Accounting for Income Taxes (AFIT) constitutes the theoretical foundation for understanding the creation, recognition, and role of deferred tax balances in financial reporting. At the core of AFIT lies the observation that the rules and principles underpinning financial reporting under generally accepted accounting principles (GAAP) differ substantially from those used in income tax reporting. These divergences produce two distinct measures of income—book income and taxable income—as well as differences in the valuation of assets, liabilities, and equity. Such discrepancies, known as book-tax differences (BTDs), often arise because tax legislation mandates departures from GAAP reporting for economic, social, political, or administrative purposes ([24]). To address these mismatches, firms are required to establish a “Deferred Income Tax” account, which reconciles income tax expense reported in financial statements with income tax actually payable ([35]).

BTDs are conventionally divided into permanent and temporary categories. Permanent differences reflect items of revenue or expense that appear in accounting income but never in taxable income, and vice versa. They are not expected to reverse and therefore do not create deferred tax balances ([44]). Temporary differences, by contrast, arise when revenues or expenses are recognized in different periods for financial reporting and tax purposes. By definition, these timing differences eventually reverse: as assets are recovered or liabilities are settled, the differences between book and tax bases are eliminated. The key accounting challenge, therefore, is to determine whether it is probable that deferred amounts will indeed be recovered or settled. This requirement places an emphasis on management judgment regarding the future profitability of the firm and the realizability of deferred tax assets ([25]).

Within the banking sector, specific categories of temporary differences have particular significance. Depreciation of assets frequently generates large deferred tax liabilities ([43]), whereas loan loss provisions (LLPs) and write-offs tend to create substantial deferred tax assets ([37]). The role of LLPs has been highlighted in several studies as a principal source of DTAs in banks’ balance sheets ([16]; [3]; [40]). In periods of heightened credit risk, banks increase their provisioning, which not only reduces accounting income but also produces deductible temporary differences under tax rules. The result is an expansion of DTAs precisely at the time when profitability is under pressure, thus raising questions about the quality and sustainability of these assets.

The recognition of DTAs is further governed by International Accounting Standard (IAS) 12, which requires that “a deferred tax asset shall be recognized for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilized” (IAS 12.24) ([27]). This rule embeds a forward-looking element into the recognition process: DTAs are recorded not merely because deductible differences exist, but because future profitability is expected to allow their utilization. In practice, this means that DTAs function as accounting representations of anticipated fiscal relief, contingent upon conditions that may or may not materialize.

This duality has important implications. On the one hand, DTAs offer a way to smooth tax liabilities over time, reflecting the intertemporal nature of taxation. On the other, their dependence on uncertain projections of taxable income makes them vulnerable to economic downturns, when profits are weakest and the probability of realization is lowest. For banks, this tension is particularly acute: just as credit losses mount and LLPs generate new DTAs, profitability erodes, undermining the likelihood that these assets can be realized.

In this way, AFIT theory highlights the inherent fragility of DTAs. They emerge naturally from the structure of financial reporting and tax law, but their recognition is conditional, judgment-driven, and forward-looking. As such, DTAs are not merely technical accounting entries but indicators of broader dynamics linking financial reporting, taxation, and expectations of future performance. This recognition provides the conceptual bridge to the regulatory debates that followed the global financial and Eurozone crises, where the prudential value of DTAs—and eventually their conversion into Deferred Tax Credits (DTCs)—became central to discussions of bank capital adequacy and fiscal sustainability.

The central role of banks in modern economies has long been linked to their function as delegated monitors. Asymmetric information between borrowers and lenders generates agency problems that banks are uniquely positioned to mitigate. Through superior monitoring of borrowers, screening of projects, and verification of contractual obligations, banks reduce credit risk and provide information to depositors and investors that would otherwise be costly or unavailable ([8]; [12]). This delegated monitoring role helps explain why banks maintain loan exposures on their balance sheets, despite the associated risks of non-performing loans (NPLs) and potential runs (Freixas and Rochet, 2008).

However, the very same monitoring function creates agency problems between bank managers and external stakeholders. Depositors and investors cannot easily observe the quality of banks’ monitoring, nor can they accurately value opaque balance sheets. The inability of outsiders to assess bank portfolios—combined with the transformation of short-term liabilities into long-term illiquid assets—makes banks inherently vulnerable to runs and panics ([13]; [20]; [1]). Empirical evidence suggests that depositors, when uncertain about the solvency of banks, may withdraw funds indiscriminately, creating systemic crises ([9]). This highlights the importance of credible and timely accounting information in limiting panic and fostering confidence in the banking system.

