Fairfax and Net Deferred Tax Liability

[Maverick47]

I have long been interested in where, how and why companies display deferred taxes on their balance sheets.  For example, some companies, such as Fairfax, display both their prepaid taxes on their balance sheet in the form of a deferred tax asset ($325 million at year end 2024) and the taxes they will eventually have to pay but are currently deferring, as a deferred tax liability ($1,714 million at year end 2024 for Fairfax).

 

Since taxing authorities generally don’t charge or pay interest on these amounts, I think of the deferred tax asset as an interest free loan from Fairfax to the tax collectors, and the deferred tax liability as an interest free loan from the tax collectors to Fairfax.

 

On a net basis then, Fairfax has a net interest free loan outstanding from the tax authorities of $1.389 billion (1.714 billion - 0.325 billion).

What other insurance companies can we find that are in a similar situation, having, on a net basis, borrowed money at zero percent interest from taxing authorities?  Berkshire is one, Markel is another.

 

But many otherwise respected insurers are in the opposite situation, having made net interest free loans to the taxing authorities…companies such as Chubb, Travelers, Progressive, Intact Financial, Hartford.

 

Now this source of funding for Fairfax is nowhere near as large as the float of their subsidiary insurance companies.  But it is also not exposed to the possibility of having its cost suddenly become significant, which could happen to the cost of float if a large catastrophe or two were to occur.

 

And given that the net interest free loan for Fairfax is currently greater than $1 billion, it seems reasonable to pay some attention to it…after all, as a US senator during a budget hearing said years ago…”a billion here, a billion there….pretty soon you’re talking about real money”.

In future posts, I plan to provide some mathematical thought experiments that can help us understand how valuable this liability can be to Fairfax in the long run.  And since many other competitors are not taking advantage of this possibility for themselves, perhaps it is one form of a financial moat that folks such as Brett Horn are missing….

 

 

[gfp]

I don't think of deferred tax assets like Fairfax Financial has as "prepaid taxes" that they have already paid and are on deposit with the taxing authority.  They usually relate to operating losses, tax credits for foreign taxes paid that will reduce future taxes due, etc...  Not prepaid cash taxes

[Maverick47]

1 hour ago, gfp said:

I don't think of deferred tax assets like Fairfax Financial has as "prepaid taxes" that they have already paid and are on deposit with the taxing authority.  They usually relate to operating losses, tax credits for foreign taxes paid that will reduce future taxes due, etc...  Not prepaid cash taxes

Thanks @gfp!  I appreciate this.  I am by no means either a tax or accounting expert, and to be clear, my focus is going to be solely on the deferred tax liability…and even there, I really am interested only in the portion of it related to deferred capital gains taxes that accumulate due to unrealized capital gains.

 

Your point about deferred tax assets is apt.  They are not in any way based on a company deciding to prepay cash taxes before they are due and so are not actual zero percent loans that a company chose to extend to a taxing authority.  I think I just fell into the trap of viewing deferred tax liabilities as similar to an interest free loan from tax authorities and tried to describe the deferred tax asset as exactly the reverse when that is not the case.

 

Here’s a simple example of a case where a deferred tax asset might be generated…please let me know if I’m not getting your point:

 

Assume that Fairfax pays taxes on income of 20% each and every year, and always had positive income in the past to pay taxes on.  The next  year they have sizable catastrophe losses that exceed all other sources of taxable income combined, such that they report taxable income of -$1 billion.  With negative reported/taxable income, in a simplistic taxing situation, Fairfax would owe zero taxes that year.  But assuming that the entire $1 billion loss was allowed to be carried forward against future income, they would record a deferred income tax asset of $200 million, and then if taxes due next calendar year were based on a reported/taxable income of $500 million, they would carry forward the $1 billion loss as an offset against the income, pay no taxes again that year, and have $500 million of a loss carry forward still available for years thereafter….and the deferred tax asset would be reduced to 20% of a $500 million loss carry forward, or $100 million.  I suppose if there was a limitation on how many years a loss could be carried forward and offset against future income, that an initial deferred tax asset might not be completely recovered through lower future taxes owed before it had to be written off completely.

 

All of this (along with previously paid foreign taxes and credits they might qualify for based on other situations) is really not something that any company can control or plan for, so viewing a deferred tax asset as an interest free loan voluntarily extended to taxing authorities by management is not at all correct.

