Deferred income tax asset or liability is defined as the deferred tax consequence1 attributable to a deductible or taxable temporary difference2. Income taxes currently payable for a particular year usually include the tax consequences of most events that are recognized in the financial statement for that year. However, because tax laws and financial accounting standards differ in the recognition and measurement of assets, liabilities, equity, revenue, expenses, gains and losses, differences arise between:
a) The amount of taxable income and pretax financial income for the year; and
b) The tax bases of assets or liabilities and their reported amounts in
financial statements.
Statement of Financial Accounting Standards No. 23, otherwise known as “Accounting for Income Taxes” recognizes the amount of taxes payable and refundable for the current year. Likewise, it recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been recognized in an enterprise’s financial statements or tax returns. It establishes standards of financial accounting and reporting for income taxes that are currently payable and for the tax consequences of :
a) Revenues, expenses, gains, or losses that are included in taxable income of
an earlier or later year than the year in which they are recognized in
financial income;
b) Other events that create differences between the tax bases of assets and
liabilities and their amounts for financial reporting; and
c) Operating loss carryforward to reduce taxes payable in future years.
From a regulatory point of view, however, deferred income tax asset is a minor concern. To ascertain the overall financial condition and results of operations of a bank, Section X106 of the Manual of Regulations for Banks removes any deferred income tax in the computation of risk-based capital adequacy ratio and risk assets ratio under Section 22 of R.A. No. 337. Further, the principal responsibility as to the fairness of presentation and integrity of the account rest primarily on the independent accountants.
Be it as it may and in furtherance of the review of internal control and operations risks, the following salient features of SFAS No. 23 may be of help to the supervisory examiner in verifying the veracity of any amount lodged under deferred income tax asset or liability.
1. An assumption inherent in an enterprise’s statement of financial position
prepared in accordance with generally accepted accounting principle is that
the reported amounts of assets and liabilities will be recovered and settled,
respectively.
2. The measurement of deferred income tax asset is reduced by a valuation
allowance, if necessary, by the amount of any tax benefits that, based on
available evidence, are not expected to be realized.
3. Deferred tax expense or benefit is the change during the year in an
enterprise’s deferred tax liabilities or assets. Total income tax expense or
benefit for the year is the sum of deferred tax expense or benefit and income
taxes currently payable or refundable.
4. Deferred tax liabilities and assets shall be adjusted for the effect of a
change in tax laws or rates. The effect shall be included in income from
continuing operations for the period that includes the enactment date.
5. An enterprise’s tax status may change from nontaxable to taxable or from
taxable to nontaxable. An example is a change in a tax law that changes the
tax status of an enterprise. A deferred tax liability or asset shall be
recognized for temporary differences. A deferred tax liability or asset
shall be eliminated at the date an enterprise ceases to be a taxable
enterprise. In either case, the effect of a change in tax status that results
from a change in tax law is recognized on the enactment date. The effect of
recognizing or eliminating the deferred tax liability or asset shall be
included in income from continuing operations.
6. Deferred taxes shall be determined as follows:
a) Identify the types and amounts of existing temporary differences.
b) Measure the total tax liability for taxable temporary differences.
c) Measure the total tax asset for deductible temporary differences.
d) Reduce deferred tax assets by a valuation allowance if, based on the
weight of available evidence, it is more likely than not (a likelihood of
more than 50%) that some portion or all of the deferred tax assets will
not be realized. The valuation allowance should be sufficient to reduce
the deferred tax assets to the amount that is more likely than not to be
realized.
Based on the foregoing, it is imperative that a bank under supervision and examination shall show sufficient cause and evidence that any amount booked under deferred tax asset will result in deductible amounts in future years and any amount booked under deferred tax liability will result in taxable amounts in future years3 based on provisions of the tax law; otherwise, the deferred income tax asset shall be reduced by a valuation allowance by the amount of any tax benefits that, based on available evidence and supervisory examiner’s judgment, are not expected to be realized and the deferred tax liability be restated to an amount that can be adequately supported.
SFAS No. 23 does not state a reglamentary period by which a foreseen event should happen. As such, some banks show periodic increment in its deferred tax asset as a consequence to a periodic loan-loss provisioning. It is the opinion of this writer that deferred tax consequences can be recognized only to asset amounts that are considered uncollectible and qualifies for write-off under existing applicable supervisory laws, regulations and circulars. Therefore, total deferred tax asset due to loan-loss provisioning at any given period shall not exceed the tax consequence of loans and receivables that are considered uncollectible and qualifies for write-off under existing applicable supervisory laws, regulations and circulars.
It is worthwhile reiterating that from the supervisory point of view, the deferred tax asset is deducted from the certified financial capital and any valuation allowance applied and provided to the deferred tax asset becomes immaterial to the computation of capital ratios.
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1 Future effects on income taxes as measured by the applicable enacted tax law resulting from temporary difference.