CMS Expert Guide to cash pooling in Bulgaria

a) Intro 

In Bulgaria, there is no specific legislation on cash pooling. Cash pooling arrangements should therefore comply with the general corporate and banking rules on shareholder loans, security interests and company solvency, amongst others.

In addition, whilst “virtual” and “physical” cash pooling are legal in Bulgaria – the practice of “physical” cash pooling being more common – Bulgarian court practice (particularly in the area of company insolvency) is still at a developing stage. As such, there are inconsistencies in the law, making the legal risks associated with cash pooling less predictable. Cash pooling arrangements must therefore be carefully structured and the applicable legislation strictly observed.

b) Social interest and due diligence

The directors of a of a Bulgarian limited liability company ("LLC") (Article 141, para (1) of the Bulgarian Commerce Act ("CA")) have a duty to manage the company's affairs with the applicable law and the shareholders' resolutions. The members of the board of directors / management board / supervisory board of a Bulgarian joint stock corporation ("JSC") (Article 237, para (2) of the CA) shall perform their duties with the diligence of a prudent businessman in the interest of the company and all shareholders. Therefore, the directors must weigh up the chances and risks of cash pooling prior to the company entering into the arrangement.

c) Shareholder’s loan provisions

Under the Bulgarian Credit Institutions Act, the public receiving of deposits and extending of credits on the basis of such deposits is activity, which can be solely performed by licensed credit institutions. However, such considerations should not be relevant in case of an intra-group cash pooling arrangement.

In addition, there are certain reporting requirements under the Bulgarian Foreign Exchange Act, when the lender to a Bulgarian entity is a foreign company and the principal amount of the loan exceeds BGN 50,000 (EUR 25,000).

d) Liquidity protection

Bulgarian capital-based companies, both LLCs and JSCs, must observe the following capital maintenance requirements:

1. The net assets of a company should not fall below the minimum registered share capital of the company (currently BGN 2 (EUR 1) for а LLC and BGN 50,000 (EUR 25,000) for a JSC).
   Directors should therefore be careful to ensure that a company’s contributions to a cash pool do not cause it to enter into a negative equity situation, particularly if the contributions may not be recoverable (e.g. due to the insolvency of another cash pool participant).
2. Distributions to shareholders are only allowed where the net assets of a company exceed its registered capital and mandatory reserves, and can be up to the amount of such excess. However, so long as the loan amount is fully recoverable, intra-group loans in a cash pooling arrangement will not be considered a hidden distribution to shareholders and do not fall within this requirement.
3. A parent holding company may only:
   1. hold cash funds of its subsidiaries if the deposited funds do not exceed three times the registered share capital of that subsidiary; and
   2. extend loans to a subsidiary if the aggregate amount of such loans does not exceed ten times the registered share capital of the parent company. Deposited funds and loans exceeding these thresholds are invalid and the excess amount must be refunded.

This will clearly have implications for cash pool arrangements where the parent company’s name is on the cash pool account. Subsidiary deposits into it, and withdrawals from it, should therefore be carefully recorded to ensure there is no breach of the rules, especially because any breach may result in the Bulgarian tax authorities not recognising the interest payments on the deposits or loans as being tax deductible.

e) Hidden distribution of profits

The payment of interest by a subsidiary to a parent company may be classified as a hidden distribution of profits for tax purposes if such interest exceeds fair market levels – or if at least three of the following conditions are fulfilled:

• the amount of the loan exceeds the amount of the subsidiary’s equity;
• the repayment of the principal or the payment of the interest is not subject to fixed terms;
• the repayment of the principal or the payment of the interest is not subject to fixed terms;
• the repayment of the principal or the payment of the interest or the amount of the interest depends on the amount of the profits of the subsidiary; or
• the repayment of the loan is subject to the payment of other debts or the payment of dividends.

If the interest payments are classified as a hidden distribution of profits, this would have the following consequences:

• the relevant interest expense will not be deductible from the profits of the subsidiary for corporation tax purposes;
• the subsidiary will be liable for a penalty amounting to 20% of the hidden distribution;
• the income from the distribution will not be eligible for deduction from the parent company’s profits for corporation tax purposes (it normally would be if the subsidiary is based anywhere within the EU); and
• the distribution will not be eligible for an exemption from withholding tax (it normally would be if the parent is based within the EU).

f) Insolvency proceedings – contestation of transactions

The relevant hardening periods in Bulgaria in an insolvency proceeding are between six months to two years, and are generally as follows:

• Fulfilment of non-due monetary obligation – within one year prior to the application for opening of insolvency proceedings; if the creditor was aware of the insolvency / over indebtedness – two years;
• Establishment of a security – within one year prior to the application for opening of insolvency proceedings; if the creditor was aware of the insolvency / over indebtedness – two years;
• Fulfilment of due monetary obligation – within six months prior to the application for opening of insolvency proceedings; if the creditor was aware of the insolvency / over indebtedness – one year.

a) Intro

Cash pooling entails a range of liability risks both for the management and the shareholders of the participating entities, as well as for the management and the shareholders of the cash pool leader.