Transparency, however, is not always unambiguously beneficial. [5] argue that banks may be optimally opaque, precisely because they issue short-term debt designed to function as “money-like” instruments. To preserve the information-insensitivity of bank liabilities, excessive disclosure about risky assets can undermine confidence, increase rollover risk, and reduce efficiency in the use of bank debt as a medium of exchange. In this view, heightened transparency can be destabilizing when creditors are prone to react strongly to negative signals. This theoretical ambiguity frames the ongoing policy debate about the optimal level of bank disclosure.

The global financial crisis underscored the importance of transparency in risk reporting. [7] show that banks’ disclosures of exposures and loan losses during 2007-2009 were often delayed, incomplete, and inconsistent with market expectations, thereby weakening market discipline and slowing corrective action. Similarly, [6] demonstrate that mandatory disclosure, such as the European bank stress tests, can improve market liquidity when complemented by voluntary reporting but may exacerbate adverse selection if banks withhold further information. These findings underscore that disclosure regimes matter not only for regulatory compliance but also for shaping investor perceptions and financial stability outcomes.

In the specific case of deferred taxation, transparency assumes an added dimension. Deferred Tax Assets (DTAs) signal future tax relief but are conditional on profitability, which is inherently uncertain during crises. As such, large reported DTAs may be interpreted either as indicators of resilience (by reflecting loss-absorbing capacity through tax carryforwards) or as signs of fragility (by highlighting accumulated losses and dependence on uncertain future profits). The subsequent transformation of DTAs into Deferred Tax Credits (DTCs) in jurisdictions such as Greece further complicates the transparency question. While disclosures formally present these instruments as part of Common Equity Tier 1 (CET1), their reliance on sovereign guarantees introduces fiscal risk and creates asymmetries in how different stakeholders—regulators, markets, taxpayers—interpret the quality of bank capital ([4]).

Taken together, the literature suggests that the interplay between information asymmetry, delegated monitoring, and disclosure is central to understanding the banking sector. Transparency can reduce uncertainty and mitigate panics, but excessive or poorly designed disclosures may destabilize expectations. In the domain of deferred taxation, the disclosure of DTAs and DTCs embodies this tension: they provide regulatory compliance on paper but raise fundamental questions about the credibility, comparability, and substance of bank capital.

The intersection of financial accounting and taxation is shaped by the strategic choices of firms. For banks in particular, the alignment—or misalignment—between accounting standards and tax rules generates significant discretion in reporting, with implications for both compliance and capital management.

Tax compliance has been conceptualized as a social contract between taxpayers and the state. [39] defines it as the decision to comply with tax laws and regulations in a timely manner, motivated by the expectation that the state will provide conditions that protect human dignity, fairness, and social order. Empirical work suggests that compliance is influenced by a mixture of economic factors, such as market development and competition, and non-economic factors, such as education, fairness perceptions, and cultural norms. Conversely, complexity in the tax system and low trust in government are associated with higher levels of non-compliance ([39]; [14]).

Tax planning and avoidance represent the legal strategies firms use to reduce tax liabilities. [10] argue that managers may exploit conformity between financial and tax reporting methods to support aggressive tax positions, thereby increasing the likelihood of defending them successfully if challenged by tax authorities. In contrast, [43] finds that conformity is associated with lower levels of earnings management and tax avoidance, implying that tighter links between financial and tax reporting can restrain opportunistic behavior. More broadly, [23] highlight that AFIT considerations significantly affect multinational firms’ decisions, including investment location and profit repatriation.

The literature distinguishes between different forms of avoidance. [21] document a strong positive relationship between financial reporting aggressiveness and tax reporting aggressiveness, facilitated by the nonconformity of accounting and tax rules. [34] further show that tax changes influence firms’ risk-taking behavior, while [15] emphasize the role of mandated disclosure as a reputational mechanism that may constrain tax avoidance.

Tax evasion, by contrast, refers to illegal actions to conceal or misrepresent taxable income. As [41] and [22] note, evasion involves underreporting income, inflating deductions, or using offshore accounts. Literature identifies demographic, cultural, legal, and economic determinants of evasion, with [29] providing a synthesis that highlights the multi-dimensional drivers of this behavior.

Among financial accounting choices, loan loss provisions (LLPs) stand out as the most significant driver of deferred tax assets in banks. LLPs reflect expected credit losses, but their tax deductibility is often restricted or delayed. As a result, banks accumulate DTAs when provisions exceed amounts recognized for tax purposes. This dual role of LLPs—as both a prudential buffer and a tax-relevant entry—has been extensively studied. [16] highlighted their importance for capital adequacy and tax treatment, while [3] demonstrated that LLPs are often used for capital management rather than earnings management. More recent work by [40] and [33] shows that tax treatment of LLPs varies across jurisdictions, with implications for banks’ effective tax rates and capital structures.

