What is the correct formula for the effective tax rate (ETR)?

What is the correct formula for the effective tax rate (ETR)?

• A. Tax expense divided by Revenue
• B. Tax expense divided by Gross Profit
• C. Tax expense divided by Profit Before Tax
• D. Tax expense divided by Net Income

Answer: (C)

ETR measures how much tax a company pays relative to the income it earns before taxes. The correct formula uses the tax expense divided by Profit Before Tax (earnings before tax) because taxes apply to pre-tax earnings, not to revenue, gross profit, or net income. Using Profit Before Tax as the denominator reflects the actual tax burden on the earnings that were taxed. For example, if tax expense is 30 and pretax income is 150, the ETR is 30/150 = 20%. Using revenue or gross profit would ignore the income base to which taxes are applied, and using net income would mix in the after-tax result, distorting the rate.

ETR measures how much tax a company pays relative to the income it earns before taxes. The correct formula uses the tax expense divided by Profit Before Tax (earnings before tax) because taxes apply to pre-tax earnings, not to revenue, gross profit, or net income. Using Profit Before Tax as the denominator reflects the actual tax burden on the earnings that were taxed. For example, if tax expense is 30 and pretax income is 150, the ETR is 30/150 = 20%. Using revenue or gross profit would ignore the income base to which taxes are applied, and using net income would mix in the after-tax result, distorting the rate.