Deferred tax assets, or DTAs, are a company's claim against the tax authorities. DTAs arise mainly in two ways: through losses that can be offset against future profits or through prepayments of taxes recoverable in the future.
In Spain, financial institutions' deferred tax assets arise in the corporate income tax calculation, mainly in two ways:
First, through tax loss carryforwards or, in other words, losses incurred in a fiscal year that can be offset against profits earned in subsequent years. Therefore, one year's losses may reduce future years' tax payments ('tax losses carried forward'). Unlike Spain, other European countries, such as Germany, the United Kingdom and France, allow losses to be offset against past profits ('tax losses carried back'), albeit subject to restrictions.
Secondly, deferred tax assets may arise from temporary differences. Since tax rules (which determine the taxable income for corporate income tax purposes, and therefore the amount of tax payable) differ in many ways from accounting rules (which determine profit for accounting purposes), in practice differences also arise between the pre-tax profit that is relevant to the tax authorities and the pre-tax profit that is relevant to institutions’ financial reporting. Sometimes these differences can be highly significant.
So, if in a given year there are accounting expenses that are not tax deductible (but will be in the future), the tax profit for that year will be greater than the accounting profit, which results in a higher payment of corporate income tax than that which would have resulted from the books. This means that the company has prepaid taxes to the tax authorities, thereby giving rise to an asset (the DTA) that will gradually decrease over time as these expenses become tax-deductible.
Deferred tax assets generated by temporary differences can be of two types: secured or unsecured, i.e. with or without a government guarantee.
Deferred tax assets in the Spanish financial services industry
"In the years following the global financial crisis, which began in 2008, Spanish banks were required, under new regulations, to set aside a substantial volume of generic provisions for their loan portfolios and financial assets as part of the restructuring of the Spanish banking system, especially in 2011 and 2012," explains Jaime Zurita, an expert in banking systems analysis at BBVA Research.
Specifically, the Spanish financial system set aside provisions in excess of €105 billion in 2011 and 2012. The provisions resulted in pre-tax accounting losses of more than €104 billion in those years.
According to tax regulations, however, generic provisions are not considered a tax expense for the year in which they are booked, so these provisions recorded in 2011 and 2012 could not be deducted from the institutions' tax bill. This gave rise to a considerable amount of tax assets relating to temporary differences. “As a result, Spanish banks accumulated more than €66 billion of deferred tax assets or DTAs on their balance sheets," explains Jaime Zurita.
While these assets gradually decreased in subsequent years, as generic provisions were allocated to specific loans (thus transforming them into specific provisions, at which point they became tax-deductible), the volume of DTAs on the balance sheets of Spanish banks, even after more than a decade, remains high (€60.73 billion in February 2023, according to data from the Bank of Spain).
What capital rules affect banks' secured DTAs?
In early 2013, Basel III regulations introduced a regulatory change whereby deferred tax assets that depend on future earnings were to be subtracted from the numerator when calculating banks' regulatory capital ratios (calculated as equity - the numerator - divided by risk-weighted assets or RWAs - the denominator).
This placed Spanish banks at a disadvantage compared to banks in other countries, where losses could be offset against past (not future) earnings and where local regulations did not require such a high level of provisions from financial institutions in the years following the onset of the 2008 crisis.
At the end of 2013, in line with what was already in place in other European countries such as Italy and Portugal, the Spanish government guaranteed certain DTAs (mainly those generated as a result of the provisions set aside following the post-2008 regulations). The government thus ensured that banks were no longer dependent on posting future profits (since they were guaranteed regardless of the volume of profits earned) and significantly reduced their impact on banks' capital (they went from having to be deducted from the numerator of the capital ratio to consuming only RWAs, with the amount of these DTAs being included in the denominator of the ratio).
This rule is not unique to the financial sector but applies to all sectors, although the pressure in terms of solvency is specific to the financial sector.
In September 2015, the Spanish government established that, in order to retain this State guarantee while avoiding any doubt about the possible existence of State aid in this matter, banks must annually, starting from the beginning of 2016, pay a fee of 1.5% on the volume of secured DTAs they hold at any given time. This amounts to a combined payment of around €500 million per year across all banks, an amount that decreases as the banks' government-guaranteed tax assets decrease.
Moreover, other categories of DTAs, apart from secured DTAs, entail a capital consumption for the banks, to a greater or lesser extent.