Deferred Tax Liability

Reviewed by Annapoorna | Updated on Sep 28, 2020


A company derives its book profits from the financial statements as per the rules of the Companies Act. Alternatively, it calculates its taxable profits under the provisions of the Income Tax Act.

Timing differences between the book profit and taxable profit arise because of certain items which are specifically allowed and disallowed as deductions for income tax purpose. For example, the depreciation under the Income Tax Act and depreciation calculated under the Companies Act.

The tax on such difference is the deferred tax liability or asset. The asset or liability figure depends upon whether the resulting figure is positive or negative, when the taxable profits is reduced from the book profits.

What is Deferred Tax Liability?

The tax impact on the timing difference is known as the deferred tax. It means taxes that are deferred. The deferred tax is recognised on all timing differences both temporary and permanent.

Temporary differences are the differences between the book profit and the taxable profit which can be reversed in subsequent assessment years. On the other hand, permanent differences are those that cannot be reversed in the future assessment years.

The tax effect of such a difference will be depicted in the financial statements in the balance sheet as either deferred tax liability (on the liability side) or deferred tax asset (on the asset side). So, either the deferred tax asset or liability shall be shown as a closing balance every year until it is exhausted by any adjustments in the future years.

The year in which the book profits are more than the taxable profits, a deferred tax liability arises. It means the company shall pay less tax in the current assessment year. But, it will be incurring more tax due to the timing difference in the future assessment years.

The year in which the book profits fall below the taxable profit levels, a deferred tax asset arises. Here, the company must pay more tax in the current year but enjoys less taxes in the future years to the extent of timing differences.

Who is eligible to pay?

The concept of deferred tax liability and asset is mostly applicable to corporate entities or companies. But that does not leave out other types of businesses who follow different methods of accounting from what is laid under the income tax laws. For instance, the accounting of employee benefits or leave encashments in books varies from the tax computation.

A detailed breakdown of the procedure for filling the tax

Every year before businesses file income tax returns, there must be calculation of the book profit. The assessee must carry out certain adjustments to the net profit as per the statement of profit and loss. It is then compared to taxable profits under the head 'business or profession'.

The adjustments are as follows: 1. Income tax paid or provision 2. An amount carried to any reserve 3. Provisions made for unascertained liabilities 4. Deferred tax provision etc

Further, it is decreased by the following: 1. Amount withdrawn from any reserve or provision 2. Depreciation debited to P&L (except revaluation depreciation) 3. Lower of the sum of loss brought forward or the unabsorbed depreciation Deferred tax credited to P&L etc.