Every entity, under the Income-tax Act, 1961, determines its taxable income annually, which involves recognizing current and deferred taxes. Current tax is computed based on taxable income determined as per the Act and represents the tax payable for that year. In contrast, deferred tax arises due to differences between accounting income (book profit) and taxable income. These differences occur because accounting standards and tax laws often treat certain revenues and expenses differently. One of the common examples is the variation in depreciation rates and methods prescribed under the Companies Act and the Income-tax Act. Deferred tax items are classified as Deferred Tax Assets (DTA) or Deferred Tax Liabilities (DTL) and appear in the balance sheet. A DTA reflects future tax benefits—either reducing future tax liabilities or resulting in refunds for taxes already paid. It arises from temporary timing differences, such as carried forward losses, unabsorbed depreciation, or expenses deductible in future periods under Section 43B. On the other hand, permanent differences, such as disallowed expenses or personal expenditure, do not reverse and hence do not give rise to DTAs. Timing differences, however, reverse in subsequent years, creating opportunities to recognize DTAs or DTLs. A DTA is recognized only when there is a reasonable expectation that sufficient taxable profits will be available in future to utilize the benefit. Examples of timing differences include depreciation, carried forward losses, and preliminary expenses, whereas permanent differences include capital expenditure or provisions disallowed for tax purposes.
A Deferred Tax Liability (DTL) represents the future increase in tax payments due to timing differences, where taxable income is temporarily lower than accounting income. For example, when accounting depreciation is charged using useful lives prescribed under the Companies Act but tax depreciation follows higher rates under the Income-tax Act, the difference results in a DTL. Deferred tax items are measured using enacted or substantially enacted tax rates applicable to the relevant timing differences on the balance sheet date. For companies paying Minimum Alternate Tax (MAT) under Section 115JB, deferred tax continues to be measured using regular tax rates rather than the MAT rate. Similarly, individuals taxed under slab rates compute deferred tax using an average effective rate based on the applicable income slabs, excluding special rates such as those on long-term capital gains. An entity can offset a DTA against a DTL if it has a legally enforceable right to set off current tax assets and liabilities, intends to settle them on a net basis, and both relate to taxes under the same law. Deferred tax accounting thus ensures that the tax impact of transactions is matched to the corresponding accounting period, presenting a more accurate view of financial performance. DTAs reflect recoverable tax benefits, while DTLs represent future obligations, both arising due to timing differences that align accounting and tax recognition over time.
Deferred tax assets and liability
Every year, an entity is required to determine the amount of taxable income and tax thereon in accordance with provisions of the Income-tax Act, 1961. Such taxes on income are accounted for in the financial statements that include current tax, deferred tax asset, and deferred tax liability in respect of an accounting period.
Meaning of Current Tax
The current tax is the amount of income tax determined in accordance with the provision of the Income-tax Act, 1961. First of all, an entity assesses its taxable income for a period and then applies applicable tax rates to such income to determine current tax.
Meaning of Deferred Tax
Deferred tax arises when there is a difference between taxable income and accounting income (the amount of net profit before tax in the statement of profit or loss of an entity for a period). Such a mismatch arises due to the differences between accounting and taxation provisions. One of the primary examples of such difference between both provisions is depreciation debited to the statement of profit or loss and depreciation allowed under the provisions of the Income-tax Act.
Deferred Tax Asset
A Deferred Tax Asset is an item of the balance sheet that ultimately either reduces the income tax liability of an entity for future periods or results in a refund of an already paid amount of income tax. It arises when there are differences in tax and accounting rules or there is a carryover of depreciation or tax losses.
Two main reasons exist for such differences between taxable income and accounting income. Firstly, there are certain items of revenue and expenses in the statement of profit or loss, which are treaty differently for tax purposes according to the Income-tax Act, 1961. Secondly, the amount of certain items of revenue or expenses in the statement of profit or loss is recognised at a lower or higher amount for the computation of taxable income.
