Cash Pooling: Legal Framework for Intra-Group Liquidity Management

Cash pooling refers to the management of the cash surpluses and deficits held in the bank accounts of companies belonging to a group of companies by concentrating them in a central account. The system aims to use liquidity more efficiently within the group and to reduce the need for external financing. The participation of a Turkish group company in an international cash pooling system, however, goes beyond its economic function as a treasury management tool and gives rise to a series of legal consequences that must be assessed separately under the capital maintenance provisions of the Turkish Commercial Code (TTK), the rules on groups of companies, tax legislation and foreign exchange regulations.

Contents

• What is cash pooling and what types exist?
• What is the legal nature of participation in a cash pooling system?
• How does the shareholder borrowing restriction apply?
• What are the liability and the compensation obligation of the controlling company?
• What liability do members of the board of directors and managers face?
• How do the thin capitalisation and transfer pricing rules apply?
• Do withholding tax, VAT and KKDF arise on interest payments?
• What must be considered under foreign exchange legislation?
• What happens if the financial position of one of the group companies deteriorates?
• What should a cash pooling agreement provide for?
• Conclusion

What is cash pooling and what types exist?

In practice, there are two basic types of cash pooling. In the structure referred to as physical cash pooling, the balances in the accounts of the group companies are transferred to a central account at set intervals, frequently on a daily basis; this method, under which the accounts are reset to zero every day, is called zero balancing. In this way, the company with a cash surplus transfers funds to the master (central) account, while the account of the company with a cash deficit is funded from the master account.

In the structure referred to as notional or virtual cash pooling, by contrast, no actual transfer of funds takes place between the accounts; the bank takes the balances of the group companies into account together when calculating interest. Since the bank may nevertheless have a right of set-off between the accounts or may require cross-guarantees from the group companies in this structure as well, the virtual structure should not be regarded as entirely free of legal risk.

What is the legal nature of participation in a cash pooling system?

In a physical cash pooling system, each transfer to the master account constitutes, as a rule, a loan granted by the transferring company to the company holding the master account; transfers from the master account are likewise treated as loans granted by the central company to the relevant group company. The system therefore consists of constantly changing reciprocal receivables and payables governed by the rules on the loan for consumption under Article 386 et seq. of the Turkish Code of Obligations (TBK).

For a Turkish company, the decisive question is against whom, on what terms and with what security it holds a claim in return for the amounts it transfers to the master account. In practice, the standard cash pooling agreements of international groups do not provide sufficient security for the repayment of the Turkish company's claim and do not take account of the specific restrictions of Turkish law.

How does the shareholder borrowing restriction apply?

Under Article 358 TTK, shareholders may not become indebted to the company unless they have fulfilled their matured obligations arising from their capital contribution obligation and the company's profit, together with its free reserves, is sufficient to cover losses carried forward. By virtue of the reference in Article 644 TTK, this provision also applies to limited liability companies. Under Article 562(5) TTK, the law provides for a judicial fine of not less than 300 days for those who lend to shareholders in breach of this prohibition.

In structures where the master account is held by the parent company that is the direct shareholder of the Turkish company, every transfer from the Turkish company to the master account must be assessed under this prohibition. Where the master account is held by a group company that is not a direct shareholder, the wording of the law does not apply directly. This does not mean that Article 358 TTK and the related penal provision are to be applied by analogy to sister companies; however, in structures that serve to channel funds to the shareholder in fact, the true nature of the transaction and the ultimate beneficiary of the funds must be determined, and such transfers must additionally be assessed under Article 202 TTK. Before the Turkish company joins the system, it should therefore be verified whether the shareholder has fulfilled its matured obligations arising from its capital contribution obligation and whether the company's profit, together with its free reserves, is sufficient to cover losses carried forward.

What are the liability and the compensation obligation of the controlling company?

Under Article 202 TTK, the controlling company may not exercise its control in a manner that causes a loss to the dependent (controlled) company; in particular, it may not induce the dependent company to transfer funds, make payments or provide guarantees and sureties. This prohibition does not apply, however, if the loss is actually compensated within the same financial year or if, by the end of the financial year at the latest, the dependent company is granted a claim of equivalent value specifying how and when the loss will be compensated. If no compensation is made, the shareholders and creditors of the dependent company may claim compensation for the company's damage from the controlling company and from those members of the controlling company's board of directors who caused the loss.

