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Meaning of Deferred Tax Liability & Asset in Simple Words

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Home > Articles > Accounts > Meaning of Deferred Tax Liability & Asset in Simple Words

Bitdefender Total Security 2012

Meaning of Deferred Tax Liability &

Asset in Simple Words
Vignesh Killur

on 21 March 2012

Comments

In Simple words, Deferred Tax Liability is a Provision for Future Taxation.

This is in stark Contrast to Provision for Taxation. Provision for Taxation is basically a
provision for Current year Taxation.
Deferred Tax Liability arises due to timing difference in the value of Assets as per Books of
Accounts and as per Income Tax Act.
Also we can say that Deferred Tax Liability/Asset arises due to the difference between Profit
as per Books of Accounts (P&L Account) and profit as per Income Tax Act. (Taxable
Income).
Depreciation is the main reason for difference in the profits as per books of Accounts and
Taxable profits as per Income Tax Act. Both Income Tax Act and Companies Act prescribe
different rates of Depreciation for different categories of Assets.
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Let me illustrate with a simple example. Suppose a Company purchases a Wind Turbine
Generator (Windmill). The Depreciation which can be claimed in the Books of Accounts in as
per Companies Act is let's say 20% (assumed). The Depreciation as per Income Tax Act is

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80% for Windmill.

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Now a Windmill is purchased for Rs. 10,00,00,000/- (10 Crores). The Depreciation Claimed in

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the First year is:

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Value of Windmill:
Depreciation

as

10,00,00,000/per

Books

Accounts:

of 10,00,00,000

20%=

Depreciation as per Income Tax 10,00,00,000

Act:

80%=

DIFFERENCE
DEFERRED TAX LIABILITY @ 30.9%

2,00,00,000/-

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8,00,00,000/-

-6,00,00,000/-1,85,40,000/-

(Deferred Tax Liability is created at the highest Marginal Rate of Tax i.e. 30.9%)
What is the Meaning of Creating this Deferred Tax Liability of Rs. 1,85,40,000/- (One Crore
eighty five lakhs forty thousand)
It simply means that the company will definitely have a tax Liability of that much in the
future years. This is because in the years to come the Depreciation as per Income Tax Act
will be lesser that the Depreciation as per Books of Accounts. Hence in these years the
Company will have to create a Deferred Tax Asset

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Meaning of Deferred Tax Liability & Asset in Simple Words

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For clarity the Following Table is provided. Let's take the figures in Lakhs for Easier
Understanding:
Let Windmill Value be Rs. 100,000/Year

5*

TOTAL

Dep as per IT
Act
(80%

OF

80,000 16,000 3,200

640

160

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100,000

WDV)

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Dep

as

per

Books

20,000 20,000 20,000

20,000

20,000

100,000

60,000 -4,000 -16,800

-19,360

-19,840

(20% SLM)
DIFFERENCE
DTL/DTA

30.9%

18,540 -1,236 -5,191.20 -5,982.24 -6,130.56 0

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Income Tax

Note * In year 5 as per Income tax act let's assume the entire Remaining Balance is written
off

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CONCLUSIONS:

C areer

1. In Year 1 Deferred Tax Liability amounting to Rs. 18,540/- has to be created. This means

Service Tax

that

C orporate Law

in Year 1, the company has postponed its tax Liability of Rs. 18,540/- to the Future

years. This Liability will come back to the company one day or the other. (Unless 80 IA is

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claimed)

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2. In Year 2, as you can clearly see the Depreciation as per Books has gone up. This means

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that Depreciation as per IT act will be lesser as a result the profit as per IT Act will be more

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and as a result the company has to pay Rs. 1236/- more tax during this year.
3. Thus in the remaining years the company will have Deferred Tax Assets And the Deferred
Tax Liability created in the first year will be reversed in the subsequent 4 years.
4. Thus when the WDV of Assets as per Books and WDV as per IT Act both become ZERO,
there is neither Deferred Tax Liability nor Deferred Tax Asset as there is no timing Difference
Deferred Tax is purely an accounting Concept. AS 22 - "Accounting for Taxes on Income
deals with Deferred Tax.
The following are the Accounting treatment and Tax treatment of Deferred Tax:
ACCOUNTING ENTRIES:
P&L A/c Dr

18,540.00

To Deferred Tax Liability A/c

18,540.00

(Being Deferred Tax Liability created in Year 1 at the Maximum Marginal Rate of Tax)
Deferred Tax is shown under Provisions in Balance Sheet.
Deferred Tax Asset
Dr

1,236.00

To P & L A/c

1,236.00

(Being Deferred Tax Liability Reversed in Year 2)

Finally at the end of Year 5 the Balance Sheet will be thus:
PROVISIONS:
Deferred Tax Liability
Less: Reversed upto year 4

18,540

Rs.Ps

12409.44

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6/25/2014

Meaning of Deferred Tax Liability & Asset in Simple Words

Reversed in year 5

6130.56

18,540

TAX TREATMENT:
INCOME FROM BUSINESS:
Net Profit as per P&L A/c

XXX

Add: Deferred Tax Liability

XXX

Less: Deferred Tax Asset

XXX

Note: As Deferred Tax Liability is a Provision, it should be disallowed as an expense. Also

deferred tax asset should be deducted from Income.
As seen from the above, deferred tax liability/asset does not affect tax computation.
PURPOSE: The Purpose of DTA/DTL: More appropriate presentation of financial statements
and to make the various stakeholders aware of the tax situation of the company.
It may be noted that 80-IA (Section 80 IA of IT Act) exemption may be availed for Windmill.
That is if the company starts to claim 80-IA benefit after 5 years (80-IA benefit can be
claimed in any 10 Assessment years out of 15 A.Y's after buying windmill), then there will be
more benefits to the company as the Income in the first 5 years will be low and the company
can claim business loss as there will be huge Depreciation as per IT.
PART II: In the next part, I will explain the how deferred tax should be computed if 80IA exemption is availed for Windmill having useful life of more than 5 years. Also I will explain
the other items which cause a difference in profits as per Books and IT Act. Also I will explain
how to deal with brought forward losses.
HOPE IT WAS AN INTERESTING READ.
REGARDS
VIGGI
(I work as an Articled Assistant for a firm in Mangalore and the Information gained was during
the course of my work.)
921

Published in Accounts
Source : Various Text Books on Accounting Standards & Own Research
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231 Comments for this Article

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Soumya Prakash Rath

Wrote on 22 June 2014

Thank you lot for the said information.

kehkashan hussain

Wrote on 09 June 2014

Thanks a lot, it's very useful information.

kishor Wrote on 26 May 2014

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