Deferred Tax Assets Mask PSU Banks Actual Performance In 2018-19

Still to recover from bad-loan stress, Indian public sector lenders would have reported much worse numbers in the previous fiscal if not for an accounting practice that helped them lower their losses: deferred tax.Sixteen state-owned banks disclosed a deferred tax asset adjustment in their financial statements that either helped cut losses or turn a loss into profit in 2018-19, according to balance sheets or financial disclosures analysed by BloombergQuint. The accounting gain reduced their cumulative losses by Rs 36,948 crore to Rs 71,349 crore..This is not the first year when banks have recognised such high deferred tax assets. In 2017-18, the same banks had recorded a tax adjustment of Rs 40,873 crore and reported a loss of Rs 75,473 crore. The trend for significant recognition of deferred tax assets has been witnessed since financial year 2015-16, after the Reserve Bank of India initiated an asset quality review, forcing banks to recognise bad loans or at least provide adequately for them.“In the case of public sector banks, with a rise in provisions for bad and doubtful debts in recent years, there has been a rise in deferred tax asset recognition,” Kajal Gandhi, vice president, research at ICICI Securities Ltd., said.To be sure, deferred tax asset recognition is a common practice allowed under Accounting Standard 22. A deferred tax asset or liability arises because revenue or expenses may be required to be recognised in different financial years, said Jairaj Purandare, chairman at tax consultancy JMP Advisors.. “The whole concept is to recognise and match the total tax expense with the profit as per the Companies Act.”But in case of the state-run banks, it’s the quantum of this benefit that masks the actual operating performance.Impact Of ProvisionsFor banks, deferred tax asset is created if provisions are more than what can be set aside under the Income Tax Act. Or if they report losses that can be set off against future profits to lower taxable income.IDBI Bank Ltd. made the largest tax adjustment worth Rs 7,711 crore in 2018-19, followed by Punjab National Bank’s Rs 5,365 crore and Oriental Bank of Commerce and Rs 3,573 crore. The accounting practice helped Bank of Baroda, Canara Bank and Oriental Bank of Commerce reported a profit.In the previous year 2017-18, Punjab National Bank, IDBI Bank and Canara Bank were the biggest beneficiaries with deferred tax assets recognition of Rs 7,114 crore, Rs 4,592 crore and Rs 4,355 crore, respectively.Here’s how 16 state-owned banks benefited from deferred tax assets in 2018-19:.Canara Bank and IDBI Bank did not disclose the deferred tax asset adjusted in their filings. The lenders didn’t respond to BloombergQuint’s queries on the amount recognised. In 2017-18, the deferred tax asset recognised by both the banks was either equal to or more than the tax adjusted..Why SBI Isn’t On That ListState-run State Bank of India didn’t recognise any deferred tax asset in the previous fiscal. In 2017-18, the country's largest bank had recognised a net deferred tax asset of around Rs 9,654 crore, lowering its loss to Rs 6,547 crore. If not for this adjustment, its actual loss would have been Rs 16,201 crore in that fiscal.But the lender reversed Rs 954.12 crore worth of tax assets in 2018-19. While it didn’t give any reason in its annual report, this could be because of recoveries from some of the provisions in the previous years.How Is A Deferred Tax Asset CreatedA deferred tax asset represents a company’s expectation regarding the value of future tax relief as per the provisions of Income Tax Act, 1961. A deferred tax asset is recognised in a company’s books when based on current operations of the company, it expects a lower income tax expenditure in the future.As mentioned earlier, deferred tax assets are created in banks due to two main reasons—disallowed provisions and losses.LossesWhen a company incurs a loss, as per the tax law it gets a right to set off that loss against future tax profits, which will eventually reduce its tax liability in that future year or years. The amount of future tax expected to be reduced is recognised as a deferred tax asset.For instance, if a bank reports a loss in a year, and say the taxable loss is Rs 1,000. The tax amount on it can be carried forward as a deferred tax asset. That is, if the tax rate applicable to the bank is 30 percent then Rs 300 would be the deferred tax asset added to its profit and loss account for that year. The deferred tax asset would enhance profit for that year by Rs 300.The rationale to this is—in the next year if it reports a taxable profit of Rs 2,000 then as per the income tax provisions, the bank would set off the Rs 1,000 loss against the taxable profit of Rs 2,000 in the next year. This would reduce the profit offered to tax from Rs 2,000 to Rs 1,000 and hence reduce the tax payment from Rs 600 to Rs 300. It would also entail writing off the Rs 300 deferred tax asset from the profit that year, reducing it to Rs 400 (Rs 1,000 – Rs 300 tax – Rs 400 deferred tax asset).Disallowed ProvisionsIn the case of banks, most often a deferred tax asset is recognised because the Income Tax Act limits the amount of deduction for provisions on account of bad and doubtful debts for computation of taxable profits. So, when a bank’s provision is more than the limits prescribed in the income tax act, the excess provision is disallowed for computing taxable profit and hence tax outgo is higher.For instance take a loan of Rs 2,000—if, as per RBI guidelines, the bank provisions Rs 1,000 in the current year (on account of it being a doubtful debt) but the income tax act limits the provisioning to Rs 750, then the excess provision of Rs 250 would be disallowed in computing profit. That is, the Rs 250 would have to be included in the taxable profit of the year. But the tax on that Rs 250 can be carried forward as a deferred tax asset. That Rs 75 (at 30 percent tax) will be added to the accounting profit for the year.When a doubtful debt turns bad, the tax law allows for a complete write-off of the loan. A complete write off in the future will include the provision disallowed in the past.To go back to the illustration above—say the loan on which bank made a provision turns bad in the next financial year. The income tax act would allow for a deduction of Rs 1,250 (Rs 2,000 loan less the Rs 750 already provided in the previous year as per tax law) as a deduction from income.Whereas, the profit computed as per accounting standards would have a deduction of Rs 1,000 (Rs 2,000 doubtful loan less Rs 1,000 provision in the previous year).Thus, a bank’s taxable profit in the year would be Rs 250 lower than the accounting profit. The bank would save Rs 75 in tax outgo. But it also has to reverse the deferred tax asset from the previous year by deducting it from the accounting profit.To summarise, as the tax-disallowed provision of the current year will be allowed in future years if the loan is to be written off, the higher taxes paid in the current year would be reversed in future years. To be clear, the reverse would apply if the loan is recovered in full.Deferred tax is an asset if it lowers the future tax outgo, and a liability if it increases the payments in following quarters. “There may be a difference in the timing to recognise expenses and incomes for computing profit under the Companies Act and the applicable accounting standard on the one hand and the income tax law on the other,” said Jairaj Purandare of JMP Advisors.PSU Banks’ ProfitsWhen the contribution of deferred tax assets in a bank’s net profit is very high, it would mean that a large part of bank’s net profit is made up of an accounting entry gain. “Therefore, the net profit, which is computed after deferred tax asset recognition, doesn’t really give the right picture,” said Aalok Shah, research analyst at Monarch Networth Capital Ltd.Agrees Gandhi who says, “Though taxability is an important part of any bank’s profit after tax, in recent years deferred tax asset recognition in banks was higher as provisions were higher and should be given less importance. Pre-provision profit, provisions on stressed book and PBT (profit before tax) should be analysed.”

Deferred Tax Assets Mask PSU Banks Actual Performance In 2018-19

PSU banks would have reported much worse numbers in FY19 if not for an accounting gain.

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