Deferred tax is recognized to account for the differences in treatment provided by accounting standards compared to tax laws. These differences, known as temporary differences, reverse in future periods, resulting in either a deduction from taxable income or an increase in taxable income. Accordingly, deferred tax assets or liabilities are recognized for these temporary differences. However, if a difference will not reverse in future periods, it is considered a permanent difference, and no deferred tax asset or liability is recognized.
Under IND AS 109, the discounting of security deposits leads to additional depreciation (through the Right of Use asset) and interest income (from the unwinding of the security deposit). These amounts will never be considered in tax returns in future periods, but they do reverse in accounting income of future periods as they are merely notional depreciation and interest income.
This raises the question of whether such differences constitute permanent differences, for which no deferred tax accounting should be done, or temporary differences, for which deferred tax accounting should be done.
When accounting for security deposits under IND AS 109, the deposit is discounted, and the difference between the amount paid and the present value of the deposit is recognized as a Right of Use (ROU) asset. This ROU asset is then depreciated over the lease period, while interest income is recognized in the profit and loss account due to the unwinding of the discount on the security deposit.
In practice, these two amounts—depreciation of the ROU and interest income—tend to offset each other over the lease term. However, when recognizing deferred tax, we typically recognize a Deferred Tax Liability (DTL) on the ROU asset since it appears on the balance sheet. This recognition leads to a DTL being recorded on the ROU asset created by discounting the security deposit.
To avoid an overstatement of the DTL, it becomes necessary to create a corresponding Deferred Tax Asset (DTA) on the discounted portion of the security deposit. If this DTA is not recognized, it would result in the recognition of an excess DTL, which would distort the financial statements.
This highlights the importance of carefully considering both sides of the transaction—ROU depreciation and interest income recognition—when determining the appropriate deferred tax treatment.
Conclusion: Conceptually, there is no inherent requirement to recognize Deferred Tax Assets (DTA) or Deferred Tax Liabilities (DTL) on security deposits. However, for practical purposes and ease of application, we often recognize a DTL on the entire Right of Use (ROU) asset and then create a corresponding DTA on the security deposit. This approach ensures that the financial statements accurately reflect the tax implications without overstating the DTL.
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