assets Supervision and Administration Commission, a listed company in China is forbidden to lend funds to its majority shareholder and other affiliated parties. Since the cash pooling arrangement is achieved via the entrustment loan structure and the actual lender is not the bank but the participants in the cash pooling, listed companies in China cannot participate in cash pooling with their shareholders and/or affiliated companies.

5. Tax Issues

a) Interest Deductibility

Under the PRC Corporate Income Tax Law, interest on loans is deductible in accordance with the following stipulations:

  • For loans borrowed from financial institutions by a non-financial institution, the interest is deductible on actual basis;
  • For loans borrowed from non-financial institutions by a non-financial institution, the interest is deductible within the limit calculated by reference to the interest rate of a similar loan with the same term as provided by financial institutions.
b) Transfer Pricing and Thin Capitalisation Rules

The interest rates and the terms of the intra-group loans should be set on an arm’s length basis (market basis). Benchmark studies can be conducted to justify the selected interest rate of related party loans from transfer pricing perspectives. A transfer pricing audit might be launched and a special tax adjustment can be made by the PRC tax authorities if the interest charges severely breach the arm’s length principle. Such tax adjustment might cause upward adjustment of interest rate which is unreasonably low for income tax purposes or non-deduction of interest expenses against the borrower’s taxable income if the interest rate exceeds market levels.

There are additional limits on interest deductibility where the interest is paid to related parties. The payment of interest to related parties for the debt exceeding twice the shareholders’ equity for a non-financial institution (or five times the shareholders’ equity for a financial institution) may not be deductible against the borrower’s taxable income and thus be treated as dividend distribution for tax purposes. Such interest expense can be deducted from the taxable income only if sufficient evidence can be provided to prove that such debt arrangement is in line with the arm’s length principle.

c) Withholding Tax

Under the PRC Corporate Income Tax Law, the China-sourced interest income earned by a non-PRC tax resident is subject to 10% withholding tax, unless a double taxation treaty is in place to stipulate a lower tax rate. In that case the tax rate in the relevant treaty prevails.

d) Value added Tax (“VAT”) and surcharge taxes

According to the current PRC VAT regulations, the interest income is subject to 6% VAT. In addition, the associated surcharge taxes at round 10% of the VAT payable shall also be triggered. Please note that the input VAT arising from interest payment is not allowed for credit against the output VAT liabilities.

e) Stamp Duty (“SD”)

Under the PRC Provisional Regulations on Stamp Duty, 0.05‰ SD is levied on both the lender and the borrower based on the total loan amount in the loan contracts.

Authors

Picture of Ulrike Glueck
Dr. Ulrike Glueck
Managing Partner
Shanghai
Angela Chen
Angela Chen
Junior Associate
Shanghai