Influence of Corporate Income Tax to Loan Loss Provision: Evidence from Uzbekistan

Abstract

This article is devoted to the analysis of the impact of corporate income tax on compulsory reserves created by commercial banks for possible loan loss provision. In the majority of countries banks are required to create compulsory reserves for potential loan loss provisions, and the corporate tax regime applies tax deductions to these compulsory reserves. The corporate tax system facilitates timely coverage of potential loan loss provision. In addition, corporate taxation is an essential factor in the transparency of banks’ financial statements. The research has revealed that reserves for potential loan loss provision are used primarily for profit regulator purposes, not to regulate capital. This implies that when deducting the amount of total reserves for tax purposes of banks the loan loss provision is positively related to the corporate income tax rate. The analysis of the selected commercial banks has confirmed that the impact of corporate income tax is more significant for the timely admitting potential loan loss provision when deducting general reserves from the tax base, mainly for the purpose of taxing banks’ profits. According to the results, an increase in the tax rate by an average of 1% could lead to an increase in the amount of required loan loss provision by 3.9%. This means that when total reserves are deducted for tax purposes, the underlying hypotheses that compulsory reserves for loan loss provisions are positively correlated with the corporate income tax rate and that the amount of loss reserves is increased at the income tax rate have been confirmed. In general, the following aspects are crucially important in the taxation of profits of commercial banks: which method is more convenient for loan loss provision (write-offs or formation of reserves); entire or partial compliance between the taxation and regulation of reserves for loan loss provision; imposing restrictions on the application of tax deductions to reserves for possible loan loss provisions.