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FEDERAL RESERVE BANK
OF NEW YORK
[
Circular No. 10563
August 19, 1992
1
TREATMENT OF DEFERRED TAX ASSETS
Comment Requested by September 2
To All Depository Institutions, and Others
Concerned, in the Second Federal Reserve District:
The Federal Financial Institutions Examination Council (FFIEC) — representing the Board of
Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National
Credit Union Administration, the Office of the Comptroller of the Currency, and the Office of Thrift
Supervision — has requested public comment on the regulatory treatment of net deferred tax assets
of federally supervised banks and savings associations, for purposes of the Consolidated Reports
of Condition and Income (Call Reports) and the Thrift Financial Reports (TFR). The request is in
response to the adoption of the Statement of Financial Accounting Standards No. 109 (FASB 109).
Printed on the following pages is the text of the FFIEC’s official notice in this matter, as pub
lished in the Federal Register of August 3. Comments should be submitted by September 2, 1992,
and should be sent to the FFIEC, as indicated in the notice, or, at this Bank, to Barbara A. Klein,
Manager, Domestic Banking Department (Tel. No. 212-720-8324).
E. G e r a l d C o r r i g a n ,
President.
Comments should be
directed to Joe M. Cleaver. Executive
Secretary, Federal Financial Institutions
Regulatory Treatment of Deferred Tax Examination Council. 2100 Pennsylvania
A s s e ts
Avenue, NW.. suite 200. Washington.
DC 20037.
AGENCY: Federal Financial Institutions
FOR FURTHER INFORMATION CONTACT:
Examination Council.
At the FRB: Gerald A. Edwards. Jr.,
ACTION: Request for comment
Assistant Director (202) 452-2741. or
Charles H. Holm, Supervisory Financial
SUMMARY: Under the auspices of the
Analyst (202) 452-3502, Division of
Federal Financial Institutions
Examination Council (FFIEC), the Board Banking Supervision and Regulation. At
the FDIC: Robert F. Storch, Chief.
of Governors of the Federal Reserve
Accounting Section, Division of
System (FRB), the Federal Deposit
Insurance Corporation (FDIC), the Office Supervision (202) 898-8906. At the OCC:
Eugene W. Green, Deputy Chief
of the Comptroller of the Currency
Accountant, or Stephen P. Theobald.
(OCC), and the Office of Thrift
Professional Accounting Fellow. (202)
Supervision (OTS) (referred to as the
"agencies") are requesting comment on 874-5180. At the OTS: David H. Martens.
Chief Accountant (202) 906-5646.
and considering various regulatory
reporting and capital treatments for net SUPPLEMENTARY INFORMATION:
deferred tax assets of federally
I. Background
supervised banks and savings
National banks, state member banks,
associations ("depository institutions ’).
This request for comment is being issued and federally insured state nonmember
banks are required to file quarterly Call
in response to the adoption by the
Reports with the OCC, FRB. and FDIC.
Financial Accounting Standards Board
respectively. Savings associations are
(FASB) of Statement No. 109,
"Accounting for Income Taxes"(“FASB required to file TFRs with the OTS. In
addition, each federally supervised
109"). in February 1992.
The alternatives under consideration financial institution is subject to the
by the agencies include: (1) Adopting all minimum capital standards issued by its
provisions of FASB 109 for purposes of primary federal regulator.
Section 1006(c) of the Federal
reporting in the Consolidated Reports of
Financial Institutions Examination
Condition and Income (Call Reports)
Council Act authorizes the FFIEC to
and Thrift Financial Report (TFR) and
develop uniform reporting standards for
calculating regulatory capital. (2)
federally supervised financial
adopting most provisions of FASB 109
for purposes of the Call Report and TFR. institutions. Section 1006(b) of the FFIEC
but prohibiting the reporting of that
Act directs the FFIEC to make
portion of net deferred tax assets that is recommendations to its member
not supported by the amount of taxes
agencies for uniformity in supervisory
previously paid that are potentially
matters. Therefore this request for
recoverable through the carryback of net comment is being proposed under the
operating losses or tax credits, (3)
auspices of the FFIEC.
