Covered taxes & adjustments

Role of covered taxes in the ETR computation

The jurisdictional ETR is the ratio of Adjusted Covered Taxes to Net GloBE Income. While the previous chapter explained how GloBE income is calculated (the denominator), this chapter focuses on the numerator: what counts as a "covered tax" and how the raw tax figures from the financial statements are adjusted for GloBE purposes.

Getting the covered tax computation right is critical. An understatement of covered taxes will depress the ETR and may trigger top-up tax that is not actually warranted. An overstatement could mean the group fails to recognise a genuine top-up tax liability. Both carry risk: in one direction, unnecessary tax cost; in the other, potential non-compliance.

What qualifies as a covered tax?

Covered taxes are taxes recorded in the financial statements of a constituent entity that satisfy the following criteria:

• Taxes on income or profits: The tax must be imposed on income, profits, or a measure of income or profits. This includes corporate income taxes, state and local income taxes, surtaxes, and similar levies.
• Taxes in lieu of income taxes: Certain taxes that are imposed as a substitute for a generally applicable income tax, for example a presumptive minimum tax based on assets or revenue that functions as an alternative to income tax, can qualify as covered taxes.
• Taxes on retained earnings and corporate equity: Taxes based on accumulated reserves, net equity, or undistributed earnings, where they function as an income-based charge.
• Taxes imposed under CFC rules: Taxes levied on a parent entity under CFC rules or similar regimes with respect to the income of a foreign constituent entity can be allocated as covered taxes to the jurisdiction of that foreign entity, increasing its ETR.

What is not a covered tax?

The following are explicitly excluded from covered taxes:

• Top-up taxes: Any top-up tax imposed under the GloBE rules themselves (whether via QDMTT, IIR, or UTPR) is not a covered tax. Including top-up tax in covered taxes would create a circular computation.
• Value-added taxes and sales taxes: Indirect taxes on consumption are not income-based and do not qualify.
• Payroll taxes and social security contributions: These are levied on employment, not on income.
• Property taxes: Taxes on real property values are asset-based, not income-based.
• Customs duties and excise taxes: Trade and commodity-based levies are excluded.
• Digital services taxes: Revenue-based digital levies do not qualify as covered taxes (though this is an area of evolving guidance).
• Taxes attributable to excluded income: Taxes on excluded dividends and excluded equity gains are removed from covered taxes to maintain consistency with the exclusion of those items from GloBE income.

Current tax adjustments

The starting point for covered taxes is the current tax expense recognised in the entity's financial statements for the fiscal year. This figure is then adjusted as follows:

Taxes accrued but relating to excluded income

Any current tax attributable to excluded dividends, excluded equity gains, or other items that have been removed from GloBE income must also be removed from covered taxes. If a constituent entity receives a dividend that is excluded from GloBE income but the local jurisdiction imposes withholding tax on that dividend, the withholding tax is removed from covered taxes.

Uncertain tax positions (UTPs)

Where a constituent entity has recognised (or not recognised) a tax position based on an uncertain interpretation of tax law, the covered tax amount may differ from the financial statement amount. The GloBE rules generally follow the accounting treatment for UTPs, but where a UTP is resolved (paid or refunded) in a subsequent year, the covered taxes for that subsequent year are adjusted accordingly.

Taxes refunded or credited

Any refund or credit received that relates to a prior period's current tax reduces covered taxes in the year the refund is received, unless the group elects to adjust the prior year's covered taxes (through the post-filing adjustment mechanism).

Taxes paid by other entities

In some structures, taxes are paid by one entity on behalf of another, for example under a tax consolidation or group relief regime. The GloBE rules require that covered taxes be allocated to the entity whose income the tax relates to, regardless of which entity makes the payment.

Deferred tax adjustments

The treatment of deferred taxes is one of the most technically challenging aspects of the covered tax computation. The GloBE rules partially recognise deferred tax, but with significant modifications:

The general principle

Deferred tax expense (or benefit) recognised in the financial statements is included in covered taxes, subject to a cap. The deferred tax amount is recalculated, or "recast," at the lower of the applicable domestic tax rate and 15% (the GloBE minimum rate).

This recasting prevents a high domestic tax rate from artificially inflating the covered tax figure through deferred tax. If a jurisdiction has a 30% tax rate and recognises deferred tax at 30%, the GloBE computation would recast that deferred tax at 15%, reflecting the fact that the GloBE ETR is being measured against a 15% floor.

How recasting works in practice

Consider an entity in a jurisdiction with a 25% statutory tax rate. The entity has temporary differences that give rise to a deferred tax expense of EUR 100,000 (measured at 25%). For GloBE purposes, this is recast at 15%:

Recast deferred tax = EUR 100,000 x (15% / 25%) = EUR 60,000

The EUR 60,000 is included in covered taxes, not the EUR 100,000. If the domestic rate were below 15% (say, 10%), no recasting would be needed; the deferred tax at 10% would be included as-is, since it is already below the cap.

Deferred tax liabilities: the recapture rule

Deferred tax liabilities (DTLs) present a particular challenge. A DTL increases covered taxes in the year it is recognised (making the ETR look higher), but if it never reverses, because the underlying timing difference is indefinitely deferred, the tax benefit was never real. The GloBE rules address this through a recapture mechanism:

• When a DTL is included in covered taxes, it must be tracked.
• If the DTL has not reversed within five years, the deferred tax amount is recaptured; that is, it is subtracted from covered taxes in the fifth year, effectively increasing the top-up tax for that year.
• This prevents groups from claiming credit for tax that is never actually paid.

Certain DTLs are excluded from the recapture rule, including:

• DTLs related to depreciation and amortisation of tangible assets
• DTLs related to lease liabilities
• DTLs related to decommissioning and environmental remediation obligations
• DTLs arising from the application of the fair value or revaluation method for tangible assets

Valuation allowances

Deferred tax assets (DTAs) that are subject to a valuation allowance (or "recognition assessment") present another complication. Under IFRS, a DTA is only recognised to the extent it is probable that sufficient taxable profit will be available. Under US GAAP, a valuation allowance reduces the DTA to the amount that is "more likely than not" to be realised.

For GloBE purposes, the movement in a valuation allowance reduces covered taxes. If an entity writes down its DTA (increases the valuation allowance), the covered tax for that year is reduced. If the entity writes up its DTA (decreases the valuation allowance), covered tax is increased. This ensures that covered taxes reflect only the portion of deferred tax that is expected to be realised.

Post-filing adjustments and true-ups

Tax positions change after the end of a fiscal year. Tax returns are filed, audits are conducted, positions are settled, and refunds are received. The GloBE rules address this through a post-filing adjustment mechanism:

• Material adjustments: Where a subsequent event results in a material change to the covered taxes for a prior year (for example, a significant audit settlement), the ETR for the prior year can be recomputed and any excess or shortfall in top-up tax is adjusted in the current year.
• Threshold: Adjustments below a materiality threshold may be included in the current year's covered taxes rather than reopening the prior year computation.
• Statute of limitations: The period during which post-filing adjustments can be made is subject to a five-year window in most jurisdictions.

Allocation of covered taxes to jurisdictions

Covered taxes must be allocated to the jurisdiction of the constituent entity to which they relate. In most cases, this is straightforward: corporate income tax is allocated to the jurisdiction that imposed it. However, several situations require specific allocation rules: