Adding Value In A Time Of Volatility Tax Topics For The Financial Services (Part 1)

As the recent financial crisis continues to reshape the global

financial services industry, there are many institutions who are

viewing this as an opportunity to 're-invent' the way they

do business. These institutions are examining what structural

changes their business will require in future, what long-standing

business processes need updating to meet the new market reality,

and what legacy systems are in need of an overhaul. They are also

examining their strategic direction, deciding what markets they

want to compete in, and even challenging the type of financial

institution they should be categorized as.

One key element of this business 're-invention' is to

carefully consider the tax impact of each of these market driven

changes. For example, acquisitions or divestments can have a

significant impact on the tax efficiency of an organization

– particularly the utilization of recent tax losses at

some business units – and this impact needs to be taken

into account before executing any deal. Tax considerations should

also be part of any operational redesign, with plenty of

opportunity to update transfer pricing models to the new

environment, or to further integrate tax reporting into finance

transformation programs. Finally, tax issues also need to be

included as institutions reshape their talent strategies,

particularly in their approach to executive compensation.

As the financial landscape continues to change, Deloitte's

Global Financial Services Industry network is committed to

providing continued thought leadership, surveys and studies on the

issues most important to global financial institutions.

Deloitte's aim is to help guide clients through these

challenging times and provide them with insights useful in not only

surviving the credit crisis, but essential for clients to

continue 'Thriving in a changing environment'.

Ellie Patsalos

Leader, Global Tax Financial Services Industry

TAX LOSS UTILIZATION - UNDERSTANDING THE UPSIDE OF

LOSSES

The current global financial crisis has left many financial

institutions awash with losses. However, the ability to utilize

these losses against future profits requires careful consideration

of local tax codes and an understanding of the time-sensitivity of

many of these tax losses.

The current global financial crisis has left many banks and

other financial institutions awash with losses. It might be

concluded that all will be plainsailing for the tax department in

the years to come as huge losses incurred through the downturn are

offset against potentially more modest profits, when the markets

eventually start to recover.

This could be a costly conclusion; now is not the time to turn

attention away from tax. But what action should the CFO be taking?

Where should the tax department focus its resources? How should it

measure its contribution and results in an environment where the

Effective Tax Rate (ETR) is becoming less relevant for many

companies?

No company can assume that the tax benefit of its operating

losses is a foregone conclusion. The CFO and tax director should be

ensuring that book losses are flowing through to the tax returns.

Both permanent and temporary or timing differences should be

understood and managed and all action should be taken with a view

to maximizing the company's ability to efficiently utilize

losses as the business recovers. In times of falling profits and

shrinking revenues tax authorities will be seeking to replenish

public coffers more than ever. A UK think tank, the Centre for

Economics and Business Research, recently put the loss of tax

revenues for the UK Treasury from the financial sector at GBP28bn

for the coming year.1 Members of the Joint International

Tax Shelter Information Center announced at the start of this year

their intention to work together to prevent manipulation of tax

losses by large banks and other businesses as they fear that new

and innovative ways of using tax losses will deprive them of

further tax revenues.2

It is absolutely essential in this environment that tax losses

and similar tax attributes are managed in real time, to minimize

risk of forfeiture and maximize current and future benefits. In

order to do this, tax should be considered at the start of the

decision-making process throughout this defining period.

Restructuring the business

Many companies are re-examining the way they do business,

determining the core successful business and restructuring to focus

on these areas. A takeover or a major change in shareholders (say,

arising through a merger of businesses) may limit a

corporation's ability to utilize losses incurred prior to the

transaction. Moreover, internal restructuring alone may be

sufficient to threaten available tax losses in some jurisdictions

or across multijurisdiction operations. At the simplest level, the

future use of losses arising in respect of a specific business may

be lost or badly limited in certain jurisdictions if that business

is terminated, even if the group as a whole continues to trade.

Consolidation of businesses, intended to reduce costs, may also put

tax losses at risk.

In profitable periods, loss restriction rules may not have been

considered in any depth in internal reorganizations, but during

periods of large losses – precisely the time when groups

are now likely to undertake major restructuring – these

rules must be considered carefully within the cost/benefit analysis

of any business model. The CFO will need to ensure that tax is

considered in the early stages of any reorganization.

Efficient loss utilization

To fully understand the impact on losses, the CFO must ensure

that the tax department is involved in business planning and

forecasting. It is all very well to protect a loss from inadvertent

forfeiture at the time of a restructure, but if significant losses

become trapped in an entity or jurisdiction where the business has

been restructured to limit future risk and therefore future profit,

it may be years before the benefit of these losses can be fully

realized. In a few jurisdictions, losses do not have a shelf life;

in many more jurisdictions, though, losses may expire if not used

within a fixed period.

One of the most effective ways to obtain a benefit from tax

losses is through carry-back against prior year profits, if

available. This may give certainty of use and result in a tax

repayment rather than a benefit at some time in the future. Such a

strategy may require a rethink of priorities and change in tax

department behavior. Early filing of returns may allow early

repayment of taxes and tax department resources should be refocused

accordingly. Helpfully, some tax authorities are acting to assist

early repayment of taxes. The 2009 Singapore Budget, for example,

includes temporary enhancements to the loss carry back regime,

including allowing provisional claims for tax refunds to be based

on estimated losses rather than finalized assessments.

Where tax losses cannot be immediately utilized, businesses need

to consider the extent to which losses carried forward can be

recognized for accounting purposes, as well as the value that

regulators might put on deferred tax assets representing loss

carryforwards. The lessons of the Japanese banks in the "lost

decade" should be remembered. A stark example of the risk

attaching to losses was the government rescue of Resona Bank in May

2003, following the bank's auditors refusing to recognize more

than three years of deferred tax assets.

Corporations cannot afford to risk a challenge from auditors who

must consider these assets with ever more caution, and banks and

other similar institutions might evaluate if there are transactions

pursuant to which deferred tax assets might be replaced with other

assets. More recently, the size of deferred tax assets included

within the regulatory capital of Fannie Mae and Freddie Mac were

widely debated when the US Treasury and Federal Housing Finance

Agency seized control of these entities last year. While it has

always been important, tax accounting has rarely had a higher

profile.

Tax vs. Book

Even assuming all tax losses may be recognized for accounting

purposes, there may be significant differences between book and tax

losses. The Board needs to be aware that a loss that has

crystallized in the books of the business may not necessarily be

triggered for tax purposes in the same period and therefore may not

be available for utilization. Many countries will not allow a tax

deduction for provisions or reserves; it is only when the loss is

realized that the deduction may be taken and even then, some

countries might impose onerous restrictions before write offs are

allowed.

This may result in material book tax differences. CFOs and tax

directors should be making sure that their Board knows exactly the

type and size of book losses that will not result in a tax loss and

at what point a tax loss may be triggered. This should not come as

an unpleasant surprise during financial reporting, or worse, when

cutting a cheque for the taxman.

The tax department needs to have good systems in place to

monitor differences between book and tax...