What is a tax expense? Well, that's the tax on the income statement, the charge for the year. So what is your ETR and MTR? Well, if we start with the MTR, that's your marginal tax rate. It's the tax on the next dollar or pound or euro or yen earned and it's normally the statutory rate in the home country of a company. So what is your effective tax rate? Well, let's use an example to help explain this.

Your effective tax rate requires you to follow the rules in the tax code of a company's home country. Here in this table, we've got the various earnings and expenses for a company. First of all, it's got earnings A of 10,000. Those earnings attract a tax rate of 25% and let's assume that that is the statutory tax rate in this country or the marginal tax rate. Thus on the 10,000, this company will have to pay 2,500 in tax. But this company also has a second source of earnings, earnings B. This figure is 12,000 and attracts a lower tax rate. Why is this? Well, maybe the government is trying to incentivize certain kinds of operations. Maybe it's trying to regenerate a particular region in the country, and it says to companies, "If you set up in this region, we'll give you a lower tax rate." Great, his company has managed to do some of that. 12,000 of earnings attracts a 15% tax rate, so it only pays 1,800 on those earnings. It then has 2,000 of expenses and if we look at its total earnings, we have 10,000 plus 12,000 minus the 2000 of expenses to get to total learnings of 20,000. However we might notice these expenses are non-deductible for tax purposes. This means we can't use them to reduce the tax paid. Why is this? Maybe these expenses are parking fines or speeding fines. In a number of countries, you can't use those kind of fines to reduce your profits and reduce your taxes paid.

So that 2,000 attracts a tax rate of 0. Unfortunately, we can't reduce our profits and we can't reduce our taxes paid. So my total earnings are 20,000, and on those earnings we pay tax of 4,300.

We thus might note that we've had three different tax rates apply to those different items. While it's really useful to have an awareness that this is happening, most practitioners don't have to calculate using the finer details.

That 4,300 is our tax expense and we might note it is a weighted average impact of all the rates applied. It's used the 25% and the 15% and the 0%. So the observed rate overall is 21.5 and that is our effective tax rate. We've taken the 4,300 of tax expense and divided it by profit before tax of 20,000. It's worth noting that the ETR for a company will often be different to its MTR.