The word Deferred is derived from the word “Deferments” which means arranging for something to happen at a later date. Thus, deferred tax is the tax for those items which are accounted in Profit & Loss A/c but not accounted in taxable income which may be accounted in future taxable income & vice versa. The deferred tax may be a liability or assets as the case may be.

As per AS 22,

Current tax is the amount of income tax determined to be payable (recoverable) in respect of the taxable income (tax loss) for a period.

Deferred tax is the tax effect of timing differences.

Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods.

Permanent differences are the differences between taxable income and accounting income for a period that originate in one period and do not reverse subsequently.”

Deferred tax is brought into accounts to make the clear picture of current tax and future tax. If  we take some advantage of Income Tax sections and pay less tax in current year, we may have to pay tax in future on that advantage being reverse. In the same way if we have to pay more tax by not allowing any expense in current year, it will be allowed in future and in that year tax will be reduced. So, we may get some benefit or loss on account of  difference in book profit and taxable profit.

Expenses amortized in the books over a period of years but are allowed for tax purposes wholly in the first year. (e.g. substantial advertisement expenses to introduce a product, etc. treated as deferred revenue expenditure in the books). Expenses paid without deducting TDS will not be allowed for tax purpose and will be allowed after deducting TDS on that. Expenditure of the nature mentioned in section 43B (e.g. taxes, duty, cess, fees, etc.) accrued in the statement of profit and loss on mercantile basis but allowed for tax purposes in subsequent years on payment basis. If we make provision of  bonus payable, provident fund contribution, Provision for staff leave encashment,  etc. but do not pay before filing of return they are disallowed in that year but will be allowed in the year of payment. If we make part payment out of this before filing of return that amount actually paid will be allowed for tax purpose and the remaining amount will be allowed in the year of payment. This is called temporary timing difference. But if we pay cash above Rs.20000/- this expense will not be allowed for tax purpose any time. So this is permanent difference.

We should keep in mind that Deferred Tax Liability or Deferred Tax Assets are created only for temporary timing difference. For permanent difference it is not created as they are not going to be reversed.

The book entries of  deferred tax is very simple. We have to create Deferred Tax liability A/c or Deferred Tax Asset A/c by debiting or crediting Profit & Loss A/c respectively.

The Deferred Tax is created at normal tax rate.

[1] Profit & Loss A/c Dr

To Deferred Tax Liability A/c

[2] Deferred Tax Asset A/c

To Profit & Loss A/c

Please, note that both the entries are not passed but only liability or asset is created for net amount of deferred tax.

If  book profit is greater than taxable profit, create deferred tax liability.

If  book profit is less than taxable profit, create deferred tax asset.

If  there is loss in the books of accounts but profit as per income tax and the difference (e.g. disallowance of exp.) subject to adjustments in future,  create deferred tax asset.

If  there is profit in the books of accounts but loss as per income tax and carry forward of loss is allowed, (we have to pay MAT), create deferred tax liability.

Thus it is understood that, Deferred Tax Asset and Liability arising on account of timing differences and which are capable of reversal in subsequent periods are recognized using the tax rates and laws that have been enacted or substantively enacted as of Balance sheet date. Deferred Tax Asset is not recognized unless there is virtual certainty that sufficient future taxable income will be available which such deferred tax asset will be realized.

In other words, DTL is recognized for temporary differences that will result in taxable amount in future years, Whereas DTA is recognized for temporary differences that will result in deductible amounts in future years and for carry forwards. It is to be noted that DTA is created in case of certainty only.

Example to understand Deferred Tax concept.

But the calculation is more important. Let us take one simple example of Depreciation difference in books of accounts and taxable income.

Suppose, one company purchases a machine costing Rs. 300000/- on 1ST April. The salvage value is assumed at zero. The working life is assumed at 3 years. The company uses straight line method for depreciation in books of accounts but this machine is of that type which can be depreciated fully in the first year for tax purpose. Suppose tax rate is 30% for 3 years. For simplification profit before depreciation and tax is assumed Rs.500000/-.