The valuation of tax-related disclosures during crises further complicates this picture. Investors’ perception of DTAs depends not only on their technical recognition under accounting rules but also on confidence in banks’ ability to generate taxable profits. [5] caution that market participants may react negatively to discretionary provisioning in the post-Basel regime, interpreting it as a reduction in Tier 1 capital. This illustrates that the informational content of LLPs and related DTAs varies over time and across regulatory contexts, with implications for how markets interpret banks’ tax positions during periods of financial stress.

In sum, the literature on financial accounting choices and tax positioning highlights the tension between compliance, discretion, and credibility. Tax planning and avoidance shape banks’ reported outcomes within legal boundaries, while loan loss provisions represent the main accounting mechanism that generates DTAs. During crises, however, the valuation of these tax-related entries is contingent on investor confidence and regulatory interpretation, underscoring the fragile balance between transparency and opportunism in bank taxation.

The recognition of Deferred Tax Assets (DTAs) is governed by IAS 12, which stipulates that a DTA may only be recognized for deductible temporary differences “to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilized” ([27]). This principle underscores the conditional nature of DTAs: their realizability depends on future profitability, a factor that becomes highly uncertain during crises. In practice, this creates tension between accounting recognition and prudential regulation, as banks are often most reliant on DTAs precisely when their capacity to generate taxable income is weakest.

From a regulatory perspective, Basel III and the EU Capital Requirements Regulation (CRR) are explicit: “Deferred tax assets that rely on future profitability and arise from temporary differences shall be deducted from Common Equity Tier 1 (CET1) items” ([11]). The rationale is that DTAs lack genuine loss-absorbing capacity—they represent anticipated tax relief rather than tangible capital available to absorb unexpected shocks. Nevertheless, Article 39 of the CRR provides an exception: if DTAs are not reliant on future profitability or are guaranteed by a sovereign, they may be recognized in CET1. Greece made extensive use of this flexibility through Laws 4172/2013, 4303/2014, and 4465/2017, which institutionalized the conversion of DTAs into Deferred Tax Credits (DTCs) with explicit state guarantees.

This transformation allowed Greek banks to include large stocks of DTCs as CET1 capital, ensuring compliance with regulatory ratios despite persistent losses. For example, evidence shows that DTCs constitute a material share of reported CET1 in systemic banks, while for Attica Bank, they have represented as much as 88% of its CET1. This reliance highlights both the stabilizing and distorting effects of DTCs. On one hand, they provide immediate regulatory relief and enable banks to withstand adverse shocks without breaching capital thresholds. On the other hand, they create contingent liabilities for the sovereign, transferring the risk of non-realization from banks to taxpayers. As noted, large-scale activation of Article 27A could transform these latent exposures into immediate fiscal obligations, thereby deepening the sovereign-bank nexus.

International experience reinforces these concerns. In Japan, regulators allowed banks to count large DTAs as capital during the late 1990s and early 2000s. While this avoided immediate breaches of solvency requirements, cases such as Resona Bank (in 2003, the Bank faced significant financial challenges, leading to a government bailout and restructuring) highlighted the fragility of relying on DTAs for solvency ([42]). Similarly, [26] found that markets reassessed the value of US banks’ DTAs after the global financial crisis, discounting them heavily due to uncertainty about future profitability. These examples underline that although DTAs can serve as regulatory buffers in times of stress, they do not enhance the fundamental earning capacity of banks and may even become signals of weakness.

The Greek DTC framework thus illustrates the trade-offs embedded in the regulatory treatment of deferred taxation. While it strengthens CET1 ratios on paper, it does so by embedding fiscal risk into bank capital structures. This blurs the line between high-quality capital, such as paid-in equity, and instruments reliant on sovereign support. Supervisors, including the [17], have expressed concern over the high share of DTCs in CET1 and the opacity of related disclosures, warning that such reliance undermines the credibility of regulatory capital and may create cliff effects when transitional arrangements expire.

In sum, DTAs as regulatory capital embody a paradox. They are simultaneously essential stabilizers and sources of fragility. As accounting constructs, they align with IAS 12 principles only under profitability assumptions; as prudential instruments, they are discounted for lacking loss-absorbing capacity; and as fiscal mechanisms, their transformation into DTCs shifts private banking risk onto the sovereign. The literature therefore treats them as “necessary but insufficient” tools, providing short-term relief but raising long-term concerns for capital quality, market discipline, and fiscal sustainability.

The introduction of Deferred Tax Credit (DTC) mechanisms reflects the effort of national policymakers to reconcile the accounting recognition of Deferred Tax Assets (DTAs) with prudential regulation. Under Basel III and the Capital Requirements Regulation (CRR), DTAs that rely on future profitability are deducted from Common Equity Tier 1 (CET1) capital, as they do not constitute immediately available loss-absorbing resources ([4]; [11]). To address this limitation, certain jurisdictions created frameworks that convert DTAs into state-backed instruments, thereby ensuring their eligibility for full CET1 recognition.

