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Deferred Tax

The government of India, just like most other governments in the world, imposes monetary charges on the people of the country as well as commercial companies. In our country, the finance ministry computes and impose different kinds of taxes, and one of the taxes is the Deferred Tax. It is levied on companies.

The word ‘deferred’ means delayed or postponed; so in simple words, deferred tax is the tax which is estimated for the current period or is due for that term, but it has not been paid yet. The delay or the postponement comes when there is a difference in time from when the tax is accumulated and when the tax is actually paid.

Forms of Deferred Tax

Deferred tax asset items as well as deferred tax liability items are a prominent aspect of every company’s financial statements. This difference in timings of both, gives rise to certain variance in the company’s accounting. The most generic forms of deferred tax are Deferred Tax Asset and Deferred Tax Liability.

Deferred Tax Asset

Deferred tax assets originate when the amount of tax has either been paid or has been carried forward but it has still not been acknowledged in the statement of income. The actual value of the deferred tax asset is generated by comparing the book income with the taxable income. The biggest benefit of the deferred tax asset is that it causes the company’s tax liability to go down tremendously in the future.

The conditions that cause origin of deferred tax asset are as follows:

  • The taxing authority takes the expenses into account much before time.
  • A tax on the revenue earned is levied before time.
  • There is a difference in tax rules for asset and liabilities.

Deferred Tax Liability

Deferred tax liabilities, on the other hand originate when a company underpays the amount of taxes due, which it would eventually pay in the future. It should be remembered, however, that underpaid does not mean that they have not fulfilled their tax-duties, it’s just that the taxes would be paid on a different timescale. It is a tax to be paid in future. In simple words, deferred tax liabilities are the opposite of deferred tax asset, which occur when the taxable income is lesser as compared to the income mentioned in the income statements of the company.

The conditions that cause origin of deferred tax liability are as follows:

  • In order to showcase great profits to the shareholders, the companies often push their profits.
  • When companies keep more than one copies of the financial statement, for their own personal use or for furnishing the same to tax authorities. This is called dual accounting.
  • Sometimes companies also push the current profits into future, this gives them the opportunity to decrease the tax amount. By doing this instead of paying the saved money as taxes, they use that extra money for making investments.

Example of Deferred Tax Asset and Liability

Deferred Tax Asset

Now, to understand these concepts better, let us discuss them with examples. Suppose ABC Company that makes washing machines, presumes that the probability of a washing machine to go for warranty repairs is 2%. If the tax for the year 2018 is INR 1,00,000, then the variation that would arise in the company’s balance sheet and the income tax department would be as follows. It is visible that the tax difference, in this case, is INR 600.

Balance sheet of the Company

Warranty Expenses2,000
Income that is Taxable98,000
Payable Taxes (at 30%)29,400

Statement Presented to the Tax Department

Warranty ExpensesNil
Income that is Taxable1,00,000
Payable Taxes (at 30%)30,000

Deferred Tax Liability

Let us now discuss the Deferred Tax Liability, for the same ABC Company that produces washing machines. It is assumed by the company that the manufacturing machine that costs around INR 60,000 will work for about 3 years and would pay 30% on the profits earned. It has to be remembered here that when the annual accounting of finances is done, INR 20,000 will be accounted for the coming three years. Therefore, the annual income will decrease INR 20,000 and there will be a tax deduction of INR 9,000, and this originates a tax liability of INR INR 3,000.

Illustration on DTA/DTL Calculation

To understand the procedure of creation of the DTA and DTL that is Deferred Tax Asset and Deferred Tax Liability, let us see this illustration, assuming that there is no opening balance of either of the two:

ParticularsFor BookFor TaxDifferenceDTA/ DTL 30%
Sales Tax That is payable50,00015,00050,00015,000
Leave Encashment2,00,0001,00,000(1,00,000)30,000
Closing Balance of DTA/ DTL---15,000

Current tax on the income that is taxable is 8,00,000*30% =INR 2,40,000

Deferred Tax calculated =INR 15,000

Net tax Effect =INR 2,25,000

Effect of Tax Holiday w.r.t DTA/ DTL

A tax holiday is an incentive scheme that is given to companies by the government. It offers a kind of tax reduction or in some cases elimination. Occasionally used for the reduction of taxes, it is a strategy used for new enterprises that are getting established in the free trade zone. With the aim of encouraging production and consumption of certain goods and items, the government discards certain taxes for a provisional period, depending on various conditions.

It should be kept in mind that the deferred tax from the difference in timing that cause a reversal during the tax holiday duration should not be regarded during the enterprise’s tax holiday period. Deferred tax that is related to the differences in time that causes a reversal after the tax holiday should be calculated in the year that it originated.

Effect on MAT w.r.t DTA/ DTL

MAT stands for Minimum Alternate Tax which is to be paid by a company if the payable tax is as per the normal provision of the income tax that is smaller than the tax calculated @18.5% of the profit in book.

An increase in the book profit is caused by:

  • Paid income tax or a provision

  • An amount that is moved to any reserve

  • Arrangements made for unpredictable liabilities

  • Provision made for Deferred Tax etc.

Now, let us see that what are the causes of its decrease:

  • An amount drawn out from a reserve or a provision

  • Depreciation, leaving aside revaluation depreciation, that is debited to P&L

  • Lesser of loss brought forward or any unabsorbed depreciation

  • The deferred tax that is credited to P&L etc.

There are certain debates about the debit of deferred tax liability to P&L, that whether it should be included in the book income during the calculation of Minimum Alternate Tax.

Frequently Asked Questions

What is a deferred tax asset?

An asset which is available on the company’s balance sheet and is used to decrease the taxable income, is called a deferred tax asset. Often created due to the taxes that have been paid or are carried forward, deferred tax assets are not until then recognised in the income statement.

What is deferred tax in simple terms?

In simple terms, deferred tax is a tax that can be put off. It could be a positive or a negative entry on the balance sheet of the company regarding the taxes owned or have been overpaid due to temporary differences.

How do I calculate deferred tax?

To calculate deferred tax, follow these steps:

  • List the assets and the liabilities in a table
  • Calculate the bases of the Tax
  • Determine the temporary differences
  • Calculate rate of the applicable tax liability
  • Determine the tax asset
  • Recognise items outside the financial position
  • Add them all up and make an entry in the accounts

What is deferred tax liabilities?

Deferred tax liability is basically just the opposite of deferred tax asset, which occurs when the taxable income is lesser as compared to the income mentioned in the income statements.

What causes deferred tax liability?

When the real-world tax bill is smaller than what is stated in the income statements of the company, it gives rise to deferred tax liability. They are like a responsibility which develops when a company purposely delays current tax expenses.

How does a deferred tax asset work?

A deferred tax on the company’s balance sheet is generally seen as a good sign, as it will work towards the company’s future tax benefit. It works like a pre-paid tax, which can help the company in reducing the tax amount in future.

Is Deferred tax a current asset?

A deferred tax can surely be called a company’s current asset as it helps in decreasing the taxable income. It is reported on the company’s balance sheets under the heading of Current Asset itself.

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