YEARIIIIII
PROFIT BEFORE DEPRECIATION AND TAXES500000.00500000.00500000.00
DEPRECIATION IN BOOKS OF ACCOUNTS100000.00100000.00100000.00
PROFIT BEFORE TAXES400000.00400000.00400000.00
TAXABLE INCOME
=PROFIT – ALLOWABLE DEPRECIATION
(500000-300000, 500000-0, 500000-0)
200000.00500000.00500000.00
CURRENT TAX @ 30 % ON TAXABLE INCOME60000.00150000.00150000.00
DEFERRED TAX LIABILITY60000.000.000.00
DEFERRED TAX ASSETS

(BEING REVERSAL OF LIABILITY)

0.0030000.0030000.00
TAX EXPENSE
= 30% OF PROFIT BEFORE TAXES
OR CURRENT TAX+DTL-DTA
120000.00120000.00120000.00
NET TIMING DIFFERENCE200000.00100000.000.00
BALANCE OF DEFERRED TAX LIABILITY60000.0030000.000.00

ENTRIES FOR THIS EXAMPLE :

In year I

Profit & Loss A/C DR 60000/-

To Provision for Income Tax A/C 60000/-

(Being provision made for tax payable for current year)

Profit & Loss A/C DR 60000/-

To Deferred Tax liability A/C 60000/-

(Being Deferred Tax liability created on account of timing difference)

In Balance sheet Deferred Tax liability will be reflected by Rs.60000/-

In year II

Profit & Loss A/C DR 150000/-

To Provision for Income Tax A/C 150000/-

(Being provision made for tax payable for current year)

Deferred Tax Asset A/C DR 30000/-

To Profit & Loss A/C 30000/-

(Being deferred tax liability reduced on reversing timing difference)

In Balance sheet Deferred Tax liability will be reflected by Rs.30000/-

In year III

Profit & Loss A/C DR 150000/-

To Provision for Income Tax A/C 150000/-

(Being provision made for tax payable for current year)

Deferred Tax Asset A/C DR 30000/-

To Profit & Loss A/C 30000/-

(Being deferred tax liability reduced on reversing timing difference)

Deferred Tax liability is zero so there is no question to reflect it in Balance sheet.

Please note that net of  deferred tax liability and asset will be reflected in Balance Sheet.

There are so many reasons for which allowable depreciation for tax purpose and depreciation booked in accounts differs. The rate of depreciation may differ in law and in books. The method of depreciation may differ in law and in books. The method of calculation may differ as in books we may depreciate the assets individually account wise whereas for tax purpose depreciation may be calculated block wise.

First time introduction of Deferred Tax in Books of accounts.

(Transitional Provisions)

As per AS 22 “On the first occasion that the taxes on income are accounted for in accordance with this Standard, the enterprise should recognise, in the financial statements, the deferred tax balance that has accumulated prior to the adoption of this Standard as deferred tax asset/liability with a corresponding credit/charge to the revenue reserves, subject to the consideration of prudence in case of deferred tax assets (see paragraphs 15-18). The amount so credited/charged to the revenue reserves should be the same as that which would have resulted if this Standard had been in effect from the beginning.”

To introduce deferred tax first time in the books, we have to find Difference between the Value of Assets as per Books of Accounts and the Value of Assets as per Income Tax Act. To simplify if we have fixed assets in the books as gross block Rs.250 lacs and accumulated depreciation Rs.150 lacs, the net value in the books is Rs.100 lacs. Suppose,  the net block value as per Income Tax calculation (as per tax audit) Rs.80 lacs. It means that in future we shall calculate depreciation on Rs.100 lacs whereas as per Income Tax Act, the depreciation will be calculated on Rs.80 lacs. This will result in less allowable depreciation creating more tax liability in future. Therefore, we have to create Deferred Tax liability for this future Tax liability. The timing difference is Rs.20 lacs on which we have to create Deferred Tax Liability of Rs.6 lacs at the assumed I.tax rate of 30%. In the same way we have to introduce for all differentiating assets and liabilities.

