Prudential Regulation Authority Rulebook

2.1

Provided firms comply with the recognition criteria set out in relevant international accounting standards (particularly International Accounting Standard (IAS) 12),^[4] they can:

• recognise DTA on the Solvency II balance sheet, thus increasing own funds; and
• reflect the tax effects of the 1-in-200 shock when calculating the SCR (known as the loss-absorbing capacity of deferred tax in the context of standard formula firms) thus lowering their SCR.

Either of these aspects may have a material impact on a firm’s Solvency II solvency position.

2.2

Under the UK tax regime a firm can recognise DTA in accordance with IAS 12 (for either balance sheet or SCR purposes) if it can:

• offset DTA arising from temporary timing differences against a deferred tax liability (DTL) arising from temporary timing differences, to the extent that the temporary difference related to the DTL is expected to reverse in the same period as the DTA, or in periods to which the tax loss can be carried back or forward; or
• develop forward projections to demonstrate that it will earn future taxable profits against which the DTA can be set in future.

2.3

The future taxable profits against which the DTA can be set in the future do not include profits on any insurance business already included within the relevant technical provisions.

2.4

When supporting the utilisation of DTA on the Solvency II balance sheet, the PRA expects that the relevant technical provisions will be the technical provisions on the Solvency II balance sheet.

2.5

When supporting the utilisation of the tax effects of stress, the relevant technical provisions will depend upon how the SCR is calculated:

• if the standard formula is used, the relevant technical provisions are again the technical provisions on the Solvency II balance sheet; or
• if an internal model is used, the relevant technical provisions are those of the biting scenario.^[5]

2.6

As well as the means of recognition mentioned above, a firm can also recognise the tax effects of the 1-in-200 stress for the purposes of calculating its SCR if it can demonstrate that the tax loss created could be:

• set against tax due in the period of the stress; or
• carried back to reclaim tax paid in prior periods to the extent permitted by applicable tax regimes.

2.7

Given the restrictions on carry-back of loss in some applicable tax regimes, the timing and duration of the loss associated with the stress event may be important when firms calculating their SCR using an internal model consider utilisation. In such cases the biting scenario might not be instantaneous, and might extend for a period of time within or beyond the twelve-month period following the preparation of the Solvency II balance sheet. Firms with internal models are expected to consider the extent to which the timing of the loss will influence their ability to use carry-back.

2.8

Judgement both by firms and supervisors will be required to decide whether future taxable profits are ‘probable’ in accordance with IAS 12 and can be used to justify recognition of relevant DTA. The IAS 12 ‘more likely than not’ recognition test applicable to the statutory balance sheet applies equally to the Solvency II balance sheet and the 1-in-200 shock scenario. However the PRA expects that the evidential requirement to demonstrate what is ‘more likely than not’ would differ depending upon the degree of uncertainty associated with the balance sheet and the shock scenario respectively.

2.9

The PRA expects the evidence required to support ‘more likely than not’ in relation to the Solvency II balance sheet to be similar to that for the statutory balance sheet. However, it expects the increased uncertainty associated with the 1-in-200 shock scenario will mean that more evidence would be needed.

2.10

The determination of the SCR calculated by an internal model is likely to require firms to consider the extent to which the gross shock can be reduced by the tax effect, having regard to the:

• source of the loss;

• ability to offset that type of tax; and

• ability to utilise the tax effect if it can be offset.

This will be the case regardless of whether the firm uses a gross or net model.

2.11

To meet the recognition test, the PRA expects that the capital resources needed to support the assumed level of trading in the post-shock environment will be consistent with a firm’s own risk and solvency assessment (ORSA). Further, the PRA expects the assumptions and projections supporting availability and timing of any capital replenishment in the post-shock environment to be credible. This will give the PRA confidence in accepting the expert judgements taken by the firm.

2.12

The PRA expects the same standard of documentation to support the tax effects of the shock, regardless of whether the SCR is calculated using an internal model or the standard formula. The PRA expects an internal model to be capable of calculating the tax effect of the shock across the whole probability distribution, but would not expect that calculation necessarily to be undertaken across the whole population as a matter of course: any pre-tax loss data points which are sufficiently far from the pre-tax biting scenario that they could not provide the post-tax biting scenario will be of less interest. However, where a firm does not calculate the tax effects across the whole population, the PRA expects the firm to document how it identifies which data points are relevant and which are not included.