Bala Balachander, Director, Deloitte & Touche LLPJohn Kinsella, Tax Director, U.S. BankLawrence Luebbers, Partner, Deloitte Tax LLP

November 7, 2014

Tax Accounting: A Regulatory & Tax Perspective

• Introduction to U.S. Capital Regulations• U.S. Basel III final rules: Summary• DTA: Capital treatment under Basel III• DTA / NOL Planning Opportunities• Practical Implications for Tax Professionals • Question and Answer

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Agenda

Introduction to U.S. Capital Regulations

Basel Regulation

• Sets risk and capital management requirements stipulating banks hold sufficient capital reserves consistent with their risk profile.

• Rules were initially developed in 1988 and have since been implemented (are being implemented) in most countries, placing internationally active banks on comparable footing with respect to capital requirements.

• The Basel Accord was formed from guidance provided by the Basel Committee on Banking Supervision (BCBS)• Consists of central-banks and banking supervisors of the group of G10 countries (now

expanded to G20 countries)• Looks to promote safety and soundness within the global banking system; formulates

broad supervisory standards and guidelines, and recommends best practices• Expects that authorities of individual member countries will take steps to implement

standards and guidelines through national systems; thus, rules are somewhat different across jurisdictions, particularly between US and EU

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Basel III: A significant milestone for U.S. banks

• The U.S. Basel III rules (finalized in early 2013), comprehensively overhauls the regulatory capital framework for banking organizations

• The U.S. Basel III final rules are generally aligned with the Basel Committee on Banking Supervision (BCBS) guidance - with differences primarily resulting from Dodd-Frank Act provisions

• Rules are already effective for the larger US banking institutions as of Jan 1, 2014; Effective date for smaller banks is Jan 1, 2015

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Basel III: A significant milestone for U.S. banks (continued)

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• All U.S. banks were operating under Basel I regime

• In U.S., Basel II was applicable to the largest banks only

• The Basel III regulations, not only make changes to Basel II regulations, but also introduces sweeping changes for the non-Basel II banks

2010 2011 2012 2013

2010: BCBS Basel III guidance

Dodd-Frank Act

• Basel III NPR (capital, standardized, advanced)

• Market risk final rule

• Basel III final rule (capital, standardized, advanced)

• Market risk NPR• Supplementary

leverage ratio NPR

1989 1997 2007

U.S. Basel I rule U.S. Basel

II rule

2004: BCBS Basel IIguidance

1996: BCBS market riskguidance

1988: BCBS Basel Iguidance

U.S. market risk rule

Basel Capital Adequacy Framework

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Pillar 1 Pillar 2 Pillar 3

Minimum Capital Requirements Supervisory Review Market Discipline

• (Tier1 & Tier 2 Capital)/ (Risk‐Weighted Assets) >= Minimum Capital (8%)

• Includes Credit, Market, and Operational risks

• Capital calculation is based on a combination of internally estimated inputs and Supervisory formula

• Increased reliance on internal processes and data

• Bank’s to have an internal estimate of capital adequacy, covering all applicable risks, over and beyond the minimum capital requirements (ICAAP)

• Supervisors to evaluate each bank’s overall risk profile as well as its risk management and internal control processes

• Expectation is to hold capital beyond the minimum required

• Stress testing 

• Mandates a common set of minimum disclosure requirements intended to improve transparency

• Broad range of quantitative and qualitative information covering various aspects

• While a bank may not be subject to U.S. Pillar 3 requirements, it still may be subject to other U.S. Basel III reporting requirements

Basel Accord

• The safety and soundness objectives of Basel regulations are achieved through three mutually reinforcing pillars

Minimum Capital Requirements

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• Banks required to maintain a minimum amount of Regulatory Capital relative to its Risk Weighted Assets (RWA)

÷ ≥

Market Risk RWA Operational Risk RWA

Risk Weighted Assets (RWA)Regulatory Capital Minimum Capital

+                                   +  Credit Risk

Evolving U.S. banking regulatory landscape

While significant, Basel III is part of the larger regulatory effort to overhaulrisk management

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Early remediation

SingleCounterparty

limits

Risk committeeand

governance

Basel III

Volcker rule

Resolutionplan

Stress testingand

capital plan

Liquidityrisk

Disclosureand

reporting

U.S. Basel III final rules: Summary

Basel III impacts a larger set of banksThe Basel I and Basel II distinction is replaced by standardized and advanced approaches respectively

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Standardized approach (credit)

Basel III capital

Advanced approach (credit)

• Replaces current Basel I/II capital calculation methodology• Stricter definition of capital; higher amount of deductions applied to CET1• Higher minimum thresholds, and buffers as applicable

• Replaces current Basel I RWA calculation methodology• Eliminates references to external credit ratings (across all Basel III

approaches)• Adopts a more risk sensitive methodology for various asset classes• Establishes the floor for advanced approaches banks (Collins

Amendment)

• Enhances current Basel II RWA calculation methodology• Increases capital requirements through additional requirements – especially

for counterparty and securitization exposures

• Replaced Basel I market risk rules; effective January 2013• Introduced new risk charges that increase RWA estimates• Banking book treatment for securitizations in trading book

Market risk

Standardized approach banks(Former Basel I banks)

Advanced approach banks (more than $250 B in total assets or $10B in foreign exposure)

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2 2

Key aspectsAreas

Implementation timelinesCapital transitions to be completed by 2018; Implementation timelines aremore immediate

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Basel III replaces Basel I and modifies Basel II

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Basel III – Snapshot and key takeaways

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Capital structureBasel III strengthens and simplifies regulatory capital structure

• CET1 is a new category of capital under Basel III• Most deductions applied to CET1, instead of Tier 1 and Tier 2, increasing the CET1 requirement• Additionally, Tier 1 and Tier 2 are simplified, by eliminating various sub-limits in each; and eligibility

criteria are strengthened

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Deferred Tax Assets: Capital Treatment under Basel III

Capital deductions and adjustmentsA series of adjustments and filters are applied to book equity to determine the capital eligible for Common Equity Tier 1 (CET1) and other regulatory capital tiers; some of these adjustments are similar to those under Basel II.