Suppose, a firm has the following positions  as on 31st March,

Asset / Liabilityas per booksas per I.tax.differenceDTL (+)
DTA (-)
@ 30%
Assets :
Net fixed assets-written down value.

( In future more tax has to be paid on less allowable depreciation as per tax law)

100.0080.0020.006.00
Liabilities:
Provision for gratuity

(when paid in future it will reduce tax at that time)

40.000.00-40.00-12.00
Provision for staff leave encashment

(when paid in future it will reduce tax at that time)

30.000.00-30.00-9.00
Total-50.00-15.00

The entry to be passed in books for Rs. 15.00 lacs DTA newly introduced.

Deferred Tax Asset A/C DR 1500000/-

To Revenue Reserve A/C 1500000/-

ANNUAL CALCULATION

It may be noted that we don’t have to calculate deferred tax on each and every transactions related to it. The Deferred Tax is calculated annually from comparison of book profit and taxable profit. The Deferred Tax Liability or Deferred Tax Asset is derived from the comparison of  Profit & Loss A/c of Balance sheet and Computation of Total Income for Income Tax purpose. If any amount is expensed out in Profit & Loss A/c but not deducted for Income tax purpose, it will create Deferred Tax Asset. If  any amount claimed in Income Tax is more than expensed out in Profit & Loss A/c, it will create Deferred Tax Liability.

The net difference of DTA / DTL is computed and transferred to Profit & Loss A/c. The Balance of Deferred Tax Liability / Asset is reflected in Balance sheet. For that the following simple statement may be used.

For the above example, Suppose in next year, the firm makes payments from provision and makes new provisions from P/L A/c.

DetailsP/L A/cComputation of IncomedifferenceDTL(+) / DTA(-)
@ 30%
Opening balance of
DTL(+) / DTA (-)
-15.00
Comparison of P/L A/c and Computation of Income
payment of staff leave encashment from provision10.0010.003.00
payment of gratuity from provision15.0015.004.50
new provision for staff leave made from P/L A/c5.00-5.00-1.50
new provision for gratuity made from P/L A/c5.00-5.00-1.50
depreciation as per books and tax audit20.0016.00-4.00-1.20
Total of comparison3.30
Closing Balance of DTL(+) / DTA (-)-11.70

Or using Balance sheet approach also we can derive same figure as under :

The closing balance of assets assuming depreciation rate of 20% will be Rs.80 & 64 lacs respectively. The closing balance of Gratuity provision will be 40-15+5=30 lacs and for Provision of Leave Encashment will be 30-10+5=25 lacs. The calculation will be as under.

Asset / Liabilityas per booksas per I.tax.differenceDTL (+)
DTA (-)
@ 30%
Assets :
Net fixed assets80.0064.0016.004.80
Liabilities:
Provision for gratuity30.000.00-30.00-9.00
Provision for staff leave encashment25.000.00-25.00-7.50
total-39.00-11.70

Last year Deferred Tax Assets were of Rs. 15 lacs which arrived at 11.70 lacs current year. So there is a deferred tax liability of Rs. 3.30 lacs for current year.

The only one entry will be passed in books for Rs. 3.30 lacs DTL newly calculated.

Profit & Loss A/C DR 330000/-

To Deferred Tax Liability A/C 330000/-

The balance of RS 11.70 lacs DTA will be reflected at asset side in Balance sheet.

As per revised schedule VI, DTL/DTA will be shown under “ Non Current Liabilities / Non Current Asset ”.

The readers are requested to consult their Tax Consultant before implementing. The writer does not take any responsibility for views reflected in the article.

By DIPESH SHAH

SOURCE = : OWN SOURCE (PERSONAL VIEWS)

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Category : Income Tax (20858)
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Tags : section 43B (69)
  • Deepa

    very beautifully and practically explained