Edited October 23, 2025 by Maverick47

[Maverick47]

37 minutes ago, Haryana said:

Canada, corporate tax losses can generally be carried back three years or carried forward up to 20 years to offset taxable income. However, there are limitations, such as restrictions on carrying forward net capital losses after an acquisition of control of the corporation. 

Thanks @Haryana.  How does this work at a holding company like Fairfax with different subsidiaries?   If one sub has losses, can they be used to offset taxable income from another?

[Maverick47]

What has intrigued me about deferred tax liabilities (to the extent that they arise from deferred taxes on unrealized capital gains) is how this relates to Charlie Munger’s admonition that one should “sit on your ass” in great companies.  He once explained that if an asset growing pretax at 15% per year was bought and sold annually, paying tax on the 15% realized capital gain each year, as compared with making one investment, allowing it to grow at 15% per year for 30 years, and then selling it and paying the tax on realized capital gains only at the very end, that the second approach would produce an annual after tax rate of return more than 2 points higher than the first approach.  This comparison also is what makes a personal tax deferred retirement account more attractive than making all one’s investments and trades in a taxable brokerage account.
 

Whether the great company is one owned in part through common stocks, or via a controlled subsidiary or associate, makes no difference to me.  The former is the case where unrealized capital gains can build up in financial investments (bonds, or common or preferred stocks).  I think the latter is more commonly occurring in Fairfax these days.  We are advised of the difference between carrying and market value for non insurance subsidiaries, but to the extent that this indicates a buildup of unrealized value, I don’t believe an estimate of deferred capital gains taxes on the difference is recorded on the balance sheet as a deferred tax liability.  But this difference,  along with the deferred tax liability on unrealized capital gains, are two items that, when combined, are indicators of how efficient the company is and has been at generating and compounding value for us on a pre-tax basis.

 

Fairfax and Berkshire ( and Markel as well) appear to be rather unique in the insurance industry in terms of making investments in assets that are allowed years to compound tax free, whether they be common stocks, or non-insurance subsidiaries.  
 

Most other insurance companies invest significant amounts of their assets in fixed income instruments, which generally don’t provide a similar potential for a substantial uninterrupted buildup of unrealized capital gains.  
 

I think this can be fairly easily explained by time frames of management.  Buffett has been managing Berkshire for 60 years, Prem has managed Fairfax for 40.  Markel was a family controlled entity for many decades but is now on its first set of non-Markel family management and is feeling some short term pressure from activist shareholders.  Based on a long runway of compounding investments tax free, even 10 years is not long enough to make a material difference in after tax results to make up for the loss of interest income on bond investments compared with generally lower dividend income from a similar investment in common stocks.

 

The really interesting points in an exponential growth curve that is compounding at a rate 2 points higher than another are the last ones, say in years 25 to 30.  Since most insurance CEO’s get their job with nowhere near even 20 years left to put their mark on their company, they selfishly pursue strategies that are likely to pay off in their work lifetime, not those that will benefit an unknown successor.

 

Family controlled companies such as Berkshire and Fairfax, as @Viking has previously argued, are best situated to take the long view, which happens to also benefit shareholders who choose to let their personal investments in the companies compound for similar periods of 30 years or so.
 

Since this approach is both valuable to Fairfax shareholders and unlikely to be matched by competitors, it sure feels like a moat to me.

 

A final hypothetical example:

 

Assume a tax rate of 25% on realized capital gains, a $1 billion investment, and a 30 year time frame.   Further assume that one is able to earn 15% pretax on investments and can either buy and sell once a year, or has been fortunate enough to also find an investment that can be left alone to compound at 15% per year for all 30 years.

 

In the first case, the after tax annual rate of return would be 11.25%.  After 30 years of buying and selling each year, starting with $1 billion in year one, the after tax value at the end of year 30 would be $1 billion x 1.1125^30 = $24.49 billion.

 

The second case would produce an after tax value of $49.91 billion after 30 years.

 

So after 30 years, the second approach would result in more than twice the after tax value of the first.  That is indeed the value of sitting on one’s ass in a great company.  Of course, the trick is how to find such a company.  
 