The risk of liability becomes particularly significant if one of the participating companies becomes insolvent, or is sold, since it is at this point that an insolvency administrator or the incoming directors / new shareholder(s) of the sold company may pursue such claims.

b) Liability of directors

The directors of a company are obliged to perform their duties and exercise their powers in the interests of the company and its shareholders, and with the care of a prudent businessman. This also includes the obligation of the directors to ensure that the company is solvent. Where the directors fail to manage the affairs of the company with the care of a prudent businessman (e.g. by entering into risky transactions outside the normal course of business, such as poorly structured cash pooling arrangements) with the consequence that the company has become insolvent, the directors will be criminally liable and responsible for any loss that occurs to the company. 

In a cash pooling arrangement, a specific conflict of interest that may therefore arise, and which could put the director in breach of his/her duty to the company and its shareholders, is where he/she is a director of more than one of the participating companies. To ensure he/she meets the due care standard, he/she must take adequate steps to ensure that each company is able to seek repayment of any funds it has contributed to the cash pool and is able to realise a benefit from partaking in the cash pool (such as preferential interest rates or easy access to liquid finance).

Furthermore, under tort and insolvency law, a director may be jointly and severally liable for the unsatisfied debts of the company if a breach of his/her due care standard has forced the company into insolvency.

Directors and shareholders therefore need to be careful that, so far as is possible, management of the cash pooling arrangement is without prejudice to the solvency of the company. An example of where liability may arise is when a parent company in need of liquidity demands that a subsidiary contribute funds to the cash pool account for the parent company’s withdrawal. If the effect of such a transaction is to cause the subsidiary to have its own liquidity problems, resulting in insolvency, the directors may be liable for failing to refuse the parent’s demand.

c) Liability of shareholders

As discussed above, a director may be jointly and severally liable for the unsatisfied debts of the company if a breach of his/her due care standard has forced the company into insolvency. This liability can also extend to a majority shareholder if the shareholder has influenced the directors in a way that is not in the interests of the company’s creditors.

In addition, the parent is liable for making and enforcing a demand, if the effect of such a transaction is to cause the subsidiary to have its own liquidity problems, resulting in insolvency.

a) Intro

In order to reduce the risk of liability associated with a cash pooling arrangement, it is advisable that a cash pooling agreement be entered into by the participants, to achieve clarity as to their rights and obligations and thereby reduce legal risks. However, as noted above, insolvency law and practice is still being developed in Bulgaria and as no specific cash pooling legislation has been put in place it is not possible to eliminate all risks.

b) Corporate power

In general, the decision to participate in the cash pool falls to the management of the cash pool leader or the cash pool participant. Under Bulgarian law, a company can generally take part in a cash pooling system as long as its articles of association do not prohibit such participation. However, it is unclear whether a cash pooling arrangement is considered an exceptional measure and therefore requires a consenting shareholders' resolution. A shareholders' resolution is recommended in any event.

c) Cash pooling agreement

1. Risk evaluation before signing the cash pooling agreement 
   It is important that the directors of the participating companies be assured that the benefits of the cash pooling arrangement outweigh any risks. The solvency of the other participants will be a key part in deciding this, for the reason that the insolvency of one could affect the solvency of all. Conflicts of interest should always be carefully considered.
2. Right to informationThe companies participating in a cash pooling arrangement should seek to have the right to up-to-date information on the liquidity and solvency of the other participating companies. An efficient and effective way of ensuring this may be for the cash pooling agreement to contain an obligation that the parent company provide the participating companies with monthly consolidated financial statements for the group as a whole, whilst each participating company should have the right to inspect the cash pool accounts.It is also advisable that an obligation be placed on each company to immediately notify all the other participants if the company's solvency is threatened. This will enable the directors of the other companies to make a timely decision as to whether to terminate their company’s participation in the arrangement.
3. Right to terminate the cash pooling arrangementThe agreement should contain a right for a company to terminate the cash pooling arrangement at any time, and to have repaid (within 24 hours) any funds it has contributed to the cash pool. This is to enable a company to leave the arrangement where it is exposed to the insolvency of another participant, whilst allowing companies with insolvency issues to seek the speedy return of liquidity.

