Estimating Operating Taxes  415
As noted earlier, operating taxes are the taxes that would be paid by a 
company with only operating income and financed entirely with equity. 
Exhibit 20.2 calculates operating taxes and NOPAT for TaxCo. To determine 
operating taxes, apply the appropriate statutory tax rate to each jurisdiction’s 
EBITA. (Although the interest tax shield is valuable, it is typically valued 
not as part of income, but as part of the weighted average cost of capital or 
valued separately in adjusted present value. And since amortization is typi-
cally nondeductible for tax purposes, it has no value. This is the rationale for 
the calculation being a function of EBITA.) In this case, multiply 25 percent 
by domestic EBITA of $2.2 billion and 15 percent by $600 million in foreign 
EBITA, which equals statutory taxes of $640 million. Since the $40 million in 
research and development (R&D) credits are related to operations and are 
expected to grow as the company grows, they are treated as operating. As a 
result, the company pays $600 million in operating taxes. To find the operat-
ing tax rate, divide operating taxes by global EBITA of $2.8 billion, for a rate 
of 21.4 percent.
Note how the statutory, effective, and operating taxes differ. The statutory 
tax rate on domestic income is 25.0 percent, the effective tax rate (shown in 
Exhibit 20.1) equals 17.9 percent, and the operating tax rate is 21.4 percent. The 
operating tax rate is the best tax rate for converting EBITA to NOPAT.
Using Public Statements to Estimate Operating Taxes
In practice, companies do not publicly disclose income by country. Instead, 
you must rely on a company-wide income statement and a tax reconciliation 
table. The tax reconciliation table can be found in the notes that accompany 
the financial statements. It explains why a company’s reported taxes do not 
equal the product of pretax profit times the statutory rate. At the company’s 
discretion, the table can express amounts in percentages or in the company’s 
reporting currency.
EXHIBIT 20.2  TaxCo: Operating Taxes and NOPAT by Geography
$ million
Domestic
subsidiary
Foreign
subsidiary
R&D
tax credits
Resolution of
tax dispute
Consolidated
EBITA
2,200
600
–
–
2,800
Operating taxes
(550)
(90)
40
–
(600)
NOPAT1
1,650
510
–
–
2,160
 
Tax rates, %
Statutory tax rate
25.0
15.0
Operating tax rate
21.4
1 Net operating profit after taxes.

416  Taxes
To illustrate how such a table denoted in percentages explains the differ-
ence between statutory and effective rates, the left side of Exhibit 20.3 presents 
the tax reconciliation table for TaxCo. Because foreign income was taxed at 
15 percent, TaxCo paid $70 million less in taxes than if it had been taxed at 
the domestic rate of 25 percent (i.e., it paid $105 million in taxes at 15 percent, 
rather than $175 million at 25 percent). To report this difference as a percent 
of pretax profit, the tax reconciliation table divides the $70 million by pretax 
profit of $1.9 billion to obtain 3.7 percent of pretax income. Each of the adjust-
ments is divided by pretax profit to determine the corresponding percentages 
in the reconciliation table.
The right side of Exhibit 20.3 shows how to use the tax reconciliation table 
to estimate operating taxes in millions of dollars. Start by calculating statutory 
taxes on EBITA. Next, work through the table looking for line items that are 
ongoing and related to operations. Finally, add the statutory taxes on EBITA 
to the operating-related adjustments. The following paragraphs take a closer 
look at these steps.
To calculate statutory taxes on EBITA for TaxCo, multiply EBITA by the 
statutory tax rate: 25 percent times $2.8 billion equals $700 million.
Next, search the tax reconciliation table for tax adjustments that are ongo-
ing and related to operations. The most common operating adjustments are 
state and foreign taxes. To determine if other adjustments are operating, look 
for consistency over time, and use the account description. Some account de-
scriptions are cryptic, so an online search may shed light on the adjustment. 
For TaxCo, we classify R&D tax credits as operating and the resolution of past 
tax disputes as nonoperating.
To calculate cumulative operating adjustments for TaxCo, sum the foreign-
income adjustment (3.7 percent) and the R&D tax credit (2.1 percent), and 
multiply the results by pretax profit, not EBITA. Use pretax profit because the 
company creates the tax reconciliation table using pretax profit, not EBITA. 
EXHIBIT 20.3  TaxCo: Operating Taxes Using a Tax Table Reported in Percent
Tax reconciliation table
Operating taxes
$ million
Statutory tax rate
25.0%
EBITA
2,800
Foreign-income adjustment
(3.7%)
× Statutory tax rate
25.0%
R&D tax credits
(2.1%)
= Statutory taxes on EBITA
700
Resolution of tax dispute
(1.3%)
Effective tax rate
17.9%
Foreign-income adjustment
(3.7%)
R&D tax credit
(2.1%)
Cumulative adjustments
(5.8%)
× Pretax profit
1,900
= Operating adjustments
(110)
Operating taxes
590