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• U.S. rules for insurance subsidiaries is very different from international guidance• ^ Standardized approach banks can make a one‐time election to opt‐out

DTA Treatment pre-Basel III

• A net DTA is allowed to the extent of the lower of• 10% of the Total Regulatory Capital• The amount that can be used in one subsequent year

• A net DTA can be reduced by a carryback prior to applying the rules above

• DTAs can generally be netted with DTLs• Certain DTLs in OCI can be either:

• Adjusted out of regulatory capital as a net amount with the OCI item• Pulled out of OCI and netted against the DTA

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DTA Treatment under Basel III

• DTA arising from temporary differences that the banking organization could not realize through NOL carrybacks included in a bucket with MSRs and Equity in Financial Institutions

• Total Limited to 15% of Regulatory Capital• Each item can not be more than 10% of regulatory capital• DTAs not deducted will be risk weighted at 250%

• Deferred tax assets (DTAs) that arise from net operating loss and tax credit carry-forwards to be fully deducted from CET1

• Phase in begins in 2014• 20% per year through 2018• 2014-2018 will require current and Basel III calculations

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DTA Treatment under Basel III (contd.)

• DTLs can be netted against DTAs provided:• DTAs and DTLs related to taxes levied by the same

taxation authority and are eligible for offsetting• DTLs must be allocated proportionately between DTA

arising from NOLs and DTA arising from temporary differences

• DTLs netted with other assets subject to deduction (Goodwill, Intangibles etc.) cannot used for netting against DTAs

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DTA Treatment under Basel III - Considerations

• Institutions will need to consider the amount DTAs from temporary differences in conjunction with MSRs and other Financial Institution Investments

• Move away from DTAs from NOL to other types of DTA

• Multi-state banks may need to perform netting on a state-by-state basis

• Usage of DTLs not used for netting in the numerator for netting against DTAs to be risk-weighted in denominator

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DTA/NOL Planning Opportunities

DTA/NOL Planning Opportunities

There is an opportunity to utilize DTAs and expiring NOLs by implementing certain DTA/NOL tax planning strategies.

These planning strategies can be implemented in the form of:

• Certain elections and other miscellaneous items• Accounting Method Changes

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Elections and other misc. items

A taxpayer may elect to capitalize certain costs in the year they are incurred opposed to deducting these costs which may provide an opportunity to increase income for a particular year. Some of these elections include but are not limited to:

• Capitalization of employee compensation and overhead under 1.263(a)-2T(f)(2)(iv)• Capitalization of costs under section 1.266-1 – Under section 266, a taxpayer may

elect to capitalize taxes and carrying charges related to real or personal property.• Election to capitalize research and experimentation costs under section 59(e)

Other elections and miscellaneous items include:• Electing out of bonus depreciation• Inclusion of disputed receivables in income• Changes to accrued bonus, vacation and sick pay plan

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Accounting Method Changes

Filing a Form 3115, Application for Change in Method of Accounting, for the method changes listed below, can result in an increase in taxable income to offset pre-existing NOLs. An accounting method change can be either classified as either automatic or advanced consent. The following are examples of accounting method changes that can be effectuated by filing a Form 3115:Automatic method changes:• Direct reallocation method• Full inclusion method• Capitalization of software development costs• Timing of liabilities

Advanced Consent method changes:• Accrual method to cash method for self-insured medical, worker’s

compensation, and retiree medical benefits• Expense to amortization for certain non-deductible prepaid expenses

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Practical Implications for Tax Professionals

CCAR / DFAST Process

Largest financial institutions have been required to do annual “stress tests”• Annual process with the Federal Reserve to determine capital adequacy in financial

institutions under various scenarios• Started in 2009 for the 18 largest financial institutions (originally called SCAP)• Expanded in 2013 to another 12 financial institutions; over $50B in assets• Capital rules eventually apply to all financial institutions

Implications for Tax Professionals• Participation in a rigorous process in assembling projections

• Income statement • Balance sheet• Coordination with Treasury, Finance, other parties

• Critical to understand tax related capital calculations• Very important to have broader understanding of how certain other items are

treated in the capital calculation and how they relate to tax calculations

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CCAR / DFAST Process (continued)

Implications to Tax Professionals (continued)• Deliverables

• Calculation of effective tax rate• Calculation of estimated current tax payable• Carryback capacity• AMT/Business credit limitation

• Estimation of temporary differences and impact on DTA/DTL• Calculation of estimated DTA that may be relevant for capital calculation

• Grossed up DTA’s / DTL’s• Carryback analysis• Carryforward identification• Allocation of DTL’s to various DTA’s

• Documentation

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CCAR / DFAST Process (continued)

Implications for Tax Professionals (continued)• Other considerations

• Technology• Process integrity• Coordination with other reporting• Tax return / estimated taxes• Required scenarios and timing• Role of advisors

Federal Reserve Methodology• “Black Box”

• Simplifying tax rate assumptions used• Potential distortion of capital levels

• ABA and Clearinghouse Initiatives• Governor level• Staff level meetings

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External Reporting

GAAP• Heightened expectations• Materiality• Capital ratio disclosures

Regulatory • DFAST / CCAR• Call reports• Legal entity integrity

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