Zeroing in on why only 72% of Tier 2 Capital Counts for 'Capital Adequacy'.
Quote:
Originally Posted by
winner69
Maybe I’m the zonc but I don’t get this bit at all — I got a sudden brain zonc during the day. Tax will be due on this subordinated capital note.
I never resolved this issue to my satisfaction, but the following RBNZ discussion paper hints at the answer
https://www.rbnz.govt.nz/-/media/Res...ital.pdf?la=en
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102. An important aspect of the regime is recognition that tax liabilities may arise for banks when contingent debt becomes loss absorbing. BS2B and BS2A require banks to accurately estimate any potential tax liabilities associated with instruments they report as capital and to deduct any potential tax liabilities from the face value when they report the value of a capital instrument (this deduction is called the regulatory “tax haircut”).
103. Given the company tax rate in New Zealand is currently 28%, the regulatory “tax haircut” is a significant consideration for issuing banks. It appears the requirement to recognise any potential tax liabilities may not always have been fully complied with in practice. This issue is discussed in more detail later in the Paper.
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Tier 2 capital is one example of 'contingent debt liability'.
The key words in the two paragraphs painted above are 'may arise'. It seems the RBNZ doesn't know for sure, so best to be conservative and assume they 'will arise'.
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203. It is important that the capital values reported by banks are accurate. If a capital instrument is likely to impose a tax liability on the issuing bank, at the time the instrument absorbs losses, the value available to absorb losses will be reduced. Hence, any potential IRD claims on the bank of this nature should be taken into account when reporting capital values.
204. The current regime requires banks to accurately estimate and deduct any potential tax liabilities arising at the point a capital instrument absorbs bank losses. If banks wish to report the full value of a contingent debt instrument, currently they must acquire a binding tax ruling from the IRD.
205. Some banks have raised matters of interpretation of the requirements, arguing that a less conservative interpretation than the stated policy intent is possible. Perhaps for this reason, some banks may have requested less than comprehensive rulings, and have thus potentially overlooked relevant tax effects.
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The above 'seems to be saying' that if Tier 2 debt is used to absorb bank losses the IRD may claim some of that bond as 'tax due'. However, since the bank would likely be in some trouble if Tier 2 capital was 'called in', I do not understand why, faced with huge losses, the bank would still be subject to any tax due if it had got to an emergency bail out situation.
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222. Tax considerations appear likely to feature prominently as a part of the decision by some banks to issue contingent debt. The proposals covered in this paper would exclude contingent debt from Tier 1 capital and, limit Tier 2 capital to subordinated debt that has, at most, only write off triggered by a non-viability event.
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One way or the other, it seems all this will be 'decided' by the RBNZ by 1st January.
SNOOPY