How should “t” which is used in the formulas in paragraph 1 of Article 473a CRR be calculated?

The question concerns the linkage between the definition of “t” which is used in the formulas in Article 473a(1) and the amount of DTA that is deducted from CET1 (Article 36(1)(c)) to be considered in accordance with Article 473a(7)(a), when an institution (standardized approach):

• is in a situation of negative taxable income and therefore the increase in provisions due to IFRS 9 cannot be deducted from tax base, and
• after the probability test, recognises in the financial statements DTAs arising from the carry-forward of unused tax losses.

In particular, the query relates to the approach to be followed for the correct determination of the adjustment to CET1 and the net exposures value determined in accordance with Article 473a(7)(b). The possible suggested approaches are:

• Approach 1: DTAs due to unused tax losses carried forward are included in t (therefore reducing ABSA) and the amount of DTAs that is deducted from CET1 capital in accordance with Article 36(1) is recalculated according to paragraph 7;
• Approach 2: DTAs due to unused tax losses carried forward are not included in t, since they do not increase CET1 capital. No recalculation of the amount of DTAs that is deducted from CET1 capital in accordance with Article 36(1) is needed according to paragraph 7.

The variables t1, t2 and t3 in Article 473a(1) of Regulation (EU) No 575/2013 (CRR) are is defined as the “increase of Common Equity Tier 1 capital that is due to tax deductibility of the amounts" A_{2, SA,} and A_{4, SA} and A_Old SA respectively, for exposures which are subject to risk weighting in accordance with the Standardised Approach (SA exposures) and as the “increase of Common Equity Tier 1 capital that is due to tax deductibility of the amounts" A_{2, IRB,} ,and A_{4, IRB} and A_Old IRB respectively,for exposures which are subject to risk weighting in accordance with the Internal Ratings Based Approach (IRB exposures).

In order to calculate the t1, t2 and t3 (hereinafter, variables "t") amounts it is first necessary: (i) to calculate the amounts A_{2, SA,} and A_{4, SA} and A_Old SA, for SA exposures as well as the amounts A_{2, IRB,} ,and A_{4, IRB} and A_Old IRB for IRB exposures and second, (ii) to determine which part of these amounts are is deductible for the purposes of determining taxable profit of the current year and which part is not and, as such, could give rise to the recognition of deferred tax assets (DTAs).

Hereafter it is provided a technical analysis of the different tax effects that can be observed and its implications in prudential terms, in particular CET1 impacts.

Current tax

When expected credit loss (ECL) provisions are tax-deductible the taxable profit is reduced and a lower tax amount is paid. The lower tax amount paid “implicitly” increases accounting equity, via the recognition of a lower amount of current tax in PL and consequently increases CET1 as well. For this reason, the provisioning amounts eligible for transitional CET1 add-back are net of such current tax effects. The variables “t” in Article 473a of the CRR corresponds to the amounts by which the current tax amounts paid are is reduced due to the fact that the tax authority would recognise the amounts A_{2, SA,} and A_{4, SA,}  A_Old SA, A_{2, IRB,} and A_{4, IRB} and A_Old IRB  (or part of those amounts) as deductible for the purposes of determining the institution’s taxable profit.

DTAs that rely on future profitability and arise from temporary differences and DTAs from the carry-forward of unused tax losses

Article 473a(7)(a) of the CRR establishes that all requirements laid down in the CRR and in Directive 2013/36/EU that use the amount of DTAs that is deducted from CET1 in accordance with Article 36(1)(c) or risk weighted in accordance with Article 48(4) of that Regulation shall be recalculated by not taking into account the effects that the ECL provisions included in CET1 in accordance with paragraph 1 of article 473a of the CRR have on that amount of DTAs. This means that before applying the requirements of Article 36(c), Article 38 and Article 48 of the CRR to the relevant DTA amounts, these DTA amounts should be recalculated so that they do not include DTAs related to provisions that are added back to CET1. For the avoidance of doubt, DTA amounts related to provisions that are added back to CET1 should not be included in CET1 capital.

Additionally, it should be noted that the variables "t" does not address tax effects in the context of deferred tax assets.

Update 26.03.2021: This Q&A has not yet been reviewed by the EBA in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR).

Update 28.10.2021: This Q&A has been amended in light of the change(s) in Article 473a to Regulation (EU) No 575/2013 (CRR), applicable from 27.06.2020.