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Deferred Taxes: Basics, Implications, and Understanding

Summary: Deferred Tax: Understand its impact on financial reporting, including assets, liabilities, and regulatory implications in India.

06 Oct 2023 by Team FinFIRST

Deferred Tax Meaning

Deferred tax is a crucial concept in income tax accounting. It arises due to temporary differences between accounting and taxable profits of a company that lead to deferred tax assets or liabilities on the balance sheet.

The Indian Accounting Standard (Ind AS) 12 governs the measurement and reporting of deferred taxes for companies in India. This article explains the meaning of deferred tax, reasons for deferred tax assets and liabilities, recognition and measurement principles, presentation in financial statements, accounting for changes in tax rates, and the importance of deferred tax under Ind AS 12. Understanding deferred tax meaning as per accounting standards and regulations is essential for proper financial reporting and analysis.

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What is a deferred tax?

Deferred tax refers to the accounting treatment of temporary differences between book value and tax base of assets and liabilities. This arises when there is a difference in the timing of recognition of income and expenses as per accounting standards and tax laws.

For example, accounting standards may require recognising an expense earlier than tax laws. This would result in lower accounting profits compared to taxable profits in the current year, creating a deferred tax asset. On the other hand, if tax laws allow faster depreciation than accounting standards, it would result in lower taxable profits than accounting profits in the current year, leading to a deferred tax liability.

The company records deferred tax to account for the tax impact of these temporary differences. The deferred tax is calculated by applying the enacted or substantively enacted tax rate to the cumulative temporary differences.”

Reasons for deferred tax assets and liabilities

Some common examples of deferred tax assets and liabilities are:

Deferred tax assets

Provision for doubtful debts and advances. These are expensed in the books but allowed for tax purposes only when actually written off.
Unused tax losses that can be carried forward to offset future taxable income.
Excess depreciation as per books over depreciation, as per tax laws.
Provision for employee retirement benefits.

Deferred tax liabilities

Accelerated depreciation for tax purposes compared to accounting depreciation.
Undistributed profits of subsidiaries, joint ventures, and associates where a dividend distribution tax is payable.
Fair valuation gains on investments taxed only when they are sold.

Recognition and measurement

The Ind AS 12 on income taxes requires deferred tax assets and liabilities to be recognised for all temporary differences, with some exceptions. For example, deferred taxes are not recorded for goodwill or assets/liabilities arising from initial recognition of transactions that do not affect accounting or taxable profits.

Tax deferred is measured based on the tax rates enacted or substantively enacted by the balance sheet date. These rates are expected to apply when the related deferred tax balances reverse. The carrying amount of deferred tax assets needs to be reviewed at each balance sheet date. It is reduced to the extent that it is no longer probable that related tax benefits will be realised.

Importance of deferred tax

Recording deferred taxes is important for a company for the following reasons:

It provides a more accurate picture of current year profit or loss by recognising tax effects of temporary differences.
It ensures that the tax expense is matched to the accounting period in which profits are earned.
It presents a better reflection of assets and liabilities by considering future tax consequences.
It provides information to the company stakeholders about future tax liabilities or assets that exist on the balance sheet date.

Wrapping up

Accounting for deferred taxes as per Ind AS 12 is mandatory for companies following Ind AS. Proper calculation and disclosure of deferred taxes help stakeholders analyse the financial statements better and make informed decisions.

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.

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