Effective Tax Rate

Why the effective rate differs from the statutory rate

IAS 12 requires companies to explain the difference in a note, usually as a reconciliation from tax at the home-country rate to the reported tax expense. The common items are:

• Foreign tax rates. A Finnish group that earns most of its profit in countries with higher rates will report an effective rate above 20%.
• Tax-exempt income and non-deductible expenses. Gains on selling shares in subsidiaries are often tax-exempt, while some costs, such as impairments of goodwill, are usually not deductible.
• Losses. If a subsidiary makes a loss that the company does not expect to use against future profits, no deferred tax asset is booked and the group rate rises. Using old losses that were never recognised lowers it.
• Associated companies. The share of associates’ results is included in profit before tax after their own taxes, which lowers the group’s rate.
• Prior-year adjustments and tax disputes. These can move a single year’s rate sharply in either direction.

Some industries pay special taxes on top of corporate income tax. Petroleum production on the Norwegian continental shelf, for example, is taxed at a combined marginal rate of 78%, which is why an oil and gas producer’s effective rate looks very high next to an industrial company’s.

The global minimum tax (Pillar Two)

From 2024, the EU and many other jurisdictions apply the OECD global minimum tax to groups with annual revenue of at least €750 million. If a group’s effective tax rate in a country, calculated under the special Pillar Two rules, is below 15%, a top-up tax brings it up to 15%.

For investors, this mainly narrows the room for very low tax rates in large groups. The Pillar Two rate is calculated differently from the rate in the income statement, so the two do not match exactly. Companies describe the expected effect in their tax notes, and IAS 12 gives a temporary exception from booking deferred taxes for the top-up tax.

How to use the effective tax rate

• Forecasting net income. Analysts apply an expected tax rate to their forecast of profit before tax. Many companies give an estimate of the coming year’s rate in their reports.
• Look at several years. One year’s rate can be distorted by a single item; a stable rate over three to five years is a better basis for a forecast.
• Compare with cash taxes. Income taxes paid in the cash flow statement can differ a lot from the tax expense in a given year, because of deferred taxes and the timing of payments.
• Question unusually low rates. A rate far below the home-country rate can be legitimate (tax incentives, exempt gains) but may not last.
• A rate on a loss is not meaningful. When profit before tax is negative, the ratio says nothing useful. The tax line can then even be income, for example from deferred tax assets booked on the loss.

The table below uses each company’s reported figures: income tax expense divided by profit before tax from continuing operations, for the latest full financial year. A single year can be unrepresentative, so treat a rate far from the company’s usual level as a reason to read its tax note rather than as a new trend.