Deferred tax is a notional asset or liability to reflect corporate income taxation on a basis that is the same or more similar to recognition of profits than the taxation treatment. Deferred tax liabilities can arise as a result of corporate taxation treatment of capital expenditure being more rapid than the accounting depreciation treatment. Deferred tax assets can arise due to net loss carry-overs, which are only recorded as asset if it is deemed more likely than not that the asset will be used in future fiscal periods. Different countries may also allow or require discounting of the assets or particularly liabilities. There are often disclosure requirements for potential liabilities and assets that are not actually recognised as an asset or liability.
Permanent and Temporary differences
If an item in the profit and loss account is never chargeable or allowable for tax or is chargeable or allowable for tax purposes but never appears in the profit and loss account then this is a permanent difference. A permanent difference does not give rise to deferred tax.
If items are chargeable or allowable for tax purposes but in different periods to when the income or expense is recognised then this gives rise to temporary differences. Temporary difference do give rise to potential deferred tax, but the rules on whether the deferred asset or liability is actually recognised can vary.
Temporary differences are usually calculated on the differences between the carrying amount of an asset or liability recognized in the statements of financial position and the amount attributed to that asset or liability for tax at the beginning and end of the year. The differences in the charges to the profit and loss account compared to the amounts taxable or allowable can also be calculated and should reconcile the change in position at the beginning and end of the year.
[IAS 12.5]
Example
The basic principle of accounting for deferred tax under a temporary difference approach can be illustrated using a common example in which a company has fixed assets that qualify for tax depreciation.
The following example assumes that a company purchases an asset for $1,000 which is depreciated for accounting purposes on a straight-line basis of five years of $200/year. The company claims tax depreciation of 25% per year on a reducing balance basis. The applicable rate of
corporate income tax
A corporate tax, also called corporation tax or company tax, is a direct tax imposed on the income or capital of corporations or analogous legal entities. Many countries impose such taxes at the national level, and a similar tax may be imposed at ...
is assumed to be 35%, and the net value is subtracted.
As the tax value, or
tax base
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or ...
, is lower than the accounting value, or
book value
In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. T ...
, in years 1 and 2, the company should recognize a deferred tax liability. This also reflects that the company has claimed tax depreciation in excess of the expense for accounting depreciation recorded in its accounts, whereas in the future the company should claim less tax depreciation in total than accounting depreciation in its accounts.
In years 3 and 4, the tax value exceeds the accounting value, therefore the company should recognise a deferred tax asset (subject to it having sufficient forecast profits so that it is able to use future tax deductions). This reflects that the company expects to be able to claim tax depreciation in excess of accounting depreciation.
Timing differences
In many cases the deferred tax outcome will be similar for a temporary difference or timing difference approach. However, differences can arise such as in relation to
revaluation
Revaluation is a change in a price of a good or product, or especially of a currency, in which case it is specifically an official rise of the value of the currency in relation to a foreign currency in a fixed exchange rate system. In contrast, ...
of
fixed assets
A fixed asset, also known as long-lived assets or property, plant and equipment (PP&E), is a term used in accounting for assets and property that may not easily be converted into cash. Fixed assets are different from current assets, such as ...
qualifying for
tax depreciation, which gives rise to a deferred tax asset under a balance sheet approach, but in general should have no impact under a timing difference approach.
Justification for deferred tax accounting
Deferred tax is relevant to the matching principle.
Examples
Deferred tax liabilities
Deferred tax liabilities generally arise where tax relief is provided in advance of an accounting expense/unpaid liabilities, or income is
accrue
Accrual (''accumulation'') of something is, in finance, the adding together of interest or different investments over a period of time.
Accruals in accounting
For example, a company delivers a product to a customer who will pay for it 30 days ...
d but not taxed until received
Deferred tax assets
Deferred tax assets generally arise where tax relief is provided after an expense is deducted for accounting purposes:
* a company may
accrue
Accrual (''accumulation'') of something is, in finance, the adding together of interest or different investments over a period of time.
Accruals in accounting
For example, a company delivers a product to a customer who will pay for it 30 days ...
an accounting expense in relation to a
provision
Provision(s) may refer to:
* Provision (accounting), a term for liability in accounting
* Provision (contracting), a term for a procurement condition
* ''Provision'' (album), an album by Scritti Politti
* A term for the distribution, storing an ...
such as bad debts, but tax relief may not be obtained until the provision is utilized
* a company may incur tax losses and be able to "carry forward" losses to reduce taxable income in future years..
