3
Areas requiring particular attention
Inappropriate set-off
3.1
The PRA expects firms’ calculation processes to be at a sufficient level of granularity to address the relevant detail of all applicable tax regimes, and to prevent inappropriate offsetting being used to support the recognition of DTA. Inappropriate offsetting would include, but is not restricted to, the offset of different types of tax which are not permitted in the relevant tax regime.
- 25/11/2016
3.2
When assumptions are made for the purposes of these calculations, the PRA expects firms to ensure that these assumptions are reasonable, and that any simplifications have been subject to a sufficient degree of testing.
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Double counting of deferred tax liabilities
3.3
If firms have both DTA and DTL in the Solvency II balance sheet, any DTL they wish to use to support utilisation of the tax effects of the SCR shock should not already be in use to support utilisation of the balance sheet DTA.
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Solvency II contract boundary assumptions
3.4
Differences in contract boundaries between statutory accounting and Solvency II may be a credible source of future taxable profits. However, double counting would occur if firms were to recognise taxable profit arising from differences in contract boundaries, and include the same taxable profits within projections of taxable profits arising from new business. If firms calculate this impact separately from projections of new business, they are reminded to take care to prevent double counting. The PRA expects that the need to ensure consistency of assumptions for the two figures will be particularly acute if they are not being calculated by the same person or team.
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Risk margin
3.5
Technical Provisions 2 to 4 of the PRA Rulebook make it clear that the risk margin is an integral part of technical provisions and will need to be determined each time a firm calculates its solvency position.
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3.6
The Solvency II regime assumes that firms will continue in business after the shock, and as such, the risk margin is maintained from year to year. Any risk margin released on liabilities which run off would usually be replaced with risk margin to be provided in respect of new liabilities. Where this is the case, it is not appropriate to include the amount of the current risk margin as an element of future taxable profits in a firm’s projections.
- 25/11/2016
3.7
Following a PRA consultation some firms asked whether the current risk margin could be permitted as a source of future taxable profits if an allowance for risk margin was made in projections of future new business profits.
- 25/11/2016
3.8
The PRA expects that including the current risk margin as a source of future taxable profit would create double counting of the risk margin on business already written, as illustrated by the example in Box 1 below.
Box 1: Example of double counting
Consider a Solvency II balance sheet before setting up a risk margin (ie liabilities valued on a best estimate basis). For simplicity, assume that this balance sheet has a net DTL.
When a risk margin is added to the best estimate, so as to obtain the Solvency II compliant technical provisions on the Solvency II balance sheet, the associated deferred tax effect would also be recognised: DTA would be created that would reduce the net DTL position.
As the risk margin reduces over time so too would the related DTA, increasing the net DTL position as the Solvency II balance sheet and tax base converge. This DTL is a way to demonstrate probable utilisation of potential loss absorbing capacity of deferred tax (LACDT).
Over time it would therefore be double counting to recognise as a source of utilisation both the DTL increase that occurs as the risk margin unwinds and the unwinding of the risk margin.
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3.9
The PRA does not expect that the inclusion of an allowance for risk margin in projections of future new business profits would be an effective mitigant to this. Since the expected tax payable on future new business is not calculated based on amounts valued using Solvency II valuation principles, the inclusion or not of a risk margin in the projections has no impact on the expected tax payable on such business.
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3.10
While different considerations might apply to firms which are completely closed to new business, the PRA still expects firms to be able to demonstrate how such double counting could be avoided. These firms would also be expected to have regard to the:
- time the firm has been in run-off;
- nature of the firm’s business and business model;
- availability of historical data regarding differences between actual and projected experience;
- likely period until run-off is complete; and
- credibility of the planning period of the firm.
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Firms with unrecognised DTA in their statutory accounts
3.11
The deferred tax effects of revaluing items from a statutory balance sheet basis to a Solvency II balance sheet basis may result in the creation of some DTL. If this occurs, it might justify the recognition of some further DTA on the Solvency II balance sheet.
- 25/11/2016
3.12
The PRA does not expect a firm to reflect any tax effects of the 1-in-200 shock in its SCR calculation if the notes to its statutory accounts disclose that:
- it has unrecognised tax losses; and
- those tax losses were not recognised because it was considered not probable that future profits would arise against them which might be utilised.
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Rule 3.13
The PRA expects any rebuttal of this expectation to include a credible explanation as to why the firm’s taxable profitability would improve to such a material extent after the stress scenario, or why losses generated in the stress scenario might otherwise be expected to be utilised, for example because they relate to a different type of tax or another jurisdiction.
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