Multinational Top-up Tax and Domestic Top-up Tax

MTT27165 - Calculating the effective tax rate: Covered tax balance: Deferred tax: Qualifying foreign tax credits where carry-forward of credits not permitted

The tax laws of some territories require domestic losses to be offset against income arising under CFC regimes, but do not permit the carry forward of the resulting surplus foreign tax credits, where the CFC income was also subject to foreign tax. The surplus foreign tax credits which arise in such a case will be wasted. However, these territories may operate alternative loss recapture rules intended to produce a comparable result to regimes that are within the scope of section 183 of Finance (No.2) Act 2023.

Where such alternative loss recapture rules apply, section 183A Finance (No.2) Act 2023 provides for the creation of a deferred tax asset (a 'special foreign tax asset') in the period in which the domestic loss is offset against the CFC income. The member can use this asset to increase its covered tax balance in subsequent periods.

The special foreign tax asset will be used in a subsequent period when there is a crediting of foreign tax credits that is only permitted because, in an earlier period, the domestic loss was offset against the CFC income. In that subsequent period, the member’s covered tax balance is increased by the amount of the special foreign tax which has been used.

An example of an alternative loss recapture mechanism would be where excess foreign tax credits arising in a subsequent year can be used to offset a domestic tax liability on domestic source income that has been re-sourced as foreign source. As long as this loss recapture mechanism doesn’t provide a more generous outcome than if the loss carry forward had been generated, an adjustment to covered taxes can be made under section 183A of the Act.

Conditions

A special foreign tax asset will arise in a period where the following conditions are met:

• the territory in which a member is located requires that domestic losses are offset against relevant foreign income before foreign tax credits can be applied against tax on foreign income,
• the territory limits the extent to which foreign tax credits can be applied against tax in a taxable period,
• the territory allows foreign tax credits to be used to a greater extent where a domestic loss has been used to offset (in whole or in part) relevant foreign income in a prior period, and
• the member has used a domestic loss (in whole or in part) to offset relevant foreign income.

See MTT27160 for guidance on the meaning of 'relevant foreign income'.

Amount of special foreign tax asset

The amount of the special foreign tax asset is the amount of the domestic loss used to offset relevant foreign income, multiplied by the lesser of:

• the nominal rate of tax in the member’s territory for the taxable period in which it was used, and
• 15%.

Amount of special foreign tax asset used

Where a member has a special foreign tax asset from a previous period, that asset will be used to increase its covered tax balance in a subsequent period. The amount so used is the lesser of:

• the remaining amount of the asset, and
• so much of the amount of the foreign tax credits which are credited in the subsequent period only as a result of the use of the domestic loss in the earlier period against the CFC income.

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 

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 30%. Assume that Xco is the only member of the multinational group which is located in country X.

Under the CFC rules of country X, Xco is subject to tax on 1,000 of income which accrued to Yco. Yco is also subject to tax on this 1,000 of income at the country Y tax rate of 30%. Under country X’s tax law this 1,000 of CFC income is treated as ‘foreign income’ and the country Y tax which is paid by Yco gives rise to a foreign tax credit (“FTC”) for Xco. Under the tax law of country X, Xco must offset domestic losses against the foreign income before FTCs can be utilised. Accordingly, Xco’s domestic loss is offset against the 1000 of foreign income arising under the country X CFC rules. The offset of the domestic loss of 1000 against the foreign income means that Xco is not liable to tax in year 1 and so is not able to utilise any of the FTC of 300 (1,000 x 30%) in respect of the country Y tax on the foreign income.  The 1,000 of CFC income which accrues to Xco is not included in Xco’s adjusted profits. The covered tax balance for year 1 before the special loss deferred tax asset is created is 0 because no tax is paid on Xco’s adjusted loss of 1,000.  Xco’s utilisation of the domestic loss against the CFC income means it has no loss to carry forward to a future period.

