Deferred Tax Assets & Liabilities
Introduction
Deferred Tax Assets and Deferred Tax Liabilities arise because accounting profit and taxable profit are calculated using different rules. Companies prepare financial statements according to standards such as Indian Accounting Standards (Ind AS) or International Financial Reporting Standards (IFRS), while taxable income is calculated under income tax laws. Due to these differences, tax expense in books may not match the actual tax payable.
A Deferred Tax Liability (DTL) arises when a company pays less tax now but will pay more tax in the future. This usually happens when tax rules allow higher depreciation in the early years compared to accounting depreciation. As a result, taxable income becomes lower today, reducing current tax payment. However, in future years, tax payments will increase when the difference reverses. Therefore, DTL represents a future tax obligation.
A Deferred Tax Asset (DTA) arises when a company pays more tax now but will pay less tax in the future. This occurs when expenses such as provisions for doubtful debts or carry-forward losses are recorded in accounting books but are not immediately allowed for tax deduction. The company pays higher tax today but will get tax benefit in the future. Hence, DTA represents a future tax benefit.
Deferred tax is calculated using the applicable tax rate on temporary differences. Accounting standards like IAS 12 and Ind AS 12 provide rules for recognition and measurement.
In summary, DTA and DTL help match tax expense with accounting income and present a true and fair view of a company’s financial position.
Meaning of Deferred Tax
| Basis | Deferred Tax Asset (DTA) | Deferred Tax Liability (DTL) |
|---|---|---|
| Meaning | Future tax benefit | Future tax payment |
| Arises When | Taxable income > Accounting income | Taxable income < Accounting income |
| Tax Payment Today | Higher tax paid now | Lower tax paid now |
| Future Impact | Lower tax in future | Higher tax in future |
| Nature | Asset (Non-current asset) | Liability (Non-current liability) |
| Common Example | Provision for doubtful debts, carry forward losses | Higher tax depreciation |
| Accounting Treatment | Dr. Deferred Tax Asset | Cr. Deferred Tax Liability |
Temporary vs Permanent Differences
Temporary Differences: Value of an asset or liability differs from its tax base. Deductible temporary differences reduce taxable income today; taxable temporary differences increase taxable income today.
Permanent Differences: Differences between accounting profit and taxable profit that never reverse. Examples include penalties, political donations, and agricultural income (India).
Deferred Tax Liability (DTL)
Definition: Taxable income < Accounting income. Company pays less tax now but more later.
Reasons: Higher tax depreciation, revenue recognized earlier, installment sales, revaluation of assets.
Example: Asset cost ₹10,00,000, higher tax depreciation reduces taxable income today, creating DTL.
Accounting Treatment: Income Tax Expense Dr. → Deferred Tax Liability Cr.
Balance Sheet: Presented under non-current liabilities.
Deferred Tax Asset (DTA)
Definition: Taxable income > Accounting income. Company pays more tax now but less later.
Reasons: Provisions (doubtful debts, warranty, leave encashment), carry forward losses, MAT credit.
Example: Provision for doubtful debts ₹1,00,000, tax disallowed, extra tax ₹30,000 = DTA.
Accounting Treatment: Tax Asset Dr. → Income Tax Expense Cr.
Balance Sheet: Presented under non-current assets, only if future taxable profits probable.
Accounting Standards Regarding Deferred Tax
IFRS (IAS 12): All temporary differences recognized; DTA only if future profit probable.
Ind AS 12: Similar to IAS 12.
Measurement of Deferred Tax
Deferred Tax = Temporary Difference × Tax Rate
Measured using enacted or expected future tax rates at reversal.
Recognition Principles
DTL: Recognize all taxable temporary differences except initial goodwill.
DTA: Recognize only if future taxable income probable (important for loss-making companies/start-ups).
Deferred Tax and Loss Carry Forward
Business losses can be carried forward, reducing future tax liability, creating DTA. Recognition depends on probability of future profit.
Impact on Financial Statements
Balance Sheet – DTA as non-current asset, DTL as non-current liability.
Cash Flow Statement – Increase in DTL added back, increase in DTA deducted.
Profit & Loss – Tax expense includes current tax + deferred tax.
Advantages
- Matches tax expense with accounting income
- Presents true financial position
- Improves comparability
- Supports long-term planning
- Reflects future tax impact
Disadvantages
- Complex calculations
- Requires estimation of future profits
- Subjective judgment
- Risk of overestimating DTA
- Tax law changes affect balances
Comparison: DTA vs DTL
| Basis | Deferred Tax Asset | Deferred Tax Liability |
|---|---|---|
| Meaning | Future tax benefit | Future tax payment |
| Arises when | Taxable income > Accounting income | Taxable income < Accounting income |
| Nature | Asset | Liability |
| Example | Provision, losses | Depreciation difference |
Risk Analysis
Risks include uncertainty of future profits, tax rate changes, regulatory amendments, and economic slowdown. Companies must reassess DTA regularly.
Deferred Tax on Profit & Loss Account
Total Tax Expense = Current Tax + Deferred Tax
Effect in Cash Flow Statement
Increase in DTL → Added back to Net Profit
Increase in DTA → Deducted from Net Profit
Conclusion
Deferred Tax Assets (DTA) and Deferred Tax Liabilities (DTL) play a vital role in modern financial reporting because they ensure that tax expenses are properly matched with accounting income. They arise due to temporary differences between accounting profit calculated under standards such as Ind AS 12 and IAS 12, and taxable profit calculated according to tax laws. These differences occur mainly because accounting principles and tax regulations recognize income and expenses at different times.
A Deferred Tax Asset represents a future tax benefit. It arises when a company pays more tax today or recognizes expenses in books that are not immediately allowed under tax law. This results in tax savings in future years when the temporary differences reverse. On the other hand, a Deferred Tax Liability represents a future tax obligation. It occurs when a company pays less tax in the current period due to higher deductions allowed under tax rules, but will have to pay more tax in the future.
Deferred tax does not directly affect immediate cash flow; rather, it adjusts the tax expense in the Profit and Loss Account to present a true and fair view of financial performance. It improves transparency, ensures compliance with accounting standards, and provides investors with insight into future tax impacts.
In conclusion: Understanding deferred tax is essential for accurate financial analysis, effective tax planning, and sound decision-making. Proper recognition and measurement of DTA and DTL enhance the reliability and comparability of financial statements, reflecting the company’s real financial position and future tax responsibilities.