The differences between taxable income and accounting income can be classified into permanent differences and timing differences
Permanent differences are those differences between taxable income and accounting income which originate in one period and do not reverse subsequently. Permanent differences are ignored in the accounting of deferred tax assets.
Timing differences are those 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. Timing differences arise because the period in which some items of revenue and expenses are included in taxable income does not coincide with the period in which such items of revenue and expenses are included or considered in arriving at accounting income.
Deferred tax asset is recognised only on timing differences which are expected to result in an income tax refund or reduction in income tax liability in future periods in which it will reverse.
Examples of timing and permanent differences:
| Timing Differences | Permanent differences |
| Depreciation | Expenses paid in cash above Rs. 10,000 |
| Receipts taxable on a cash basis but not received during the year | Provision for doubtful debts (in case of an entity not being a bank, NBFC or financial institution) |
| Carried forward losses | Provision for unascertained liability |
| Unabsorbed depreciation | Capital expenditure |
| Preliminary expenses | Personal expenditure |
| Expenses specified in Section 43B, the payment of which is made after the due date for filing the income-tax return, for example, bonus, gratuity contribution, interest on borrowing from banks, etc. |
Deferred Tax Liability
Deferred Tax Liability is an item of the balance sheet that increases the income tax liability of an entity or decreases the amount of tax refund in future periods. It arises when there are differences between the provisions of income tax and accounting rules. Such as, for accounting income, depreciation is charged using useful lives of fixed assets specified under the Companies Act, 2013, but for taxable income, depreciation is allowed based on depreciation rates as specified under the Income-tax Act.
The differences between taxable and accounting income can be classified into permanent differences and timing differences (as discussed above). The deferred tax liability is recognised only on timing differences which are expected to increase the income tax liability of an entity in future periods in which it shall be reversed.
Measurement of the deferred tax asset/liability
In normal cases
Deferred tax asset/liability is measured using enacted or substantially enacted tax rates and tax provisions applicable for the relevant timing differences at the date of measurement.
The tax rates and tax provisions which have been notified by the government in its Official Gazette till the balance sheet date are considered as enacted or substantially enacted. However, certain announcements of tax rates and tax provisions by the government in the Finance Budget may have the substantive effect of actual enactment even before notification. In these circumstances, deferred tax asset/liability is measured using such announced tax rates and tax provisions.
Where MAT is applicable
The Income-tax Act, 1961 states that a company is required to pay a minimum tax amount as computed in accordance with the provision of Section 115JB. Such tax is known as minimum alternate tax, and where an entity is required to pay it for any period, it is treated as the current tax for that period.
Where a company pays minimum alternate tax under Section 115JB for any period, the deferred tax asset/liability on timing differences arising during the period is measured using the applicable regular tax rates and not the specified tax rate under Section 115JB of the Income-tax Act, 1961.
Further, in a case where an entity expects that the timing differences arising in the current period would reverse in a period in which it may pay minimum alternate tax under Section 115JB, the deferred tax asset/liability on timing differences arising during the current period is measured using the applicable regular tax rates and not the specified tax rate under Section 115JB of the Income-tax Act, 1961.
Where slab rate is applicable
The Income-tax Act, 1961 has specified income tax slab rates for certain classes of taxpayers, like for individuals. In this case, the deferred tax asset/liability is measured using average rates computed on the basis of applicable slab rates. Tax amounts calculated using separately specified rates should not be considered for the computation of average rates, like a tax on the long-term capital gain which is calculated at the rate of 12.5%/20% (as the case may be).