In the case of dependent companies wholly owned by the controlling company, the board of directors of the controlling company may, under Article 203 TTK, issue instructions to the dependent company, provided that these are required by the defined and concrete policies of the group. Under Article 204 TTK, however, no instruction may be given that clearly exceeds the dependent company's ability to pay, could endanger its existence or could lead to the loss of its significant assets. It is therefore important that participation in the cash pooling system remains within these limits and that the recoverability of the Turkish company's claim is monitored on an ongoing basis.

What liability do members of the board of directors and managers face?

The members of the board of directors or the managers of the Turkish company are subject to a duty of care with regard to the company's participation in the cash pooling system and the transactions within that system. A failure to monitor the financial position of the company holding the master account, the transfer of the company's funds abroad without security and without limit, or the provision of security in favour of group companies without regard to the statutory limits may give rise to personal liability under Article 553 TTK. While Article 395(3) TTK recognises that companies belonging to a group of companies may provide guarantees and sureties for one another, the law makes this possibility subject to the proviso that the limits set out in Article 202 TTK are observed.

Experience shows that local managers frequently implement cash pooling instructions received from group headquarters without assessing them separately. Under Turkish law, however, the source of liability is whether the manager has safeguarded the interests of his or her own company; it is therefore advisable to document the decision to participate in the system and the terms of participation by a resolution of the board of directors or the board of managers.

How do the thin capitalisation and transfer pricing rules apply?

For tax purposes, transactions under a cash pooling arrangement are treated as loan transactions between related parties. Under Article 13 of the Corporate Tax Law (KVK), transactions that entities conduct with related parties at a price or consideration determined in breach of the arm's length principle are deemed to constitute disguised profit distribution through transfer pricing, and the borrowing and lending of money is assessed within this scope in all circumstances. The interest that the Turkish company receives on funds it transfers to the master account and pays on funds it draws from the master account must therefore be at arm's length, and this must be documented.

With regard to the funds that the Turkish company draws from group companies under the cash pooling arrangement, the thin capitalisation rule in Article 12 KVK must be taken into account. Accordingly, borrowings that entities obtain directly or indirectly from their shareholders or from persons related to their shareholders and use in their business are assessed collectively, subject to statutory exceptions. The portion of these borrowings that, at any time during the fiscal period, exceeds three times the equity at the beginning of the fiscal period is deemed thin capital, and the interest relating to that portion is not deductible as an expense in determining the tax base. In addition, the limitation on financing expenses under Article 11(1)(i) KVK must be taken into account separately.

Do withholding tax, VAT and KKDF arise on interest payments?

Interest paid by the Turkish company under the cash pooling arrangement to a group company abroad may be subject to withholding tax under Article 30 KVK; the applicable rate has been set by Presidential Decree, and the provisions of the relevant double taxation treaty must additionally be taken into account. Intra-group financing transactions must also be assessed for VAT purposes. While interest earned by the Turkish company in return for financing provided to group companies is, as a rule, within the scope of VAT, a financing service provided to a group company abroad and used abroad may benefit from the service export exemption, provided that the conditions of Articles 11 and 12 of the Turkish VAT Law (KDVK) are met. Conversely, for interest relating to a financing service obtained from a group company abroad and used in Türkiye, a reverse-charge VAT return under Article 9 KDVK may become relevant.

Loans obtained from abroad by companies resident in Türkiye may also be subject to a deduction for the Resource Utilisation Support Fund (KKDF), depending on their maturity and currency. Since the characterisation of fund drawings under a cash pooling arrangement for tax and fund deduction purposes may vary depending on the operation of the system and the structure of the agreement, it is important that this assessment is carried out together with tax advisers before joining the system.

What must be considered under foreign exchange legislation?

