Interim Report - 24 of 28

1  Overseas tax included Hong Kong profits tax of US$607m (first half of 2012: US$476m; second half of 2012: US$573m). Subsidiaries in Hong Kong provided for Hong Kong profits tax at the rate of 16.5% (2012: 16.5%) on the profits for the period assessable in Hong Kong. Other overseas subsidiaries and overseas branches provided for taxation at the appropriate rates in the countries in which they operate.

Tax reconciliation

The tax charged to the income statement differs to the tax charge that would apply if all profits had been taxed at the UK corporation tax rate as follows:

The effective tax rate for the first half of 2013 was 19.4% compared with 28.5% for the first half of 2012. The effective tax rate for the first half of 2013 benefited from the non-taxable gain on the reclassification of Industrial Bank as a financial investment and the Ping An disposal. The effective tax rate in 2012 was higher because of the US tax charge arising on the disposal of the US branch network and cards business and an adjustment to prior period liabilities.

The UK Government announced that the main rate of corporation tax for the year beginning 1 April 2013 will reduce from 24% to 23% to be followed by further a 2% reduction to 21% for the year beginning 1 April 2014 and a 1% reduction to 20% for the year beginning 1 April 2015. The reduction in the corporate tax rate to 23% was enacted through the 2012 Finance Act and this results in a weighted average of 23.25% for 2013 (2012: 24.5%). The reductions to 21% and 20% that were announced in the 2012 Autumn Statement and the 2013 Budget respectively became enacted through the 2013 Finance Act on 17 July 2013. It is not expected that the future rate reductions will have a significant effect on the net UK deferred tax asset at 30 June 2013 of US$0.5bn.

The Group's legal entities are subject to routine review and audit by tax authorities in the territories in which the Group operates. The Group provides for potential tax liabilities that may arise on the basis of the amounts expected to be paid to the tax authorities. The amounts ultimately paid may differ materially from the amounts provided depending on the ultimate resolution of such matters.

Deferred taxation

The net deferred tax assets totalled US$6.3bn at 30 June 2013 (30 June 2012: US$6.1bn; 31 December 2012: US$6.5bn). The main items to note were as follows:

US

The net deferred tax asset relating to HSBC's operations in the US was US$4.3bn (30 June 2012: US$5.0bn; 31 December 2012: US$4.6bn). The deferred tax assets included in this total reflected the carry forward of tax losses and tax credits of US$0.2bn (30 June 2012: US$0.2bn; 31 December 2012: nil), deductible temporary differences in respect of loan impairment allowances of US$1.5bn (30 June 2012: US$2.5bn; 31 December 2012: US$2.0bn) and other temporary differences of US$2.6bn (30 June 2012: US$2.3bn; 31 December 2012: US$2.6bn).

Deductions for loan impairments for US tax purposes generally occur when the impaired loan is charged off, often in the period subsequent to that in which the impairment is recognised for accounting purposes. As a result, the amount of the associated deferred tax asset should generally move in line with the impairment allowance balance.

On the evidence available, including historical levels of profitability, management projections of future income and HSBC Holdings' commitment to continue to invest sufficient capital in North America to recover the deferred tax asset, it is expected there will be sufficient taxable income generated by the business to realise these assets. Management projections of profits from the US operations are prepared for a 10-year period and include assumptions about future house prices and US economic conditions, including unemployment levels.

Management projections of profits from the US operations currently indicate that tax losses and tax credits will be fully recovered by 2015. The current level of the deferred tax asset in respect of loan impairment allowances is projected to reduce over the 10-year period.

As there has been a recent history of losses in HSBC's US operations, management's analysis of the recognition of these deferred tax assets significantly discounts any future expected profits from the US operations and relies to a greater extent on capital support from HSBC Holdings, including tax planning strategies implemented in relation to such support. The principal strategy involves generating future taxable profits through the retention of capital in the US in excess of normal regulatory requirements in order to reduce deductible funding expenses or otherwise deploy such capital to increase levels of taxable income. As financial performance in our US operations improves it is anticipated that projected future profits will be considered in the evaluation of the recognition of the deferred tax asset.

Brazil

The net deferred tax asset relating to HSBC's operations in Brazil was US$1.1bn at 30 June 2013 (30 June 2012: US$0.7bn; 31 December 2012: US$0.9bn). The deferred tax assets included in this total arose primarily in relation to deductible temporary differences in respect of loan impairment allowances.

Deductions for loan impairments for Brazil tax purposes generally occur when the impaired loan is charged off, often in the period subsequent to that in which the impairment is recognised for accounting purposes. As a result, the amount of the associated deferred tax asset should generally move in line with the impairment allowance balance.

Loan impairment deductions are recognised for tax purposes typically within 24 months of accounting recognition. On the evidence available, including historical levels of profitability, management projections of income and the state of the Brazilian economy, it is anticipated there will be sufficient taxable income generated by the business to realise these assets when deductible for tax purposes.

There are no material carried forward tax losses or tax credits recognised within the Group's deferred tax assets in Brazil.

Mexico

The net deferred tax asset relating to HSBC's operations in Mexico was US$0.4bn at 30 June 2013 (30 June 2012: US$0.5bn; 31 December 2012: US$0.6bn). The deferred tax assets included in this total related primarily to deductible temporary differences in respect of accounting provisions for impaired loans. The annual deduction for loan impairments is capped under Mexican legislation at 2.5% of the average qualifying loan portfolio. The balance is carried forward to future years without expiry but with annual deduction subject to the 2.5% cap.

Following the clarification of tax law by the Mexican fiscal authority during the second quarter of 2013 which led to a write down of the deferred tax assets on loan impairments of US$0.3bn, management's analysis of the recognition of these deferred tax assets now relies on the primary strategy of selling certain loan portfolios, the losses on which are deductible for tax in Mexico when sold. Any such deductions for tax would lead to the reversal of the carried forward loan impairment provision recognised for deferred tax purposes.

On the evidence available, including historical and projected levels of loan portfolio sales and profitability, it is expected that the business will now realise these assets over a shorter period, within the next 10 years, than originally was the case under the previous strategy of projecting loan portfolio growth, loan impairment rates and profitability, which expected that the assets would be realised within the next 15 years.

There are no material carried forward tax losses or tax credits recognised within the Group's deferred tax assets in Mexico.

UK

The net deferred tax asset relating to HSBC's operations in the UK was US$0.5bn (30 June 2012: net liability US$0.3bn; 31 December 2012: net asset US$0.3bn). The deferred tax assets included in this total reflected the carry forward of tax losses and tax credits of US$0.1bn (30 June 2012: nil; 31 December 2012: US$0.3bn) and other temporary differences of US$0.4bn (30 June 2012: net liability US$0.3bn; 31 December 2012: nil).

On the evidence available, including historical levels of profitability and management projections of future income it is expected that there will be sufficient taxable income generated by the business to recover the deferred tax asset for tax losses within the current period.

Trading securities valued at fair value¹

1  Included within these figures are debt securities issued by banks and other financial institutions of US$21,653m (30 June 2012: US$22,285m; 31 December 2012: US$20,274m), of which US$3,262m (30 June 2012: US$3,981m; 31 December 2012: US$3,469m) are guaranteed by various governments.

2  Includes securities that are supported by an explicit guarantee issued by the US Government.

3  Excludes asset-backed securities included under US Treasury and US Government agencies.