adopting most provisions of FASB 109
In addition, section 121 of the FDIC
for purposes of the Call Reports and
Improvement Act (FDICIA) indicates
TFR. but limiting the reporting of net
that the agencies shall maintain uniform
deferred tax assets in a manner that is
accounting standards. Section 121 of the
consistent with Accounting Principles
FDICIA also indicates that the
Board Opinion No. 11, "Accounting for accounting principles of the agencies
Income Taxes" ("APB 11"). and (4)
should:
adopting one of the above limitations on
(A) result in financial statements and
net deferred tax assets only for
reports of condition that accurately
regulatory capital purposes rather than reflect the capital of the institution;
for both regulatory reporting and capital
(B) facilitate effective supervision of
purposes. The agencies seek comment
the institution; and
on whether, with respect to insured
(C) facilitate prompt corrective action
depository institutions, these
to resolve the institution at the least cost
approaches or any other approaches
to the insurance funds.
would be an appropriate supervisory
If the agencies determine that the
response by the agencies to the new
application of generally accepted
reporting guidance set forth in FASB
accounting principles (GAAP) is
Statement 109.
inconsistent with these objectives.
DATES: Comments must be received by
FDICIA permits the agencies to
September 2, 1992.
prescribe an accounting principle that is
FEDERAL FINANCIAL INSTITUTIONS
EXAMINATION COUNCIL
ADDRESSES:
2
no less stringent than GAAP,
II. Discussion and Concerns
Characteristics of Net Deferred Tax
Assets
Net deferred tax assets may arise
because of specific limitations under tax
laws of different tax jurisdictions that
require that certain net operating losses
(i.e.. when, for tax purposes, expenses
exceed revenues) or tax credits be
carried forward if they cannot be used
to recover taxes previously paid * These
net operating loss or tax credit
carryforwards are realized only if the
institution generates sufficient future
taxable income during the carryforward
period.
Net deferred tax assets may also arise
from the tax effects of certain events
that have been recognized in one period
for financial statement purposes but will
result in deductible amounts in future
periods for tax purposes, i.e., the tax
effects of deductible temporary
differences. For example, many
depository institutions may report
higher income to taxing authorities than
they reflect in their regulatory reports
because of differences between tax
reporting and financial reporting with
respect to the treatment of the
allowance for loan and lease losses.
Deferred tax assets, arising from an
institution’s deductible temporary
differences, may exceed the amount of
taxes previously paid that the institution
could recover if the difference fully
reversed at the report date. Thus, similar
to net operating loss and tax credit
carryforwards, these deductible
temporary differences will be realized
only if there is sufficient future taxable
income during the carryforward period.12
Current Regulatory Policies and
Progression of GAAP
In 1985, the OCC and FDIC issued
supervisory policies that limited the
1 The term "net" deferred tax assets is used
herein because FASB 109 permits the netting of
deffered tax liabilities and assets within a
particular tax-paying component of an enterprise
and within a particular tax jurisdiction. Netting of
deferred tax assets and liabilities attributable to
different tax-paying components of the enterprise or
to different tax jurisdictions is not permitted. The
agencies intend to permit netting to the same extent
that netting is permitted by FASB 109
2 Net deferred tax assets that are associated with
net operating loss or tax credit carryforwards and
net deferred tax assets, arising from deductible
temporary differences, that exceed the amount of
taxes previously paid that the institution could
recover if the differences fully reversed at the report
date are hereafter referred to as "net deferred tax
assets that are dependent upon future taxable
income".
reporting of net deferred tax assets
(charges) in the Call Reports filed by
national and insured state nonmember
banks, respectively. The FDIC’s policy,
set forth in bank Letter BL-36-85, dated
October 4,1985, states:
Banks are perm itted to carry net deferred
tax charges on their reports o f con d ition to
the ex ten t that such tax charges do not
e x c e e d ta x e s p reviou sly paid w h ich are
p o ten tia lly a v a ila b le through carryback o f net
op eratin g lo s s e s (NOLs). A bank w h ich is a
m em ber o f a co n solid ated group for tax
p u rp oses (e.g., certain bank su b sid iaries of
h olding com p anies) should gen erally
ca lcu la te its NOL carryback p otential b ased
upon the assu m p tion that it is filing a
sep arate return. H ow ever, if the NOL
carryback p otential o f the con solid ated group
is le s s than that o f the ban k s (e.g., w h ere
other su b sid ia ries h ave exp erien ced prior net
operating lo sse s), then the bank should
further limit its net deferred tax charges to an
am ount w hich it could reason ab ly ex p ect to
h a v e refunded by its parent. The O C C s
policy, set forth in Banking Circular 202 dated
July 2.1985. in clu d es language that is
co n sisten t with the FDIC p olicy. T he OCC
and FDIC a d o p ted their su p ervisory p olicies
b eca u se o f con cern s about the realizab ility of
an institution’s net deferred tax charges in
e x c e s s o f its net operating lo ss carryback
potential.
