Bank of Montreal 2007 Annual Report Download - page 45

MD&A
BMO Financial Group 190th Annual Report 2007 41
Provision for Income Taxes
The provision for income taxes reflected in the Consolidated Statement
of Income is based upon transactions recorded in income, regardless of
when such transactions are subject to taxation by tax authorities, with
the exception of the repatriation of retained earnings from foreign sub-
sidiaries, as outlined in Note 24 on page 128 of the financial statements.
As explained on pages 34 and 36, BMO adjusts revenue to a tax-
able equivalent basis for analysis, with an offsetting adjustment to the
provision for income taxes. The adjustment was $180 million in 2007,
up from $127 million in 2006. Unless indicated otherwise, the provision
for income taxes and associated tax rates are stated on a taxable equiv-
alent basis in this MD&A. In 2008, we will no longer report on a taxable
equivalent basis when reporting consolidated results, as explained
further on page 36.
The provision for income taxes charged against earnings was
$369 million, compared with $844 million in 2006. The reduction was
primarily due to lower income in the current year. The effective tax
rate in 2007 was 14.3%, compared with 23.6% in 2006. The low effective
rate was due to a relatively higher proportion of income from lower-
tax-rate jurisdictions and the favourable resolution of income tax audits
that resulted in the recovery of prior year income taxes. In 2006, there
were recoveries of prior year income taxes in addition to tax recoveries
from business-based initiatives. The components of variances between
the effective and statutory Canadian tax rates are outlined in Note 24
on page 128 of the financial statements.
Excluding any special adjustments, we expect that the effective
tax rate in 2008 should be 21% to 24% on a non-teb basis and consider
that rate to be sustainable.
BMO hedges the foreign exchange risk arising from our net invest-
ment in our U.S. operations by funding the net investment in U.S. dollars.
Under this program, the gain or loss on hedging and the unrealized
gain or loss on translation of our net investment in U.S. operations are
charged or credited to retained earnings, but usually are approximately
equal and offsetting. For income tax purposes, the gain or loss on
hedging activities incurs an income tax charge or credit in the current
period, which is charged or credited to retained earnings; however, the
associated unrealized gain or loss on our net investment in U.S. oper-
ations does not incur income taxes until the investment is liquidated.
The income tax charge/benefit arising from a hedging gain/loss is
a function of fluctuations in exchange rates from period to period. The
$1,659 million gain on hedging our net investment in U.S. operations
in 2007 was subject to an income tax charge of $575 million recorded
in retained earnings, compared with a $451 million gain on hedging
and a $156 million income tax charge in 2006. Refer to the Consolidated
Statement of Changes in Shareholders’ Equity on page 94 of the finan-
cial statements for further details.
Table 8 on page 81 details the $1,022 million of total government
levies and taxes incurred by BMO in 2007. The reduction in provincial
capital taxes in 2007 was primarily due to the resolution of audit issues
with the taxing authorities.
The foregoing Provision for Credit Losses, Non-Interest Expense and Provision for Income Taxes sections and the following 2007 Review of Operating Groups
Performance and Quarterly Earnings Trends sections of this Annual Report contain certain forward-looking statements, in particular regarding our outlook for
certain aspects of the Canadian and U.S. business environments in 2008, our productivity ratio, effective income tax rates and our strategies and priorities
for 2008. By their nature, forward-looking statements require us to make assumptions and are subject to inherent risks and uncertainties. Please refer to the
Caution Regarding Forward-Looking Statements on page 28 of this Annual Report for a discussion of such risks and uncertainties and the material factors and
assumptions related to the statements set forth in such sections.
Transactions with Related Parties
In the ordinary course of business, we provide banking services to
our directors and executives and their affiliated entities, joint ventures
and equity-accounted investees on the same terms that we offer to our
customers. A select suite of customer loan and mortgage products is
offered to our employees at rates normally accorded to our preferred
customers. We also offer employees a fee-based subsidy on annual
credit card fees.
Stock options and deferred share units granted to directors are
discussed in Note 27 on page 132 of the financial statements.
Preferred rate loan agreements for executives, relating to
transfers we initiate, are discussed in Note 27 on page 132 of the
financial statements.
expenses, in both absolute and percentage terms, thereby improving
their productivity ratios.
P&C Canada is BMO’s largest operating segment, and its productivity
ratio of 56.3% improved by 40 basis points from last year, after having
improved by 74 basis points in 2006. The productivity improvement was
lowered by some notable items that affected revenues, most notably
the adjustment to the liability for future customer loyalty rewards
redemptions. P&C Canada’s productivity ratio would have improved by
133 basis points in the absence of such items. Private Client Group pro-
ductivity improved by 140 basis points to 69.4%. The group’s productivity
has improved substantially over the past four years as it has grown
revenues while practicing effective expense management. The produc-
tivity ratio in P&C U.S. deteriorated by 143 basis points because revenue
grew more slowly than expenses. Revenue growth has been reduced
by a decline in net interest margin, while expense growth primarily
reflects acquisition-related expenses. Management has focused on con-
trolling expenses in a challenging revenue environment. In the fourth
quarter of 2007, excluding the impact of acquisition integration costs,
the P&C U.S. cash productivity ratio fell below 70.0%. BMO Capital
Markets’ productivity ratio deteriorated significantly, rising more than
20 percentage points. Excluding the significant items that affected
results in 2007, productivity improved by 399 basis points to 53.6%.
BMO’s cash productivity deteriorated in 2007 because of the
significant items. Excluding the impact of those items, the cash produc-
tivity ratio improved by 150 basis points. We improved BMO’s overall
cash productivity ratio in 2006 by 25 basis points to 62.4%, after having
improved the ratio by 538 basis points over the three previous years.
Examples of initiatives to enhance productivity are outlined
in the 2007 Review of Operating Groups Performance, which starts
on page 42. In 2008, we are targeting operating leverage of 2%,
increasing revenues by at least two percentage points more than the
rate of cash-based expense growth. We plan to achieve this by driving
revenues through an increased customer focus, by ongoing expense
management, and by working to create greater efficiency and effective-
ness in all support functions, groups and business processes that
support the front line.