Multinational Top-up Tax and Domestic Top-up Tax

MTT27160 - Calculating the effective tax rate: Covered tax balance: Deferred tax: Qualifying foreign tax credits

The recognition and reversal of deferred tax assets arising from the generation or use of tax credits are generally excluded from the computation of a member’s total deferred tax adjustment amount.

However, there is an exception for qualifying foreign tax credits (also referred to in the legislation as a ‘substitute loss carry forward’).

Some territories’ tax laws have Controlled Foreign Company (“CFC”) regimes that require domestic losses to be offset against the income arising under the CFC regime. Where the CFC income has been subject to foreign tax, this may result in surplus foreign tax credits that the territory’s tax law may allow to be carried forward.

Usually, territories limit the use of foreign tax credits so they can be offset against domestic tax on foreign income. However, some territories may operate ‘loss recapture’ rules under which, where a domestic loss has been offset against CFC income in an earlier period, in a later period foreign tax credits may be offset against domestic income. This is an exception to the usual rules.

 The qualifying foreign tax credit rule in section 183 is intended to cater for cases where such loss recapture rules are operated.

The rationale for the exception is to recognise the deferred tax asset that would have arisen if the domestic loss had been carried forward, instead of being offset against the foreign income arising under the CFC regime. This exception allows for the same outcome whether a territory permits a loss carry-forward or foreign tax credit carry-forward (or equivalent mechanism) when there is a domestic source loss and foreign source income in the same year.

This is set out in section 183 of Finance (No.2) Act 2023.

Conditions for qualifying foreign tax credits

A foreign tax credit is qualifying if:

• the member with the foreign tax credit must be required, under the legislation of its territory, to first offset domestic losses against relevant foreign income before foreign tax credits can be utilised against tax on foreign income,

• the member must actually offset a domestic loss against relevant foreign income,
• to the extent that domestic losses have been offset against relevant foreign income in a previous period, the member with the foreign tax credit must be permitted under its domestic legislation to utilise foreign tax credits against domestic profits, and
• the foreign tax credit must be in respect of tax imposed by a territory other than the member’s territory on the relevant foreign income. 

Amount included in the total deferred tax adjustment amount (substitute loss carry forward asset)

The amount to be included in the total deferred tax adjustment amount is restricted to the lesser of:

• the foreign tax paid, and
• the amount of the domestic loss used to offset the relevant foreign income, multiplied by the tax rate in the territory in which the member is located.

Section 182(7) (adjustment where rate of tax exceeds 15%) applies to a qualifying foreign tax credit included in the member’s total deferred tax adjustment amount.

Relevant foreign income

The ‘relevant foreign income’ of a member includes:

• the income of a CFC of that member on which the member is taxed as a result of a CFC regime, and
• other qualifying income.

‘Other qualifying income’ is income that meets the requirements in the administrative guidance on substitute loss carry-forward guidance, which can be found in Chapter 4.1 of the June 2024 Agreed Administrative Guidance document published by the OECD.

Amendment in Finance Act 2025

Section 183 was amended by FA25. This guidance page reflects the current version of the legislation. Consult FA25 for legislation applicable to prior periods if the retrospection election does not apply (see MTT09490).

Example

The example below illustrates the operation of section 183. Company X (“Xco”) is resident in country X which has a 15% tax rate. In year 1, Xco has a domestic loss of 1,000. Xco also holds a 100% interest in company Y (“Yco”). Yco is resident in country Y and is treated as a CFC under country’s X tax law. The tax rate in country Y is 10%.

Under country X’s CFC rules, Xco is subject to tax on 500 of income which accrued to Yco and is subject to country Y’s tax of 10%.

Under country X’s tax law, this 500 of CFC income is treated as ‘foreign income’. Country X operates a system under which foreign tax is creditable and the country Y tax which is paid by Yco gives rise to a Foreign Tax Credit (“FTC”) for Xco. Under the law of country X, Xco must offset domestic losses against the foreign income before FTCs can be utilised. Accordingly, 500 of Xco’s domestic loss is offset against the 500 of foreign income arising under the CFC rules of country X.

Accordingly, Xco has a carried forward loss of 500, for which Xco recognises a deferred tax asset of 75 (500 x 15%) in its accounts. The offset of 500 of the 1000 domestic loss against the foreign profit means that Xco is not liable to tax in year 1 and so is not able to utilise any of the FTC of 50 (500 x 10%) in respect of the country Y tax on the 500 foreign income arising under the CFC rules of country X. However, country X permits the unutilised FTC to be carried forward and offset against future domestic income. Within Xco’s accounts, the unutilised FTC of 50 is recognised as a deferred tax asset. 

In year 2, Xco has domestic profit of 1000 and no foreign income. After the offset of the 500 carried forward domestic loss from year 1, Xco has taxable profits in year 2 of 500 resulting in a country X tax liability of 75 (500 x 15%). Xco also has a brought forward FTC of 50 from year 1 which it then utilises against this tax liability resulting in a tax liability of 25 in year 2.

The table below summarises the impact of section 183 on covered taxes for Xco. Section 203 (additional top-up amounts where covered taxes less than expected) does not apply in this example.

Country X	Year 1	Year 2	Explanation
Taxable profit / (loss)	(500)	500	In Y1, foreign income of 500 is offset against domestic loss of 1000. In Y2, 500 c/f domestic loss partially offsets domestic income of 1000.
Financial accounts	-	-	-
Current tax expense	0	25	In Y2 500 taxable profit at 15% tax rate, offset by FTC of 50 (75-50=25)
Deferred tax expense: Domestic loss FTC	(75) (50)	75 50	c/f domestic loss of 500 at 15% c/f FTC of 500 at 10%
Tax expense in P/L	(125)	150	Current tax expense plus deferred tax expense
Without S183	-	-	-
Covered taxes	(75)	100	FTCs excluded from total deferred tax adjustment amount
Adjusted profits	(1000)	1000	Only Xco’s income
ETR	-	10%	Covered taxes / adjusted profits
Top up tax due	0	50	In Y2, top-up tax would be due as FTCs are excluded from deferred tax adjustment amount.
S183 Impact	-	-	-
Substitute loss carry forward asset	(50)	50	Lower of: Foreign tax paid of 50 (500 x 10%) Domestic loss used to offset foreign income 75 (500 x 15%)
Covered taxes	(125)	150	In Y1, the substitute loss carry forward asset results in a credit to covered taxes of 50.
Adjusted profits	(1000)	1000	-
ETR	-	15%	-
Top up tax due	0	0	No top up tax due as a result of special loss carry forward asset being recognised.