The Greek case illustrates this process most clearly. Through Article 27A of the Income Tax Code, DTAs arising from loan loss provisions, write-offs, and sovereign bond restructuring losses can be automatically converted into DTCs when banks record after-tax losses ([30]; [31]; [32]). These credits are irrevocable and unconditional, providing banks with the ability either to offset future tax liabilities or, in the absence of taxable profits, to claim reimbursement from the state. As a result, what begins as an accounting entry contingent on future profitability is transformed into a sovereign-backed asset with full regulatory recognition.

From a theoretical standpoint, the mechanism achieves two objectives. First, it neutralizes the prudential concern regarding DTAs’ lack of credibility as regulatory capital by converting them into guaranteed claims. Second, it transfers part of the banking sector’s risk to the sovereign balance sheet, creating contingent fiscal liabilities ([7]). In this sense, DTCs are hybrid constructs: they function simultaneously as accounting items, prudential instruments, and fiscal commitments.

The implications of this design extend beyond technical compliance. DTCs demonstrate how deferred taxation can be mobilized as a policy instrument to stabilize bank capital during crises. At the same time, they raise concerns about the long-term sustainability of capital structures heavily reliant on state guarantees and the reinforcement of the sovereign-bank nexus ([1]).

The Greek framework for DTCs illustrates the theoretical trade-off between immediate stabilization of bank solvency and the embedding of fiscal risk into the structure of financial stability. It exemplifies how deferred taxation, typically regarded as an accounting matter, has become a central pillar in the interaction of banking regulation and public finance.

The conversion of Deferred Tax Assets (DTAs) into sovereign-backed Deferred Tax Credits (DTCs) has profound fiscal and macro-financial implications. As emphasized in the literature, DTCs constitute a form of contingent liability for the state, crystallizing during periods of weak profitability or systemic stress ([28]; [18]). In this sense, they represent a direct transformation of private-sector losses into potential public obligations, blurring the line between financial stability tools and fiscal commitments.

The mechanism reinforces the sovereign-bank nexus, a self-reinforcing cycle in which banks rely on state guarantees for solvency, while sovereigns remain exposed to banking fragility through both direct (guarantees) and indirect (bond holdings) channels. This nexus has been extensively documented in the European context, where sovereign risk and bank stability are tightly linked ([36]; [2]; [19]). In Greece, where banks hold large volumes of domestic government securities and simultaneously depend on DTCs for capital adequacy, the feedback loop is particularly acute.

From a stability perspective, the short-term benefits of the DTC mechanism are clear: it prevents immediate capital shortfalls and systemic bank runs by ensuring compliance with prudential capital ratios. However, this stabilization comes at the cost of long-term vulnerabilities. First, fiscal space is reduced, as contingent liabilities may become explicit during crises, undermining debt sustainability. Second, market participants increasingly interpret DTCs not as private capital but as implicit sovereign support, thereby adjusting risk assessments. Sovereign credit spreads may widen in anticipation of future fiscal burdens, while investor confidence in the banking sector remains conditional on continued state backing ([17]; [38]).

This dynamic embeds what has been described as the “doom loop”: banking crises generate fiscal costs through DTC activation and recapitalization needs; rising sovereign debt burdens, in turn, erode the credibility of state guarantees and increase bank fragility; this interdependence amplifies systemic risk ([1]). The Greek framework, by institutionalizing unconditional and irrevocable guarantees, exemplifies how deferred taxation can stabilize bank capital in the short run but simultaneously entrench structural fragility in the sovereign-bank relationship.

In theoretical terms, DTCs illustrate the dual nature of deferred taxation as both an accounting tool and a fiscal instrument. While they enhance regulatory compliance ex ante, they also reshape the distribution of risk in the financial system by transferring losses from private stakeholders to taxpayers. Consequently, the sovereign-bank nexus emerges as a central dimension of systemic risk analysis, demanding close coordination between fiscal, regulatory, and supervisory policies to avoid perpetuating the cycle of mutual dependence.

While Greece represents the most explicit institutionalization of DTCs, similar though less comprehensive schemes have been discussed or implemented in other EU jurisdictions. Italy introduced tax asset conversion mechanisms under Decree-Law 225/2010, later extended by Decree-Law 59/2016, allowing partial transformation of deferred tax assets related to loan losses and goodwill into credits. Spain and Portugal considered comparable frameworks during 2014-2015 but opted for more limited transitional arrangements. Conversely, countries such as Germany and France rejected DTC-style conversions, emphasizing fiscal prudence and market-based recapitalization. These variations underscore that DTCs are a discretionary policy tool rather than an EU-wide standard, raising questions about their comparability and long-term fiscal neutrality.