An asset on a company's balance sheet that may be used to reduce any subsequent period's income tax expense. Deferred tax assets can arise due to net loss carryover.
Deferred tax in modern accounting standards
Modern accounting standards typically require that a company provides for deferred tax in accordance with either the
temporary difference or
timing difference approach. Where a deferred tax liability or asset is recognised, the liability or asset should reduce over time (subject to new differences arising) as the temporary or timing difference reverses.
Under
International Financial Reporting Standards
International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's f ...
, deferred tax should be accounted for using the principles in
IAS 12 IAS 12: Income Taxes is part of the International Accounting Standards (IAS) and International Financial Reporting Standards
International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundati ...
: Income Taxes, which is similar (but not identical) to
SFAS 109 under
US GAAP
Generally Accepted Accounting Principles (GAAP or U.S. GAAP, pronounced like "gap") is the accounting standard adopted by the U.S. Securities and Exchange Commission (SEC) and is the default accounting standard used by companies based in the Uni ...
. Both these accounting standards require a
temporary difference approach.
Other accounting standards which deal with deferred tax include:
*
UK GAAP
Generally Accepted Accounting Practice in the UK, or UK GAAP, is the overall body of regulation establishing how company accounts must be prepared in the United Kingdom. Company accounts must also be prepared in accordance with applicable company ...
-
Financial Reporting Standard 19: Deferred Tax (
timing difference approach)
* Mexican GAAP or NIF - NIF D-4, Impuestos a la utilidad
*
Canadian GAAP
Generally Accepted Accounting Principles (GAAP) of Canada provided the framework of broad guidelines, conventions, rules and procedures of accounting. In early 2006, the AcSB decided to completely converge Canadian GAAP with international GAAP, ...
-
CICA Section 3465
*
Russia
Russia (, , ), or the Russian Federation, is a List of transcontinental countries, transcontinental country spanning Eastern Europe and North Asia, Northern Asia. It is the List of countries and dependencies by area, largest country in the ...
n PBU 18 (2002) ''Accounting for profit tax'' (
timing difference approach)
*
INDIAN AS
Indian or Indians may refer to:
Peoples South Asia
* Indian people, people of Indian nationality, or people who have an Indian ancestor
** Non-resident Indian, a citizen of India who has temporarily emigrated to another country
* South Asia ...
-
Derecognition of deferred tax assets and liabilities
Management has an obligation to accurately report the true state of the company, and to make judgements and estimations where necessary. In the context of tax assets and liabilities, there must be a reasonable likelihood that the tax difference may be realised in future years.
For example, a tax asset may appear on the company's accounts due to losses in previous years (if carry-forward of tax losses is allowed). In this case a deferred tax asset should be recognised if and only if the management considered that there will be sufficient future taxable profit to use the tax loss.
[IAS 12.34] If it becomes clear that the company does not expect to make profits in future years, the value of the tax asset has been ''impaired'': in the estimation of management, the likelihood that this
tax loss
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, o ...
can be used in the future has significantly fallen.
In cases where the carrying value of tax assets or liabilities has changed, the company may need to do a
write-down
A write-off is a reduction of the recognized value of something. In accounting, this is a recognition of the reduced or zero value of an asset. In income tax statements, this is a reduction of taxable income, as a recognition of certain expenses ...
, and in certain cases involving in particular a fundamental error, a restatement of its financial results from previous years. Such write-downs may involve either significant income or expenditure being recorded in the company's profit and loss for the financial year in which the write-down takes place.
See also
*
Deferred financing costs Deferred financing costs or debt issuance costs is an accounting concept meaning costs associated with issuing debt (loans and bonds), such as various fees and commissions paid to investment banks, law firms, auditors, regulators, and so on. Since t ...
*
Tax shield
A tax shield is the reduction in income taxes that results from taking an allowable deduction from taxable income. For example, because interest on debt is a tax-deductible expense, taking on debt creates a tax shield. Since a tax shield is a way ...
Notes
External links
Summary of International Accounting Standard 12: Income Taxesby the International Accounting Standards Board
Summary of Financial Accounting Standard 109: Income Taxes- US Financial Accounting Standard
Financial Reporting Standard 19: Deferred Tax- UK Financial Reporting Standard
{{Authority control
Tax terms
Corporate taxation
Tax accounting