For example, a taxpayer whose status is individual for taxation purposes has computed its taxable income at Rs. 7,50,000 after claiming all applicable exemptions and deductions under the Income-tax Act. There is a timing difference of Rs. 50,000 between taxable income and accounting income which will be allowed as a deduction/taxable in future periods as per the Act. In this case, the income tax amount as per the slab applicable for FY 2024-25 will be Rs. 62,500 [(2,50,000 * 5%) + (2,50,000 * 20%)]. Hence, the average rate would be 8.33% (62,500/7,50,000*100). Accordingly, deferred tax asset/liability would be measured by applying 8.33% to Rs. 50,000. (Assuming the taxpayer chooses to opt out of the default tax regime under section 115BAC)
Offset of deferred tax asset with deferred tax liability
An entity may offset the amount of deferred tax asset with a deferred tax liability if:
a. the entity has a legally enforceable right to set off current tax assets against current tax liabilities;
b. intends to settle the asset and the liability on a net basis; and
c. the deferred tax assets and liabilities relate to taxes on income levied by the same governing taxation laws, i.e. the Income-tax Act, 1961.
MCQs on Deferred tax assets and liability
Q1. Deferred Tax Asset is an item of the balance sheet that ultimately___________ .
a. Reduces the income tax liability of an entity for future periods
b. Results in a refund of an already paid amount of income tax
c. Either (a) or (b)
d. None of the above
Correct answer: (c)
Explanation: Deferred Tax Asset is an item of the balance sheet that either reduces the income tax liability of an entity for future periods or results in a refund of taxes already paid.
Q2. Permanent differences are those differences between taxable and accounting income which originate in one period and are capable or expected to be reversed in one or more future periods.
a. True
b. False
Correct answer: (b)
Explanation: Permanent differences are those differences between taxable income and accounting income which originate in one period and do not reverse in any future period at the time of computation of taxable income.
Timing differences are those differences between taxable income and accounting income for a period which originate in one period and are capable or expected to be reversed in one or more future periods.
Q3. Deferred tax asset is recognised only on__________ which are expected to result in an income tax refund or reduction in income tax liability in future periods in which it will reverse.
a. Timing differences
b. Permanent differences
c. Both (a) and (b)
d. None of the above Correct answer: (a)
Explanation: Deferred tax asset is recognised only on timing differences which are expected to result in an income tax refund or reduction in income tax liability in future periods in which it will reverse.
Q4. Which of the following is the Timing Difference?
a. Depreciation
b. Preliminary expenses
c. Carried forward losses
d. All of the above
Correct answer: (d)
Explanation: These are examples of the timing differences because the assessee can claim the benefit of these items in future.
Q5. Which of the following is a Permanent Difference for a trading entity?
a. Provision for doubtful debts
b. Bonus paid after the return filing due date
c. Leave encashment, paid after return filing due date
d. All of the above
Correct answer: (a)
Explanation: The provision for bad and doubtful debts is allowed under Section 36(1)(vii)/(via) only to the eligible assessee, being a bank, NBFC or financial institution.
Q6. Deferred Tax Liability is an item of the balance sheet that___________
a. increases the income tax liability of an entity
b. decreases the amount of refundable tax in future periods
c. Either (a) or (b)
d. None of the above
Correct answer: (c)
Explanation: Deferred Tax Liability is an item of the balance sheet that increases the income tax liability of an entity or decreases the amount of refundable tax in future periods.
Q7. Minimum Alternate Tax (MAT) paid by a company in accordance with the provisions of Section 115JB is considered as
a. Current Tax
b. Deferred Tax Asset
c. Deferred Tax Liability
d. None of the above
Correct answer: (a)
Explanation: The Income-tax Act, 1961 states that a company is required to pay a minimum tax amount as computed in accordance with the provision of Section 115JB. Such tax is known as minimum alternate tax, and where an entity is required to pay it for any period then it is treated as current tax for that period.
Q8. Where MAT is applicable, the deferred tax asset/liability is calculated by applying .
a. Regular tax rates
b. Rates mentioned in Section 115JB
c. Either (a) or (b)
d. None of the above
Correct answer: (a)
Explanation: Where a company pays minimum alternate tax under Section 115JB for any period, the deferred tax asset/liability on timing differences arising during the period is measured using the applicable regular tax rates and not the specified tax rate under Section 115JB of the Income-tax Act, 1961.
(Republished with amendments)
