Deferred tax refers to the accounting taxes that are either payable or recoverable in future periods. Deferred taxes straight-line the impact of accounting profit and taxable profit. This gap leads to the creation of either a Deferred Tax Asset (DTA) or a Deferred Tax Liability (DTL) for the entities. Let us try to have a thorough understanding of the entire concept of deferred taxes, the accounting standards that govern it, and the concept of DTA and DTL, as well as the triggers that help identify the time differences which might lead to the creation of DTA and DTL.

I. The Concept of Deferred Tax and the Creation of DTA and DTL

The discrepancy between accounting profit and taxable profit often arises because of different treatment of allowances and deductions for accounting and tax purposes. As a result of it, the entity might end up reporting higher or lower profits for its tax purposes in comparison to its accounting profits. This discrepancy creates two key concepts in taxation which are:

A. Deferred Tax Asset (DTA):

• DTA is recognized in the books only when there is virtual certainty, supported by convincing evidence, that sufficient future taxable income will be available to utilize the asset.
• It arises from the timing differences that lead to the recognition of expenses or losses earlier in accounting terms compared to their recognition for tax purposes or recognition of income later in accounting terms than for tax purposes

B. Deferred Tax Liability (DTL):

• DTL is recognized for timing differences that lead to taxable amounts in the future.
• It arises when expenses or losses are recognized earlier for tax purposes than in accounting terms, or when income is recognized later for tax purposes than in accounting terms.

Note: The Tax rate to be used for DTA/DTL computation shall be the income tax rate applicable for the entity at the Time of reversal of such temporary differences.

II. Standards Governing the Deferred Taxes

Deferred taxes are governed by standards specified by The Institute of Chartered Accountants of India (ICAI) in its guidelines[1]. The two frameworks that regulate the concept of Deferred Taxes are Accounting Standards (AS) and Indian Accounting Standard (Ind AS). These standards do not deal with the methods of accounting for government grants, state taxes or duty drawbacks. Both these frameworks address the recognition and measurement of deferred taxes, but there exist slight differences between the two. The key differences between AS 22 and Ind AS 12 are as follows:

III. Illustrations of Timing Differences Leading to DTAs and DTLs

 Various triggers and factors can lead to the creation of DTAs or DTLs. Some of the common triggers that lead to timing differences are:

IV. Disclosures

The notes to accounts should disclose the breakdown of deferred tax assets and deferred tax liabilities into major components. This includes

• the amount, deductible temporary differences, unused tax losses, and unused tax credits for which no deferred tax asset is recognized.
• the aggregate current and deferred tax related to items charged or credited directly to equity, and each component of other comprehensive income, should be disclosed.

In case an entity has accumulated losses, recognition of DTA shall be justified by such disclosure as necessary.

V. Conclusion

The measurement of the deferred taxes under various accounting standards such as AS 22 and Ind AS 12 and recognition of various factors that trigger the DTAs and DTLs, helps ensuring that deferred taxes are properly accounted for and helps in determining the true profitability at profit after tax level.

Contributors

CA Prajwal Bhat – LinkedIn
CA Sindhushree M – LinkedIn
Kuldeep Sarma – LinkedIn
Poonam Vernekar – LinkedIn