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All about Deferred tax

All about Deferred tax

Deferred tax is an accounting concept (also known as future income taxes), meaning a future tax liability or asset, resulting from temporary differences or timing differences between the accounting value of assets and liabilities and their value for tax purposes.

Temporary differences are differences between the carrying amount of an asset or liability recognized in the statements of financial position and the amount attributed to that asset or liability for tax which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or

deductible temporary differences, which are temporary differences that will result in deductible amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.

An asset on a company’s balance sheet that may be used to reduce any subsequent period’s income tax expense. Deferred tax assets can arise due to net loss carryovers, which are only recorded as assets if it is deemed more likely than not that the asset will be used in future fiscal periods.

Illustrated example

The basic principle of accounting for deferred tax under a temporary difference approach can be illustrated using a common example in which a company has fixed assets which qualify for tax depreciation.

The following example assumes that a company purchases an asset for Rs. 1,000 which is depreciated for accounting purposes on a straight-line basis of five years. The company claims tax depreciation of 25% per year. The applicable rate of corporate income taxis assumed to be 35%. And then subtract the net value.



Year 1

Year 2

Year 3

Year 4

Accounting value

Rs. 1,000Rs. 800Rs. 600Rs. 400Rs. 200

Tax value

Rs. 1,000Rs. 750Rs. 563Rs. 422Rs. 316

Taxable/(deductible) temporary difference

Rs. 0Rs. 50Rs. 37Rs. (22)Rs. (116)

Deferred tax liability/(asset) at 35%

Rs. 0Rs. 18Rs. 13Rs. (8)Rs. (41)

As the tax value, or tax base, is lower than the accounting value, or book value, in years 1 and 2, the company should recognize a deferred tax liability. This also reflects the fact that the company has claimed tax depreciation in excess of the expense for accounting depreciation recorded in its accounts, whereas in the future the company should claim less tax depreciation in total than accounting depreciation in its accounts.

In years 3 and 4, the tax value exceeds the accounting value, therefore the company should recognize a deferred tax asset (subject to it having sufficient forecast profits so that it is able to utilize future tax deductions). This reflects the fact that the company expects to be able to claim tax depreciation in the future in excess of accounting depreciation.

Deferred tax is relevant to matching principle.

Deferred tax liabilities

Deferred tax liabilities generally arise where tax relief is provided in advance of an accounting expense, or income isaccrued but not taxed until received. Examples of such situations include:

  • a company claims tax depreciation at an accelerated rate relative to accounting depreciation
  • a company makes pension contributions for which tax relief is provided on a paid basis, whereas accounting entries are determined in accordance with actuarial valuations

Deferred tax Assets

Deferred tax assets generally arise where tax relief is provided after an expense is deducted for accounting purposes..Examples of such situations include:

  • a company may accrue an accounting expense in relation to a provision such as bad debts, but tax relief may not be obtained until the provision is utilized
  • a company may incur tax losses and be able to “carry forward” losses to reduce taxable income in future years.

All about Deferred tax

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