Deferred Tax Asset and Deferred Tax Liability

What is Deferred Tax Asset and Deferred Tax Liability?

Deferred Tax Assets and Deferred Tax Liabilities are important parts of financial statements.

Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. Whereas, Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of (a) deductible temporary differences; (b) the carryforward of unused tax losses; and (c) the carryforward of unused tax credits.

Differences between book profits and tax profits that can be reversed in subsequent periods are known as temporary differences for which a deferred tax asset(DTA) or a deferred tax liability (DTL) must be created.

Any difference between book and tax profits that cannot be reversed in the subsequent period is permanent.

Accounting Standard (AS) 22 follows an income statement approach involving the concept of temporary difference based on the difference between book and tax profits. However, Indian Accounting Standard (Ind AS) 12 follows a balance sheet approach that accounts for deferred tax on temporary differences arising from the carrying amount of assets and liabilities as per accounting and tax records.

Deferred Tax means the deferment of taxes due to temporary differences. The tax may be required to be paid in the future. DTA arises if you are required to pay less tax in the future, and DTL arises if you have paid less tax today and are thus required to pay more tax in the future. The same is summarised below:

As per AS 22:

As per Ind AS 12:

Importantly: No DTA and DTL provisions are required to be made for permanent differences. E.g., Penalties and fines are part of book profits but are not allowed as expenses for tax purposes. Such differences are not reversible and are permanent ones.

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Instances, where DTA or DTL arises

The amount of depreciation allowed as per books of accounts and the amount of depreciation allowable as per tax authorities are different due to the difference in depreciation rates or method of depreciation, i.e. SLM or WDV.

Expenses that are allowed to be debited in the statement of profit or loss for accounting purposes but the same are allowed to be debited for taxation purposes in the subsequent year(s). E.g.:
i) Section 43B allows certain expenditures to be claimed only in the year of actual payment, irrespective of the year in which it was liable to be made. ii) Expenses under section 35D for preliminary purposes, 35DD for amalgamation, etc., are not allowed in a year. They are allowed over a period of a few years.

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Presentation of Deferred Tax Asset and Deferred Tax Liability in the Balance Sheet

An enterprise must offset both DTA and DTL amounts if it has a legally enforceable right to set off the assets against liabilities representing current tax, and it also intends to settle such assets and liabilities on a net basis.

• As per AS-22:
  After such set-off, the DTA (net of the DTL) shall be disclosed on the face of the balance sheet separately after the head ‘Investments’ or DTL(net of the DTA) shall be disclosed on the face of the balance sheet separately after the head ‘unsecured loans’ as the case may be.
• As per Ind AS-12:
  After such set-off, the DTA (net of the DTL) or DTL(net of the DTA) as the case may be, shall be disclosed on the face of the balance sheet separately under the non-current assets or non-current liabilities, respectively.

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Illustration on Deferred Tax Asset and Deferred Tax Liability

An entity has acquired an asset for INR 10,000. The depreciation rate as per income tax is 40% on a WDV basis. In books of account, the entity claims depreciation on an equivalent SLM basis of 16.21%.

The entity has accounting and taxable profits of INR 20,000 from year 1 to year 4 before any allowance of depreciation in either case. The tax rate is 30%.

Thus, from the above two tables, the tax should be INR 5,514 in all cases as per the accounting profit. The results are distorted. In year 3, in books, the amount of tax provision is higher by INR 54, and in year 4, it is higher by INR 227. This is so because, in years 1 & 2, these figures are lower by INR 714 & INR 234. Thus, the liability that was incurred in years 1 & 2 is paid from year 3 onwards. However, no provision of the differential (INR 714 in year 1 & INR 234 in year 2) is made. The creation of DTA/ DTL will converge this gap.

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What is the effect of Deferred Tax Assets and Deferred Tax Liability on MAT?

Minimum Alternate Tax (MAT) is the minimum tax that a company is required to pay if the tax payable under the provisions of the Income Tax Act (excluding surcharge and health and education cess) exceeds the specified percentage of tax on book profits. Such excess tax paid is termed as MAT credit which can be carried forward and utilized for the next 15 years.

Section 115JB of the Income Tax Act governs the MAT computation. It is calculated by adjusting the entity’s book profit. Certain adjustments are discussed here. The book profit shall be increased by the following:

• The income tax paid or its provision;
• An amount transferred to any reserve;
• Amount of deferred tax or its provision
• Provisions for meeting unascertained liabilities

The book profit shall be decreased by the following:

• Amount withdrawn from any provision or reserve
• Depreciation (except depreciation charged on revaluation of assets)
• Notional gain
• Amount of deferred tax credited to Profit and Loss A/c etc.

Adjustment of deferred tax liability debited to P&L for the purpose of MAT computation was a contentious and controversial issue. In the Prime Textiles Ltd case, the Chennai Tribunal has held that the deferred tax liability shall be added back, whereas the Kolkata Tribunal in Balrampur Chini’s case has held otherwise. However, Finance Act 2008 introduced an amendment in 115JB to explicitly include a specific clause related to ‘Amount of Deferred Tax in Profit and Loss A/c’. Post this amendment, the following effect has to be given in respect of deferred tax amounts:

• Increase the book profit by the amount of deferred tax and its provision or
• Decrease the book profit by the amount of deferred tax, if at all such an amount appears on the credit side of the profit and loss account.

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