Effective tax rate
Total tax expense over pre-tax accounting profit. It blends things that recur with things that do not, so projecting it forward is where forecasts go wrong.
Where you will meet it
Effective tax rate appears in 4 learning outcomes on the CFA syllabus. A few of them:
- Tell current tax expense apart from deferred tax
“Permanent differences, such as income that is never taxable, do not create deferred tax; they simply change the effective tax rate.”
- Explain how operating across countries changes a company's effective tax rate
“A multinational's effective tax rate is income tax expense divided by pre-tax income, and it is a blend of the statutory rates of every country where profit is earned.”
- Explain what the reconciliation of the effective tax rate shows
“The effective tax rate is total tax expense divided by pre-tax accounting profit, and it rarely equals the statutory rate.”
- Work out the effective, statutory and cash rates of tax and contrast them
“The effective tax rate is income tax expense divided by pre-tax income, and it departs from the statutory rate because of foreign earnings taxed at different rates, tax-exempt income, credits and non-deductible expenses; the reconciliation in the tax note explains each difference.”
Practise it
Practise effective tax rate until it is automatic: questions that explain every wrong option.
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