With respect to the recognition of net
operating loss carryforwards, the OCC’s
and FDIC’s policies were generally
consistent with APB 11, the GAAP
standard in existence at the time these
policies were issued. APB 11 did not
allow the recognition of such benefits
unless their realization was assured
beyond any reasonable doubt.
Furthermore, these two agencies’
policies were generally consistent with
FASB Statement No. 98, “Accounting for
Income Taxes" ("FASB 96”), a GAAP
standard issued in 1987, which some
institutions s u b s e q u e n t ly adopted in lie u
of APB 11.
The FRB and OTS did not issue
policies explicitly addressing the
recognition of net deferred tax assets.
Consequently, state member banks and
savings institutions were able to report
net deferred tax assets in accordance
with GAAP. Since the explicit guidelines
issued by the OCC and FDIC were for
the most part consistent with GAAP, the
reporting criteria applicable to all
depository institutions were similar.
In February 1992, the FASB issued
Statement No. 109, which supersedes
APB 11 and FASB 96. FASB 109 provides
guidance on many aspects of accounting
for income taxes, including the
accounting for deferred tax assets. FASB
109 potentially allows some institutions
to record significantly higher net
deferred tax assets than previously
permitted under GAAP. Statement 109 is
effective for fiscal years beginning on or
after December 15,1992, but early
adoption of this standard is encouraged
by the FASB. The recording of
additional net deferred tax assets in
Call Reports and TFRs in accordance
with FASB 109 would directly impact an
institution’s Tier 1 capital and earnings.
Contrary to the general practice under
APB 11, FASB 96, and the policies off the
OCC and FDIC, FASB 109 permits the
reporting of deferred tax assets
associated with net operating loss and
tax credit carryforwards. Moreover,
compared to these standards and
policies, FASB 109 generally permits a
more liberal recognition of net deferred
tax assets arising from deductible
temporary differences when the
realization of deductible temporary
differences is dependent upon taxable
income during the carryforward period.
However, FASB 109 requires the
establishment of a valuation allowance
that is intended to reduce the net
deferred tax asset to an amount that is
more likely than not (i.e., a greater than
50 percent likelihood) to be realized.
Arguments For and Against Regulatory
Limitations on Net Deferred Tax Assets
Arguments can be made both for and
against permitting institutions to
recognize, in regulatory reports and for
capital adequacy purposes, net deferred
tax assets that are dependent upon
future taxable income. On the one hand,
institutions that are ultimately able to
realize these net deferred tax assets will
benefit from a reduction in the future tax
payments that they otherwise would be
obligated to make. For many healthy
institutions, these benefits may
eventually result in a realizable asset.
Thus, from this perspective, it could be
argued that some institutions should be
able to report net deferred tax assets
that are dependent upon future taxable
income and increase their Tier 1 capital
levels.
On the other hand, institutions that
are unable to realize their net deferred
tax assets may be more likely to pose a
risk to the deposit insurance funds.
Moreover, it may be difficult to
accurately distinguish those institutions
that will benefit from these assets from
those that will nbt. The ultimate
realization of a net deferred tax asset
depends on the existence of taxable
income during the carryback or
carryforward period. The existence of
taxable income and associated tax
payments during the carryback period
provides greater assurance that net
deferred tax assets will be realized. In
3
the absence of sufficient taxable income
during the carryback period, realization
of the net deferred tax asset depends on
whether an institution has sufficient
future taxable income during the
carryforward period.
Since an institution that is in a net
operating loss carryforward position is
often experiencing financial difficulties,
its prospects for generating sufficient
taxable income in the future are at best
uncertain. In addition, the condition of
and future prospects for an institution
often can and do change very rapidly in
the environment in which depository
institutions operate. This raises
concerns about the realizability of net
deferred tax assets that are dependent
upon future taxable income, even when
an institution appears on the surface to
be sound and well-managed. Thus, for
many institutions, such net deferred tax
assets may not be realized and, for other
institutions, there will be a high degree
of subjectivity in determining the
realizability of this asset.
In addition, as an institution’s
condition deteriorates, it is less likely
that net deferred tax assets that are
dependent upon future taxable income
of the institution will be realized.
Therefore, the institution would be
expected under FASB 109 to reduce its
net deferred tax assets through
increases to the asset’s valuation
allowance. This reduces the institution’s
regulatory capital at precisely the time it
needs capital support the most. Thus,
the reporting of net deferred tax assets
that are dependent upon future incomes
raises, for safety and soundness
reasons, a significant supervisory
concern.
Moreover, net operating loss
carryforwards of an acquired institution
can be severely limited to the acquirer
when an acquisition or change in control
occurs. If an acquisition is structured as
a taxable asset purchase, the net
operating loss carryforwards are
generally extinguished. In addition, if an
acquisition or change in control qualifies
as a tax-free reorganization, a strict
limitation (Section 382 of the Internal
Revenue Code) on the use of the
acquired institution’s NOL
carryforwards generally applies. This
limitation is based on the value of the
acquired corporation at the time of its
acquisition, and thus the potential value
of a carryforward to a prospective
purchaser tends to decline as the
institution’s financial condition
weakens.
Because of these concerns, the
agencies recently issued separate letters
ItiSfo
to the depository institutions under their generally less likely to be able to realize
3. Amending the Call Report and TFR
supervision indicating that the
this asset than institutions that are in a
instructions to adopt most aspects of
institutions should not adopt FASB 109
FASB 109, but limiting the reporting of
stronger financial condition. In order to
or regulatory purposes until the
provide greater protection to the deposit net deferred tax assets, net of their
appropriate regulatory reporting and
valuation allowance, in a manner that is
insurance funds and to provide more
capital treatment is determined.3
objectivity to the valuation process, this consistent with APB 11. APB 11
generally does not permit the reporting
III. Alternative Approaches for Deferred supervisory guidance would likely
mandate valuation allowance levels for of net deferred tax assets arising from
Tax Assets
net operating loss carryforwards.
institutions experiencing financial
As part of their consideration of FASB difficulties. Thus, this supervisory
However, some accountants believe that
109, the agencies have determined to
APB 11 in some cases permits the
guidance
may
not
be
entirely
consistent
seek public comment on alternative
reporting of net deferred tax assets
with
FASB
109.
Furthermore,
this
treatments of net deferred tax assets for
arising from temporary differences
approach
does
not
necessarily
alleviate
regulatory reporting and capital
(referred to as “timing differences” in
the concern that capital would be
purposes. In general, the agencies
APB 11) that are realizable only if there
reduced
at
the
time
the
institution
needs
believe that most provisions of FASB
is sufficient future taxable income. By
capital support the most.
109 are appropriate for supervisory
limiting the amount of such assets that
2.
Amending
the
Call
Report
and
TFR
purposes and can be adopted by the
could be reported under this approach,
instructions to adopt most aspects of
agencies for regulatory reporting
the Tier 1 capital of an institution would
FASB 109, but limiting the reporting of
purposes. However, the agencies are
similarly be affected. This approach has
net deferred tax assets, net of their
concerned about those provisions of
the advantage of generally being
FASB 109 that as noted above, permit
valuation allowance, to the amount of
consistent
with the existing policies of
institutions to recognize net deferred tax taxes previously paid that are
the FRB and OTS, which permitted
assets that are dependent upon future
potentially recoverable through the
institutions to report net deferred tax
taxable income. Therefore, the agencies carryback of net operating losses or
assets under APB 11 (or alternatively,
are seeking public comment on the
unrealized tax credits.4*This approach
under
FASB 96). On the other hand, this
appropriate regulatory treatment for
would not be consistent with FASB 109.
approach would maintain a reporting
these assets. The alternatives under
However, it would be consistent with
standard for net deferred tax assets that
consideration by the agencies include:
the current supervisory policies of the
has been superseded by FASB 109 and
1.
Amending the Call Report and TFRFDIC and OCC. Furthermore, this
would be inconsistent with the current
instructions to adopt all aspects of FASB approach would, for the most part, be
policies of the OCC and FDIC.
