IFRS require a reconciliation between the corporate tax rates HMRC requires and the effective tax rates. The difference often includes adjustments for foreign earnings, if any, R&D tax credits, deferred tax adjustments, noncash factors, valuation allowances, and other factors.

For smaller enterprises, this reconciliation is not clear, but “stock-based compensation can have a significant impact on the effective tax rate,” argue the authors in “Effective Tax Rates and Stock-Based Compensation,” the newest analysis from The Footnotes Analyst. If you’re working on engagements with restricted stock, this new article offers welcome guidance that may be completely hidden in a target company’s financial statements or tax documents.

The article notes that tax affects post-tax profitability and values, particularly those

[D]erived from applying multiples of post-tax profit such as EV/NOPAT and a P/E ratio. In DCF analysis effective tax is a component of free cash flow, usually incorporated by starting the derivation of FCF with post-tax operating profit (NOPAT). Even if your approach to valuation uses pre-tax metrics, such as in EV/EBITDA, effective tax rates still matter.

The article includes an analysis of tax rates at Netflix in 2021 to conclude that “excess tax benefits on stock-based compensation reduced the effective tax rate by 5%.” This material change in free cash flow could dramatically increase the value of smaller enterprises similarly.