Country X does not permit the unutilised FTC of 300 to be carried forward. However, although the usual rule in country X is that foreign tax credits can only be offset against domestic tax on foreign income, where there has been an offset of a domestic loss against CFC income in an earlier period, country X allows the foreign tax credits to be used to a greater extent.  Accordingly, under section 183A a special foreign tax asset can be recognised in Xco in year 1 of 150 (being the domestic loss that has been used (1000) multiplied by country X’s tax rate of 15%).

In year 2, Xco has a domestic profit of 1,000 and foreign income of 1,000 which is subject to tax in country Y at 30% resulting in 300 of foreign tax being paid. Under country X’s tax law, Xco has total taxable income of 2,000 resulting in a country X tax liability of 300. The usual rule in country X is that only 150 of the foreign tax of 300 would be creditable because only 150 of domestic tax is chargeable on the 1,000 of foreign income. However, because there has been an offset of a domestic loss against CFC income in year 1, the tax law in country X recharacterises the 1000 of domestic income as foreign income, and so permits the entire 300 of year 2 foreign tax to be credited. After this credit there is no tax payable in country X. In the absence of section 183A, Xco’s covered tax balance for year 2 would be 0 whilst Xco’s adjusted profits would be 1,000. This would result in an effective tax rate of 0% and a top-up tax liability of 150 (1,000 x 15%). However, since the foreign tax credit has been used to a greater extent on account of the domestic loss offset in year 1, section 183A applies so that the special foreign tax asset must be used. Xco’s covered tax balance is increased by 150 (that is the amount of the special foreign tax asset which is used in year 2). The effective tax rate is therefore increased to 15% and no top-up tax is due.

Example – application of s183A

Country X	Year 1	Year 2	Explanation
Taxable profit (loss)	0	2,000	In Y1, foreign income of 1,000 is offset against domestic loss of 1,000. In Y2, Xco has domestic profit of 1,000 and foreign income of 1,000.
Financial accounts	-	-	-
Current tax expense	0	0	In Y1, taxable profit is nil and no tax payable. In Y2, taxable profit of 2,000 at 15% is offset by full Y2 FTC of 300 (1,000 x 30% in country Y), resulting in 0 tax payable.
Deferred tax expense:	0	0	No deferred tax recognised as FTC of 300 in Y1 not usually allowed to be carried forward.
Tax expense in P/L	0	0	Current tax expense plus deferred tax expense
Without S183A	-	-	-
Covered taxes	0	0	In Y1, no tax is paid on the adjusted loss of 1,000.   In Y2, 1,000 of foreign income is subject to tax at 30% in country Y, resulting in foreign tax paid of 300. Per the laws of country X, foreign tax paid can only be credited against domestic tax on foreign income which would be 150 in Y2 (1,000 x 15%). However, because Xco offset foreign income of 1,000 against a domestic loss in Y1, country X allows the domestic income of 1,000 to be recharacterised as foreign income and the full 300 foreign tax paid can be credited. This results in 0 tax payable in Y2.
Adjusted profits	(1,000)	1,000	In Y1, the 1,000 of foreign income is not included in Xco’s adjusted profits, so the adjusted loss consists of the 1,000 domestic loss. In Y2, Xco has a domestic profit of 1,000. The foreign income of 1,000 is excluded from the adjusted profits.
ETR	-	0%	Covered taxes / adjusted profit
Top up tax due	0	150	In Y2, top up tax would be due on the 1,000 domestic profit.
S183A Impact	-	-	-
Special foreign tax asset	(150)	150	In Y1, 1,000 domestic loss is used to offset foreign income at country X’s tax rate of 15%. In Y2, the special foreign tax asset is used.
Covered taxes	(150)	150	In Y2, the special foreign tax asset from Y1 is used, which increases covered taxes by 150.
Adjusted profits	(1,000)	1,000	As above
ETR	-	15%	As above
Top up tax due	0	0	No top up tax due as a result of the special foreign tax asset being recognised and used.