Multinational Top-up Tax and Domestic Top-up Tax

MTT27130 - Calculating the effective tax rate: Covered tax balance: Deferred tax: Valuation adjustments and accounting recognition adjustments

In some cases, a deferred tax asset will be recognised in the accounts, but a valuation adjustment (liability) will be recorded against the asset to limit its value. In other cases, a deferred tax asset will not be recognised in the accounts because of a failure to meet the criteria for recognition. Either a valuation or recognition adjustment is applied in the accounts to the extent that the deferred tax asset is not forecast to be usable in the future. The terminology for such adjustments may vary in different accounting standards.

In subsequent periods, a further valuation adjustment or accounting recognition adjustment might be made in the accounts, which could result in the deferred tax asset being recognised, or recognised at a different value.

All such adjustments are to be excluded when determining the total deferred tax adjustment amount.

Because the generation of deferred tax assets reduces the covered taxes balance, it is necessary to ensure that a deferred tax asset relating to a domestic tax loss is recorded in the same year as the loss for MTT purposes. The above rule ensures that the deferred tax asset is recorded for MTT purposes in the same year as the economic loss which gave rise to such asset. Because valuation allowances and accounting recognition adjustments are disregarded under MTT rules, a deferred tax asset will be recorded in respect of a domestic tax loss regardless of whether there is a forecast of probable future use of the asset.

This is set out in section 182(2)(c) and (4) of Finance (No.2) Act 2023.

Deferred tax asset fails to meet accounting recognition criteria

Where a deferred tax asset relating to the carry forward of unused tax losses is not recognised in the accounts because the accounting recognition criteria are not met, the deferred tax asset is to be reflected in the total deferred tax adjustment amount.

For example, a tax loss that can be carried forward may not be recognised (in full in or in part) as a deferred tax asset for accounting purposes, due to uncertainty about whether there will be future profits against which to utilise the loss. For MTT purposes, the tax loss will nevertheless be reflected in the total deferred tax adjustment amount as a deemed deferred tax asset in the period when the loss arises.

Accounting recognition or revaluation in subsequent period

In some cases, amounts which were not originally recognised as a deferred tax asset may be recognised in a subsequent period, as the result of an accounting recognition adjustment. For example, a tax loss may not be recognised as a deferred tax asset because there is no expectation of future profits against which to utilise that loss. In a subsequent period, there may be a new expectation of future profits. The deferred tax asset could then be recognised in the accounts through a recognition adjustment.

Similarly, a valuation allowance (liability) may be recorded against a deferred tax asset that has been recognised, which offsets the recorded value of that deferred tax asset to the extent the loss is forecast to not be usable. If the financial forecast changes and it becomes probable that taxable profit will arise in the current or future period, the offsetting liability is reversed in the period in which the forecast changes.

In these cases, the impact of the adjustment on the deferred tax asset is to be excluded when calculating the total deferred tax adjustment amount.

Utilisation of deferred tax asset that had been subject to a valuation or accounting recognition adjustment

Where the tax loss is utilised in a subsequent period, there will be a corresponding impact on the deferred tax expense in the accounts to reflect the utilisation of the deferred tax asset. On utilisation, the amount of the deferred tax asset that has reversed in the accounts should be reflected in the total deferred tax adjustment amount (this reversal is not ignored for MTT purposes).

Example

In Year 1, A Ltd incurs a tax loss of 100 in its business operations. The tax rate in the territory is 15%.

A Ltd is uncertain whether there will be sufficient future profits from its business operations against which to utilise a deferred tax asset. Because of this, no deferred tax asset is recognised in the financial accounts.

When determining the total deferred tax adjustment amount, a deemed deferred tax asset for the loss is recognised for MTT purposes. Consequently, the covered tax balance for Year 1 includes the deemed deferred tax asset of (100 * 15%) = 15.

In Year 2, A Ltd determines that there will be future profits in its business operations. It recognises a deferred tax asset of 15 in its financial accounts by an accounting recognition adjustment. This adjustment is excluded for MTT purposes when determining the total deferred tax adjustment amount for Year 2. This is because it has already been recognised for MTT purposes in Year 1.

In Year 3, A Ltd makes a profit from its business operations against which it utilises the deferred tax asset recognised in its financial accounts. The utilisation of 15 will be reflected in the deferred tax expense and also recognised in the total deferred tax adjustment amount. No adjustment is required for MTT purposes.