As an aside, Fairfax has beaten a 15% annual return on book value over its first 40 years, and currently targets an annual 15% rate for the future….and Berkshire’s annual rate of return on book value over 60 years was 18.2%.

[jbwent63]

10 hours ago, Haryana said:

Not an accountant here but would imagine fairly certain that each subsidiary has to file their own tax in its jurisdiction. 

In Canada, this is correct. We do not have the ability to file consolidated tax returns. In the US you can. This is why when Warren makes the statement that BH's tax return is 1000's of pages, its because there are many subsidiaries that file together under the parent umbrella. Not sure about other foreign jurisdictions (other than Poland where I have some familiarity, and consolidation of tax filings for corporations is not allowed.)

 

So in the US if you have profits in one entity (NICO for example) they can be offset by losses or tax credits (BHE for example).

 

Gfp's comment above about deferred tax assets is correct. They are not prepaid taxes. There is a separate tax liability/asset account for current tax accounts. Deferred or Future tax assets generally arise from timing differences, as was noted, typcially unused NOL's. Deferred tax liabilities come from timing differences such as accounting depreciation being less than allowed tax depreciation, booked but unrealized capital gains etc.

Edited October 23, 2025 by jbwent63

[Maverick47]

5 hours ago, jbwent63 said:

In Canada, this is correct. We do not have the ability to file consolidated tax returns. In the US you can. This is why when Warren makes the statement that BH's tax return is 1000's of pages, its because there are many subsidiaries that file together under the parent umbrella. Not sure about other foreign jurisdictions (other than Poland where I have some familiarity, and consolidation of tax filings for corporations is not allowed.)

 

So in the US if you have profits in one entity (NICO for example) they can be offset by losses or tax credits (BHE for example).

 

Gfp's comment above about deferred tax assets is correct. They are not prepaid taxes. There is a separate tax liability/asset account for current tax accounts. Deferred or Future tax assets generally arise from timing differences, as was noted, typcially unused NOL's. Deferred tax liabilities come from timing differences such as accounting depreciation being less than allowed tax depreciation, booked but unrealized capital gains etc.

Thanks @jbwent63!  I really appreciate you taking the time to educate me.  Now I think I understand some of the commentary about deferred taxes in the notes to the annual report.  The deferred tax asset on the balance sheet is only that portion of tax assets that are likely to be netted against future earnings.  A much larger figure is referenced in the notes, but since the tax credits from one subsidiary cannot be offset against tax liabilities of others, as you noted, management has apparently not determined that they are likely to be usable before the net operating losses from which they stem are expected to expire…and so they are not included in the much smaller deferred tax asset number on the balance sheet.

[Viking]

@Maverick47, thanks for bringing this important topic forward. And thanks to everyone who has chimed in - adding lots of value to the discussion. So am I understanding this correctly? Fairfax has two ‘non-perilous’ sources of leverage:

• Deferred tax liability = $1.7 billion at Dec 31, 2024 
• Float (insurance) = $35.4 billion at Dec 31, 2024 (P/C insurance)

Is $1.7 billion the right number to use for Fairfax to (roughly) match what Buffett simply calls ‘deferred taxes’?

Why does this matter to Fairfax shareholders? 
 

These two items give Fairfax “access to two low-cost, non-perilous sources of leverage that allow (the company) to safely own far more assets than (their) equity capital alone would permit.”

 

Below is how Buffett described these two items in 1999.

From Bershire Hathaway’s Owner Manual (1999)

 

“…Berkshire has access to two low-cost, non-perilous sources of leverage that allow us to safely own far more assets than our equity capital alone would permit: deferred taxes and "float," the funds of others that our insurance business holds because it receives premiums before needing to pay out losses. Both of these funding sources have grown rapidly and now total about $32 billion. 
 

“Better yet, this funding to date has been cost-free. Deferred tax liabilities bear no interest. And as long as we can break even in our insurance underwriting - which we have done, on the average, during our 32 years in the business - the cost of the float developed from that operation is zero. Neither item, of course, is equity; these are real liabilities. But they are liabilities without covenants or due dates attached to them. In effect, they give us the benefit of debt - an ability to have more assets working for us - but saddle us with none of its drawbacks. 

 

“Of course, there is no guarantee that we can obtain our float in the future at no cost. But we feel our chances of attaining that goal are as good as those of anyone in the insurance business.”

