Money & Banking

Why PSBs have gained by not moving to lower corporate tax rate in Q2

Radhika Merwin BL Research Bureau | Updated on November 06, 2019 Published on November 06, 2019

Else the sharp write-downs in their deferred tax assets, could have eaten into earnings and capital

The Centre’s move to bring down corporate tax rate may have cheered the market. But public sector banks (PSBs)have not jumped the gun and adopted the new tax regime yet. All public sector banks that have so far declared their September quarter results have continued to recognise taxes as per the earlier applicable tax rate of 30 per cent (effective 34.94 per cent), rather than moving to the lower tax rate of 22 per cent (effective 25.17 per cent).

It appears that while the move would benefit banks by lowering the tax outgo on the current fiscal’s earnings, the gain would be more than offset by sharp write-downs in their deferred tax assets. The net impact (negative) could have eroded profits and capital, forcing the Centre — the perpetual benefactor — to infuse yet more capital into these state-owned banks. PSBs are currently evaluating the option to shift to lower tax. But given the already weak earnings performance and persisting challenges on the bad loan front, it is highly likely that they may drag their feet. Though a one-time impact and essentially an accounting entry, the optics and headline numbers on profit and capital ratios could spook the market and throw up concerns on the fiscal front, as the government may have to pump in additional capital.

The DTA animal

Moving to the lower corporate tax rate will have two main implications for banks. One, lower tax on profit earned during the fiscal. Two, adjustment of net deferred tax assets (DTA) sitting on banks’ balance sheet, computed based on the earlier tax rate. For banks with large bad loans, the latter (DTA impact) would have a substantial impact on profit. At present, banks provide for bad/stressed loans. However, for taxation purposes, under the Income-Tax Act, the provisions allowed may be lower. Among other reasons, this mismatch also leads to creation of deferred tax assets. Banks moving to the new tax rate regime will have to re-assess the DTA based on the lower tax rate (DTAs currently under balance sheet at higher tax rate applicable earlier). This could lead to sharp write-downs, impacting profit.

For instance, in the case of Axis Bank and ICICI Bank there was a one-time steep write-down in DTA of ₹2,138 crore and ₹2,920 crore, respectively, in the September quarter, which impacted their earnings.

 

The DTA figures for PSBs, as disclosed in the FY19 annual report, suggest that for most of them a similar re-adjustment on a move to lower tax rate would lead to sharp mark-downs. While most analysts had pegged in the possible impact of DTA write-down in the September quarter, PSBs may have put off the decision to move to lower tax for now, given that weak core performance and elevated provisioning on bad loans are already eating into profits.

For instance, in the case of PNB, based on the DTA figure for FY19, the re-adjustment could mean a little over ₹5,000 crore of write-down. The bank had witnessed a rise in bad loans and provisioning in the latest September quarter, and the modest ₹507 crore of profit was due to the deferment of about ₹2,200 crore of provisions in respect of certain frauds.

A sharp write-down could have led to huge loss eating into capital. Bank of India, Central Bank of India and SBI are other PSBs that could take a huge hit on account of DTA adjustment when they move to the lower tax rate. Of course, the overall DTA impact would be offset to some extent by the benefit on lower tax outgo for the fiscal. But given the weak earnings performance of most PSBs , it appears that the negative impact of DTA would far outweigh the gains.

Published on November 06, 2019
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