The drawing of funds by the Turkish company from a master account abroad may constitute the obtaining of a loan from abroad for the purposes of foreign exchange legislation. Decree No. 32 on the Protection of the Value of the Turkish Currency and the related Communiqué subject the use of loans from abroad by persons resident in Türkiye, and in particular the use of foreign-currency loans, to restrictions linked to criteria such as the company's foreign-currency income and outstanding loan balance.

The Capital Movements Circular of the Central Bank of the Republic of Türkiye (CBRT) is also of particular importance in structuring international cash pooling systems. Under Article 48 of the Circular, companies resident in Türkiye may grant loans to their parent companies or group companies abroad; however, such loans may not be extended in the form of current-account (overdraft-type) or revolving credit. Similarly, Article 24 of the Circular, as a rule, restricts the use of revolving credit from abroad by persons resident in Türkiye other than banks and financial institutions. The feasibility of physical cash pooling structures based on daily cash transfers for a company in Türkiye must therefore be assessed separately, taking into account the legal nature of the fund movements and the restrictions under foreign exchange legislation.

In this context, the currency of the cash pooling system, the direction of fund transfers and the periods of use must be structured in a manner consistent with foreign exchange legislation. In practice, banks examine separately, within the framework of foreign exchange legislation and their own compliance rules, any request to connect accounts in Türkiye to an international cash pooling system.

What happens if the financial position of one of the group companies deteriorates?

The most significant risk of a cash pooling system arises if the financial position of the company holding the master account or of the group deteriorates. In that event, the funds transferred by the Turkish company to the master account may turn into an unsecured claim ranking equally with those of the central company's general creditors. If the Turkish company's own financial position deteriorates, its board of directors must fulfil the obligations relating to capital loss and over-indebtedness laid down in Article 376 TTK.

In addition, in the event of the Turkish company's bankruptcy or the issuance of a certificate of insolvency (aciz belgesi) against it, transfers made in favour of group companies within certain periods before the bankruptcy or attachment may become the subject of actions for annulment of transactions (actio pauliana) under Article 278 et seq. of the Enforcement and Bankruptcy Law (İİK). This risk makes it necessary to document carefully the terms of participation in the system and the related resolutions, particularly with regard to transfers made in periods of financial difficulty.

What should a cash pooling agreement provide for?

A cash pooling agreement to which the Turkish company becomes a party should expressly provide for upper limits on the amounts the company will transfer, for the interest rate to be set at arm's length, for regular information on the financial position of the central company and, in the event of its deterioration, for the right of the Turkish company to withdraw from the system with immediate effect and to reclaim its receivable. Provisions preventing transfers that could breach the borrowing restriction under Article 358 TTK or the restrictions on revolving credit under foreign exchange legislation should also be included in the agreement.

In international group agreements, such local restrictions are frequently addressed through a country schedule or a Turkish-law limitation clause added to the agreement. This approach preserves the group's standard contractual structure while ensuring that the Turkish company and its managers remain within the statutory limits.

Conclusion

The participation of a Turkish group company in a cash pooling system is subject to limits not only under the shareholder borrowing restriction in Article 358 TTK, but also under the rules on groups of companies in Article 202 et seq. TTK and the managers' duty of care. The provisions of the Capital Movements Circular that restrict the extension of loans to group companies in the form of current-account or revolving credit and the use of revolving credit from abroad directly affect, in particular, the feasibility of physical cash pooling structures for the company in Türkiye. For tax purposes, thin capitalisation, the limitation on financing expenses, transfer pricing, taxes withheld on interest payments, VAT and the fund deduction must also be assessed separately.

Before the decision to participate in the system is taken, the capital and financial position of the Turkish company should therefore be reviewed, the cash pooling agreement should be adapted to the limits of Turkish law, and the decisions relating to participation should be documented by the company's corporate bodies.

GEMS Schindhelm advises on the assessment of cash pooling and intra-group financing structures within groups of companies under Turkish company law, the adaptation of cash pooling agreements to Turkish law and the preparation of resolutions of management bodies. This article is for general information purposes only and does not constitute a legal opinion or legal advice; each transaction must be assessed separately according to the circumstances of the specific case and the legislation in force.