 

https://www.berkshirehathaway.com/owners.html

Edited October 23, 2025 by Viking

[Maverick47]

33 minutes ago, Viking said:

So am I understanding this correctly? Fairfax has two ‘non-perilous’ sources of leverage:

• Deferred tax liability = $1.7 billion at Dec 31, 2024 
• Float (insurance) = $35.4 billion at Dec 31, 2024 (P/C insurance)

Is $1.7 billion the right number to use for Fairfax to (roughly) match what Buffett simply calls ‘deferred taxes’?

Why does this matter to Fairfax shareholders? 
 

These two items are “sources of leverage that allow (Fairfax) to safely own far more assets than (their) equity capital alone would permit.”

@Viking — Yes, I think you’ve nailed this.  
 

Buffett and Munger (for Berkshire and Wesco separately) used to focus mainly on their deferred tax liabilities arising from unrealized capital gains on their equity investments.  But since Berkshire’s railway and utility businesses mushroomed, the deferred tax liability/zero percent interest funding source from those subsidiaries, based on tax laws allowing accelerated depreciation of capital investments in very long term assets, now exceeds the amount of Berkshire’s deferred tax liabilities arising out of their unrealized capital gains, and Buffett purports to value this utility-produced deferred tax liability roughly as much as he does the portion generated by deferred taxes on unrealized gains.

 

For what it’s worth, Charlie Munger, when discussing Wesco’s deferred tax liability in his shareholder letters in the 90’s appeared to make an ad hoc intrinsic value estimate/adjustment that he felt would be directionally reasonable to make.  He appeared to believe that anywhere from one fifth to one third of the deferred tax liability would be a reasonable approximation of the net present intrinsic value of it for shareholders.  
 

Of the four sources of funding that Fairfax has available:   debt, equity, insurance float and what we might call deferred taxes float, the deferred tax liability is the smallest, but since it does not appear to be used at all by many of the insurers that Fairfax competes with, it may help to differentiate Fairfax’s long term expected results from them, and along with their employee culture, could be another contributor to what I believe to be a moat that Fairfax is building for itself.

Edited October 23, 2025 by Maverick47

[benchmark]

55 minutes ago, Viking said:

@Maverick47, thanks for bringing this important topic forward. And thanks to everyone who has chimed in - adding lots of value to the discussion. So am I understanding this correctly? Fairfax has two ‘non-perilous’ sources of leverage:

• Deferred tax liability = $1.7 billion at Dec 31, 2024 
• Float (insurance) = $35.4 billion at Dec 31, 2024 (P/C insurance)

Is $1.7 billion the right number to use for Fairfax to (roughly) match what Buffett simply calls ‘deferred taxes’?

Why does this matter to Fairfax shareholders? 
 

These two items give Fairfax “access to two low-cost, non-perilous sources of leverage that allow (the company) to safely own far more assets than (their) equity capital alone would permit.”

 

Below is how Buffett described these two items in 1999.

From Bershire Hathaway’s Owner Manual (1999)

 

“…Berkshire has access to two low-cost, non-perilous sources of leverage that allow us to safely own far more assets than our equity capital alone would permit: deferred taxes and "float," the funds of others that our insurance business holds because it receives premiums before needing to pay out losses. Both of these funding sources have grown rapidly and now total about $32 billion. 
 

“Better yet, this funding to date has been cost-free. Deferred tax liabilities bear no interest. And as long as we can break even in our insurance underwriting - which we have done, on the average, during our 32 years in the business - the cost of the float developed from that operation is zero. Neither item, of course, is equity; these are real liabilities. But they are liabilities without covenants or due dates attached to them. In effect, they give us the benefit of debt - an ability to have more assets working for us - but saddle us with none of its drawbacks. 

 

“Of course, there is no guarantee that we can obtain our float in the future at no cost. But we feel our chances of attaining that goal are as good as those of anyone in the insurance business.”

 

https://www.berkshirehathaway.com/owners.html

How did you get that $1.7B number?

[Maverick47]

1 hour ago, benchmark said:

How did you get that $1.7B number?

On the Dec 31, 2024 Consolidated Balance sheet, the deferred income tax liabilities are recorded as $1.714 billion.