In addition, it may be advisable to include a provision in the agreement that a company experiencing solvency problems is obliged to terminate its participation in the cash pool by repaying all intra-group loans and reclaiming deposited funds. However, this must be done in consideration of the limitations on payments to shareholders prior to insolvency

d) Facility agreement

Should the cash pooling transaction be structured so that each participant must enter into an individual facility agreement, the terms of the group cash pooling agreement must work in sync with the individual facility agreements. In addition, there are some specific issues to consider in relation to the facility agreements.

1. Termination rights of individual participating companiesThe group cash pooling agreement may state that only the parent company can submit a valid legal notice to the bank in respect of the cash pooling arrangement. However, it is important that this rule does not prevent an individual participating company from terminating the facility agreement to which it is party. The group cash pooling agreement will therefore need to be drafted with an exception for this.
2. Joint and several liability and securityThe facility agreements may provide that the participating companies are jointly and severally liable for any negative balance on the master account, and require intra-group security for the same. In any case, an individual company’s liability should be restricted, at the very least, to the lesser of:
3. Liability in a sale of a group company

If a company that has participated in a cash pooling arrangement is sold, the seller will usually ask for an indemnity for potential liabilities in connection with the arrangement. One such liability (and indemnity) may be for capital maintenance matters, since the purchaser will be liable as an incoming shareholder for any payments previously made in contravention of capital maintenance provisions.

e) Guarantee

Abstract corporate guarantees are not recognized under Bulgarian law.

a) Intro

Cash pooling agreements are not explicitly dealt with by the Bulgarian tax legislation. The general rules apply to the resulting interest income and expenses. Specific rules and regimes that may have effect on intra-group borrowings are detailed in the section below. 

b) Thin capitalisation rules

Interest expenses deductibility may be limited if the debt to equity ratio of the company exceeds 3:1. In such cases the deductibility of interest expenses will be restricted to the total amount of:

1. the interest income of the company; and 
2. 75% of the company’s profits before interest and tax. If the company is at a loss position, the deductibility of interest is limited to the interest income of the company.

Interest expenses restricted in a particular year may be deducted from the financial result for tax purposes during the following years under a specific formula. 

c) Interest deductibility

Interest limitation rules transposing the EU Anti-Tax Avoidance Directive (ATAD) apply in addition to the thin capitalization regime. 

Under this regime, the net borrowing costs of an entity will be deductible for tax purposes up to 30% of the company’s tax-adjusted earnings before interest, taxes, depreciation, and amortisation (EBITDA).

If the net borrowing costs for the year are up to EUR 3 million, no restrictions apply under the interest limitation regime (the thin capitalisation rules may still apply).

Any resulting non-deductible borrowing costs can be carried forward and deducted in future years.

Credit institutions are out of the scope of the interest limitation regime.

d) Transfer pricing

Bulgarian tax law requires that all entities should apply the arm’s-length principle in their transactions. In the case of interst income and expenses, the market interest rate is defined as the interest payable under the same conditions for a loan provided or received, notwithstanding the form of the loan, between non-related parties. Bulgarian transfer pricing rules generally follow OECD Transfer Pricing Guidelines.

Mandatory transfer pricing documentation justifying the arm’s-length nature of related-party transactions will be required if the company exceeds at least two of the following thresholds:

1. the balance sheet value of their assets exceeds BGN 38 million (approximately EUR 19 million),
2. their net sales exceed BGN 76 million (approximately EUR 39 million),
3. the average number of employees exceeds 250.

In the case of loans the Local file should cover the loans  exceeding BGN 1 000 000 (approximately EUR 510 000) or for loan related interest and other loan related income/expenses exceeding BGN 50 000 (approximately EUR 26 000) on an annual basis. 

The transfer pricing documentation comprises of a Local file and a Group Master file (where the company is part of a multinational group).

e) Withholding tax

Bulgaria applies 10% withholding tax on interest income paid by a local company (or a local PE of a foreign company) to a non-resident entity. 

The interest withholding tax may be reduced or eliminated under the applicable double tax treaty (Bulgaria has over 65 active double tax treaties in place). 

Interest paid between affiliated companies within the EU may be exempt under the local rules transposing the EU Interest-Royalties directive. 

f) Corporation tax

The interest income of an intra-group lender will be included in the profits of that company, which are subject to the standard 10% corporate tax rate. Correspondingly, the interest paid by the intra-group borrower will normally be deductible for corporate tax purposes.

g) VAT rules

VAT will not apply to the interest under a cash pooling agreement. 

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