MTT27010 - Calculating the effective tax rate: Covered tax balance: Deferred tax: Special loss deferred tax asset election

A group may elect that, for a territory, all of the standard members of the group will not calculate a total deferred tax adjustment amount. Instead, a special loss deferred tax asset is to be created where those standard members make an aggregated net adjusted loss in the effective tax rate calculation for the period (See step 2 of MTT20100). This asset is carried forward and utilised in subsequent periods in which there is a profit in the territory. For instance, where there is no tax regime in a territory, a group may elect for this treatment in order to determine a deferred tax asset for any losses in the territory.

This is set out in sections 187 and 188 of Finance (No.2) Act 2023.

Nature of the election

A special loss deferred tax asset election is different to other MTT elections.

It applies in respect of a territory.

It must be made to have effect for the first accounting period in which the Pillar Two rules apply to a standard member of the group in that territory.

It cannot be made in any other period. Hence, once revoked, it cannot be made again.

The election cannot be made in respect of territories with an eligible distribution tax system.

Once the election has been made, it will continue to apply in subsequent periods until it is revoked.

Effect of the election

Where the election applies, the standard members in the territory will not have a total deferred tax adjustment amount.

A special loss deferred tax asset will be generated for the territory if there was a net adjusted loss in the effective tax rate calculation for the standard members in the territory (See MTT20100).

The value of that loss will be 15% multiplied by the net adjusted loss (expressed as a positive figure).

Utilisation of a special loss deferred tax asset where there is a net adjusted profit

Where, for an accounting period:

  • a special loss deferred tax asset election applies to a territory,
  • a group has a special loss deferred tax asset for that territory, and
  • there is a net adjusted profit in the effective tax rate calculation for the standard members of that territory,

the special loss deferred tax asset is to be used to increase the covered tax balance of those members which made a profit.

The amount of the special loss deferred assets that will be used is the lower of:

  • the total amount of the assets available, and
  • the result of step 2 in the effective tax rate calculation (i.e. the aggregate adjusted profits) multiplied by 15% (See MTT20100).

Any remainder will continue to be a special loss deferred tax asset and will carry forward for use in subsequent periods in which the election has effect.

The amount of assets to be used are allocated between the profit-making members in proportion to the adjusted profits of each of those members which made a profit.

Example 1

A group has two members (A Ltd and B Ltd) in Territory Z, which does not impose a corporate income tax. It enters the Pillar 2 regime in the accounting period ending 31 December 2035.

In 2035, A Ltd has an adjusted profit of nil and B Ltd has an adjusted loss of 200. In the effective tax rate (ETR) calculation there is a net adjusted loss of 200, and therefore the ETR is deemed to be 15%. No deferred tax asset is recognised in the accounts of B Ltd because there is no corporate income tax imposed in Territory Z. Accordingly, B Ltd will have a nil total deferred tax adjustment amount for the accounting period ending 31 December 2035.

The group chooses to make a special loss deferred tax asset election in respect of Territory Z, with effect from the 2035 period.

As a result of the election:

  • no deferred tax adjustment amount is recognised for either member in Territory Z, and
  • because there was a net adjusted loss for the standard members in the territory, a special loss deferred tax asset of (15% * 200) = 30 is created.

In 2036, A Ltd has an adjusted profit of 100 and B Ltd has an adjusted profit of 200. Because there is no corporate income tax in the territory, the combined covered tax balance for members A and B is nil.

The effective tax rate for each of members A and B in 2036 will be 0% and, absent the election, there would be a top-up tax due of (300 * 15%) = 45.

As a result of the election:

  • a special loss deferred tax asset of 30 exists, and
  • because there was a net adjusted profit for the standard members in the territory, that asset must be utilised.

The asset is to be used to increase the covered tax balances of the standard members.

The amount of the special loss deferred tax asset to be used is 30 being the lesser of:

  • the special loss deferred tax asset of 30, and
  • the net adjusted profits of 300 multiplied by 15%, giving 45.

The asset is to be split between the members in proportion to their respective adjusted profits. A Ltd made an adjusted profit of 100 and B Ltd made an adjusted profit of 200. Therefore, A Ltd will use (30 * 100 / 300) = 10 of the asset and B Ltd will use (30 * 200 / 300) = 20 of the asset. Their respective covered tax balances will be increased by these amounts.

A top-up amount would arise in this case because after the full utilisation of all available special loss deferred tax assets, the ETR remains below 15%.