New Basel III Deferred Tax Asset Rules Apply to Call Reports for the Quarter Ending March 31, 2015
The new Basel III rules affecting, among other things, the amount of deferred tax assets that count towards regulatory capital become effective for the first time with the Call Report quarter ending March 31, 2015. The new rules are quite different than the old rules in that they: 1) abandon the twelve-month, forward-looking-utilization component of permissible deferred tax assets, 2) disallow deferred tax assets from NOL and credit carryforwards entirely, and 3) require an allocation of deferred tax liabilities between allowed and disallowed deferred tax assets.
The new rules continue to incorporate the principle that deferred tax assets that could be recovered in a hypothetical carry-back refund claim if all the temporary differences had reversed on the balance sheet date of the Call Report count as regulatory capital, with the related asset given a 100% risk-weighting.
The new rules also provide a 10%-of-Common-Equity-Tier 1 capital limitation, but as a permissible deferred tax asset component, limited to deferred tax assets resulting from temporary differences (not NOL or credit carryovers) in excess of those that could be realized in the hypothetical carry-back mentioned above. This permissible deferred tax asset component is risk weighted 250%.
Deferred tax liabilities related to intangible assets such as goodwill and core deposit intangibles, which are themselves disallowed as regulatory capital, can either be netted against the related intangible asset in determining the adjustment to capital for that asset or netted with other deferred tax liabilities against deferred tax assets in the process mentioned above.
Most importantly, the new rules provide community banks a one-time election on the Call Report for the quarter ended March 31, 2015 to exclude items of AOCI from regulatory capital. If this so-called “opt-out” election is made, then the items of AOCI are netted by their related deferred tax amounts in determining the adjustment to regulatory capital.
The new rules will require institutions to sort through their deferred tax items separating them into the various categories mentioned above and also separating them by taxing jurisdiction to assure that deferred tax liabilities in one jurisdiction are not offset against deferred tax assets in another jurisdiction. Institutions must also note that the new rules are further complicated by the provision that the deductions from Common Equity Tier 1 capital discussed above phase in over four years, commencing with 2015. Finally, while the new rules “overlay” underlying GAAP, they do not replace it. Thus, the rules apply to deferred tax assets net of GAAP valuation allowances. The example to the right illustrates the new rules.
In the example, the DTA allowed as regulatory capital is $19,000 ($25,000 gross DTA, less disallowed NOL/credit carryforward DTA of $5,200 and disallowed temporary difference DTA of $800).
Getting the calculations and the elections correct the first time while always important is especially so this quarter. If you have questions about the application of the new rules, contact us.