Loss absorbing capacity of deferred tax : Chapter 8 , Pg 12

Discussion in 'SA2' started by Jishnu Bhatia, Jan 1, 2019.

  1. Jishnu Bhatia

    Jishnu Bhatia Member

    Hi everyone,

    Could anyone please explain the loss absorbing capacity of deferred tax in detail, may be through an example. Basically I am not clear which stress event is used, i.e. 99.5th stress or some average stress or loss is calculated in each stress separately?
    And thereafter the change in value of deferred tax is calculated.
     
  2. Em Francis

    Em Francis ActEd Tutor Staff Member

    Hi

    LACDT is the beneficial change in value of deferred taxes arising from the stresses applied in the SCR calculation. As this is the SCR calculation it will be the 99.5th stress.

    So, for example, say that there are unrealised equity gains of 100m before stress and that these fall to 60m after the SCR equity fall stress is applied. Assume this is taxed at 20% (ignoring any discounting due to deferral); then tax due falls from 20m to 12m. The reduction in deferred tax liability of 8m can be recognised on the SII balance sheet. This happens through the adjustment to the Basic SCR as described in Chapter 11; in this case the SCR will be 8m lower due to the LACDT.

    Hope this helps.

    Thanks
    Em
     
    Hemant Rupani likes this.
  3. Jishnu Bhatia

    Jishnu Bhatia Member

    Hi Em,

    I understand your example. Thanks for replying.

    So you are saying here that in B/sheet company would be holding 20m DTL in BEL and -8m in SCR. Therefore 12m of DTL in total. But in reality the company has to pay this 20m in future if the adverse scenario doesn’t arise. So aren’t we under reserving for this future tax liability in the books?

    Thanks,

    Jishnu Bhatia
     
  4. mugono

    mugono Ton up Member

    The DTL entry on the balance sheet remains unchanged. Therefore there is no ‘under reserving’. DTL is not a component of BEL.

    The adjustment as described by Em is recognised within the capital requirement (SCR).
     
  5. Em Francis

    Em Francis ActEd Tutor Staff Member

    Hi
    Thank you Mugono
    Yes, you right.

    The DTL remains at 20m, as part of the ‘reserves’ (provisions) being held. Remember that the point of the SCR is to provide sufficient capital to meet provisions under stressed conditions. If the adverse scenario arises, the tax bill will be 8m lower - so the amount of capital required to be held to meet such a scenario (ie the SCR) can also be 8m lower to reflect this. If the adverse scenario does not arise, the SCR is not needed and can be released as the policies run off.

    Hope this helps.
    Thanks
    Em
     
  6. Jishnu Bhatia

    Jishnu Bhatia Member

    Yes that helps a lot.. Thanks a lot both of you for explaining this concept in detail.


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