[Viking]

5 hours ago, Maverick47 said:

Of the four sources of funding that Fairfax has available: debt, equity, insurance float and what we might call deferred taxes float, the deferred tax liability is the smallest, but since it does not appear to be used at all by many of the insurers that Fairfax competes with, it may help to differentiate Fairfax’s long term expected results from them, and along with their employee culture, could be another contributor to what I believe to be a moat that Fairfax is building for itself.

@Maverick47, that is very clear… thanks for connecting the dots on this topic for me. Much appreciated.

Edited October 24, 2025 by Viking

[benchmark]

1 hour ago, Maverick47 said:

On the Dec 31, 2024 Consolidated Balance sheet, the deferred income tax liabilities are recorded as $1.714 billion.

Thanks, i should have looked it up first

[Viking]

The trend in the deferred income tax liability at Fairfax is interesting - it has been growing like a weed, especially when measured per share. Today, it is a benefit for Fairfax of $91/share. Looks like this is an emerging benefit for Fairfax. As I said before, @Maverick47, thanks for bringing this forward and getting it on the radar of investors.

 

 

Edited October 24, 2025 by Viking

[Maverick47]

@Viking — I always appreciate how you clarify things by converting to the critical per share figures over time, taking into account the reduction in share count and the growth in unrealized capital gains and the associated deferred taxes!

 

For Berkshire, this sort of increase in their liability over time could be fairly easily understood by the tremendous buildup in deferred capital gains taxes driven by growth in unrealized capital gains on their longer term equity holdings such as Coca Cola, American Express, and Apple among others.

 

Fairfax always seems to me to find more unusual investments and strategies however, and not surprisingly, I think they have a bit more of an off-the-beaten path explanation for the recent growth in their deferred tax liability as well.  If I’m following the trail of crumbs in their annual report correctly, I think a large part of their unrealized capital gains are in the preferred stock bucket rather than from their common stock holdings.

 

I’ve never owned preferred stocks myself, considering them more of a pseudo-bond instrument that would not normally produce significant capital gains absent dramatic changes in underlying interest rates, so this struck me as a bit odd.  However, it appears that Fairfax owns convertible preferred shares for Digit Insurance, and that is the investment likely driving the lion’s share of the increase in their unrealized capital gains and associated deferred capital gains tax liability.

[Viking]

2 minutes ago, Haryana said:

Grown at a rate of over 50% over 4.5 years, however, this growth may be temporary if due to one position i.e. Digit. 

@Haryana, that is true. So we will see how things play out moving forward. At the end of the day, I do appreciate all the input from all the board members as we all continue on our journey of trying to improve our understanding of Fairfax, investing and accounting   

[villainx]

These deferred tax liabilities are macro bets on changing tax regimes?  

 

Just kidding!

 

 

[Hektor]

9 minutes ago, villainx said:

These deferred tax liabilities are macro bets on changing tax regimes?  

 

Just kidding!

 

 

[jbwent63]

On 10/23/2025 at 1:48 PM, Maverick47 said:

Thanks @jbwent63!  I really appreciate you taking the time to educate me.  Now I think I understand some of the commentary about deferred taxes in the notes to the annual report.  The deferred tax asset on the balance sheet is only that portion of tax assets that are likely to be netted against future earnings.  A much larger figure is referenced in the notes, but since the tax credits from one subsidiary cannot be offset against tax liabilities of others, as you noted, management has apparently not determined that they are likely to be usable before the net operating losses from which they stem are expected to expire…and so they are not included in the much smaller deferred tax asset number on the balance sheet.

The deferred tax asset created by losses is typically net of what is known as a "valuation allowance". Typically the tax impact of NOL's are not fully recognized due to the lack of absolute certainty they will be realized (this is conservatism in action), and so the amount is reduced in some fashion. Some companies describe this more fully than others in their disclosures...

[Maverick47]

37 minutes ago, jbwent63 said:

Typically the tax impact of NOL's are not fully recognized due to the lack of absolute certainty they will be realized (this is conservatism in action), and so the amount is reduced in some fashion.

Really good to know!  I like Fairfax being conservative in the setting of their loss reserve liabilities, and now we have a clear indication in their disclosures that they are also conservative in estimating their valuation allowance/deferred income tax asset for the amount of NOL’s they expect to be able to utilize in the future.  It’s nice to see this sort of accounting treatment/philosophy at work on both sides of the ledger.