109 for regulatory reporting (and capital consistent with the policies of the FRB
4. The above approaches could
adequacy) purposes. Because FASB 109 and OTS, which permitted institutions to
provide for a more stringent reporting
provides for a limitation on the
report net deferred tax assets in
limitation on net deferred tax assets
recognition of net deferred tax assets
accordance with FASB 96 and APB 11.
than is required by FASB 109. Rather
through establishing a valuation
The agencies have long believed that
than adopting a more stringent
allowance, it could be argued that the
such limitations on the reporting of net
limitation for reporting purposes, an
agencies might not need to provide for
deferred tax assets are appropriate
alternative would be to adopt one of the
additional limitations on these assets.
because of the concerns noted above
above limitations only as an adjustment
The reporting of this asset would be
with respect to the realization of this
to regulatory capital calculations. Net
subject to review by examiners and, if
asset. While no final determination will
deferred tax assets in excess of the
applicable, an institution’s external
be made until all comments are
prescribed limitation would be deducted
auditor. This approach has the
received, the agency staffs believe this
in determining Tier 1 capital for riskadvantage of maintaining consistency
approach would be the most appropriate based, leverage, and tangible capital
between GAAP and the regulatory
course of action at this time because of
ratio purposes, and a depository
reporting and capital treatment of net
the concerns noted above.8
institution would have the same
deferred tax assets. However, as noted
regulatory capital ratios as if the same
4 An institution that is a member of a
above, the agencies are concerned that
limitation had been adopted for
consolidated group for tax purposes (e.g., certain
this alternative could result in an
regulatory reporting purposes. This
depository institution subsidiaries of holding
companies) would be instructed generally to
immediate and potentially significant
approach has the advantage of
its carryback potential based upon the
maintaining
consistency between
reduction in capital at precisely the time calculate
assumption that it is filing a separate return.
regulatory reporting instructions and
the institution needs capital support the However, if the carryback potential of the
GAAP. However, unlike a reporting
most.
consolidated group is less than that of the
(e.g.. where other subsidiaries of the
limitation, it would allow institutions to
A variation of this approach would be institution
holding company have experienced prior net
report earnings based on net deferred
for the agencies to issue supervisory
operating losses), then the institution would be
tax assets that may not be realized.
instructed
to
further
limit
its
net
deferred
tax
asset
guidance on the determination of the
Furthermore, since certain dividend
to an amount that it could reasonably expect to
amount of the valuation allowance
have refunded by its parent.
restrictions (i.e., 12 U.S.C. 60 and similar
needed for an institution’s net deferred
8 Although this proposed reporting instruction is.
tax assets to supplement the guidance
tax asset amounts in excess of what they would be
for the most part, consistent with GAAP prior to the
allowed under this approach. Therefore, state
adoption of FASB 109, some differences exist. For
provided in FASB 109. Institutions
member banks and savings associations would be
example. APB 11 did not require the automatic
exhibiting financial weaknesses are
able to continue to report such excess net deferred
* OTS' letter indicated that savings associations
could adopt the provisions of FASB 109, except that
any net deferred tax asset could not exceed what
was allowed to be reported under APB 11 or FASB
96.
write-off of net deferred tax assets arising from
deductible temporary differences (referred to as
“timing differences" in APB 11) that are dependent
on future taxable income. Since state member banks
and savings associations previously followed GAAP
for reporting net deferred tax assets, these
institutions may have reported some net deferred
4
tax assets, to the extent they remain unamortized,
provided the assets are recorded prior to the
adoption of a final rule. This provision would also
be followed if another alternative were adopted that
required a limitation on deferred tax assets that is
stricter than the limitation under APB 11.
(t&3>
Comment is also sought on whether any
other approaches might be appropriate.
In addition, specific comment is
solicited on the following issues:
1. Whether there are certain deferred
tax assets, associated with specific
IV. Issues for Comment
events or other factors, that possess
The agencies seek comment on which, characteristics that reduce or eliminate
if any, of the above possible approaches the agencies' concerns relative to the
for addressing net deferred tax assets is realization of net deferred tax assets.
appropriate in light of the agencies’
2. What criteria could be used to
supervisory concerns about net deferred distinguish institutions that are likely to
tax assets that are dependent upon
be able to realize net deferred tax assets
future taxable income and the objectives that are dependent upon future taxable
that regulatory accounting principles
income from those institutions that are
must satisfy as set forth in FDICIA.
not likely to realize these assets.
state statutes) for banking institutions
are based on reported earnings, it could
allow such institutions to pay dividends
based on the increased earnings arising
from reporting such assets.
5
3.
If an approach were adopted by the
agencies that is more conservative with
respect to net deferred tax assets than
APB 11, whether the grandfathering
provision for state member banks and
savings associations that is discussed in
footnote 5 should be adopted.
Dated: July 29,1992.
Joe M. Cleaver,
Executive Secretary, Federal Financial
Institutional Examination Council.
|FR D oc. 92-18245 F iled 7-31-92; 8:45 am]
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