Future Income and Alternative Taxes

Transcription

1 Practice Education Course Cours orienté vers la pratique Future Income and Alternative Taxes Thomas Hinton, FCIA, FSA CIA Practice Education Course Finance/Investment June 1-4, 2014 Ottawa, ON 1

2 Background An important principle of GAAP accounting is to report revenue when it is earned, i.e., accrual basis accounting. Taxes that are payable in different periods than GAAP earnings cause issues. Future Tax Assets or Liabilities are a way to recognize these differences but they do not recognize the time value of money. 2

3 Background Differences between GAAP earnings and Taxable earnings can be Temporary or Permanent. Temporary Differences Will unwind over time. Arithmetic sum of earnings are equal. Maximum Tax Actuarial Reserves (MTAR) Pre-1996 Tax Reserves were based on 1.5 PTR and grandfathered. Post-1995 Tax Reserves are equal to CGAAP. Grandfathering was eliminated and differences amortized, eliminated a significant source of Future Taxes for reporting Canadian business. An issue for reporting international operations. Permanent Differences For example differential tax rates or deductability. 3

4 Deferred Taxes Future Tax Asset: Tax is paid sooner than GAAP income. Intangible assets set up to replace cash used to pay taxes. Write down asset value to reduce future GAAP income. Future Tax Liability: Tax is paid later than GAAP income. Intangible liability set up when GAAP statements show income. Write down liability value to offset future tax paid. 4

5 Deferred Taxes Would you rather have a Future Tax Asset or Liability? Hint: if you pay taxes early you don t have the money anymore! How would your answer change if you expect tax rates to change in the future? 5

6 Deferred Taxes: Example C1 - page 40 Add 2010 cash flows to issue the policy. 35% level tax rate (not the declining rate in the paper). Use Liability Cash Flows with margins at all times. Based on you expert knowledge of Sources of Earnings, what would you expect the income statement to look like? Liab CF w/margins 1, (128.00) (324.80) (458.50) (532.50) ICLIFT = PV@6.5% - 1, , MTAR - 1, ICLIFT 2010 = (ICLIFT 2011 CF 2011 ) / (1 + yield rate) = (1, ) / (1.065) 6

7 Deferred Taxes: Example C1 ICLIFT Calculate Taxable Income and Cash Taxes Payable: CF w/margins 1, (128.00) (324.80) (458.50) (532.50) Net Inv Inc Chng Tax Rsv (1,000.00) Taxable Income (25.00) (50.05) (50.00) (75.00) Tax Rate 35.00% 35.00% 35.00% 35.00% 35.00% Taxes Payable (8.75) (17.52) (17.50) (26.25) Net Investment Income = ICLIFT * yield rate 7

8 Deferred Taxes: Example C1 ICLIFT GAAP Income if we book the ICLIFT and no accounting provisions are made for Future Taxes: CF w/margins 1, (128.00) (324.80) (458.50) (532.50) Net Inv Inc Chng ICLIFT (1,200.04) Net Income B/T Less: Taxes (8.75) (17.52) (17.50) (26.25) Net Income A/T (5.02) What looks odd about this pattern of After-Tax earnings? 8

9 Deferred Taxes: Example C1 ICLIFT + FTA Tax Reserves < GAAP Reserves mean we pre-pay taxes. Why do we need to set up a Future Tax Asset? Why not a Liability? ICLIFT - 1, , MTAR - 1, Difference Tax Rate % 35.00% 35.00% 35.00% 0.00% FTA/(L) Change (70.02) Note: I reversed the signs of the change so that I can deduct it! 9

10 Deferred Taxes: Example C1 ICLIFT + FTA Add change in FTA/(L) to GAAP Income Statement: CF w/margins 1, (128.00) (324.80) (458.50) (532.50) Net Inv Inc Chng ICLIFT (1,200.04) Net Income B/T Less: Taxes (8.75) (17.52) (17.50) (26.25) Less: FTA (70.02) Net Income A/T What is wrong with this? Why not stop here? 10

11 An Aside: what if What would happen to the DTA if tax rates changed to 0% in year 2011? What would our 2011 GAAP Income look like? What would happen if taxes doubled in year 2? How would this look if Tax Liability/MTAR was greater than Book Reserves? 11

12 Deferred Taxes: Example C1 DFTP We have a vector of future cash flows, let s discount it! There are several ways to do this: CALM, Discounting, Iterative. We will just discount it for simplicity. Taxes Payable (8.75) (17.52) (17.50) (26.25) Discount Rate Before Tax 6.50% 6.50% 6.50% 6.50% 6.50% After Tax 4.23% 4.23% 4.23% 4.23% 4.23% DFTP (62.2) (56.1) (41.0) (25.2) DFTP 2010 = (Taxes DFTP 2011 ) / (1 + after-tax yield rate) = ( ) / (1.0423) What is significance of DFTP < 0? 12

13 Deferred Taxes: Example C1 ICLBCO ICLBCO = ICLIFT + DFTP ICLBCO - 1, , What would happen if we booked this? What sort of FTA/L would the accountants book in turn? 13

14 Deferred Taxes: Example C1 ICLBCO The accountants will book the following FTA/(L) ICLBCO - 1, , MTAR - 1, Difference Tax Rate 35.00% 35.00% 35.00% 35.00% 35.00% 0.00% FTA/(L) Change (48.24)

15 Deferred Taxes: Example C1 ICLBCO And the following GAAP Statement will result: CF w/margins 1, (128.00) (324.80) (458.50) (532.50) Net Inv Inc Chng ICLBCO (1,137.82) Net Income B/T (6.12) (15.15) (15.77) (25.19) Less: Taxes (8.75) (17.52) (17.50) (26.25) Less: FTA (48.24) Net Income A/T (3.98) (9.84) (10.25) (16.37) Effective Tax Rate 35% 35% 35% 35% 35% 15

16 Deferred Taxes: Example C1 FTCO We need to solve for an adjustment such that the interaction of the FTA/L calculated by the accountants will get us the result we desire! i.e., the carve out! From page 17 (ignoring GAAP_A and Tx_A): FTCO = tx * (MTAR (ICLIFT + DFTP)) / (1 tx) FTCO (74.21) (64.05) (45.25) (26.82) - ICLACO = ICLBCO - FTCO ICLACO - 1, ,

17 Deferred Taxes: Example C1 ICLACO Book the ICLACO and the accountants will book the following FTA: ICLACO - 1, , MTAR - 1, Difference Tax Rate 35.00% 35.00% 35.00% 35.00% 35.00% 0.00% FTA/(L) Change (74.21)

18 Deferred Taxes: Example C1 ICLACO GAAP Income with our ICLACO and FTA CF w/margins 1, (128.00) (324.80) (458.50) (532.50) Net Inv Inc Chng ICLACO (1,212.03) Net Income B/T Less: Taxes (8.75) (17.52) (17.50) (26.25) Less: FTA (74.21) Net Income A/T Effective Tax Rate 35% 35% 35% 35% 35% 18

19 Deferred Taxes: Example C1 ICLACO SUCCESS! 19