All about DEFERRED TAX and its entry in books

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TG Team

The word Deferred is derived from the word “Deferments” which means arranging for
something to happen at a later date. Thus, deferred tax is the tax for those items
which are accounted in Profit & Loss A/c but not accounted in taxable income which may
be accounted in future taxable income & vice versa. The deferred tax may be a liability or
assets as the case may be.

“As per AS 22,

Current tax is the amount of income tax determined to be payable (recoverable) in respect of
the taxable income (tax loss) for a period.

Deferred tax is the tax effect of timing differences.

Timing differences are the differences between taxable income and accounting income for a
period that originate in one period and are capable of reversal in one or more subsequent
periods.

Permanent differences are the differences between taxable income and accounting income for
a period that originate in one period and do not reverse subsequently.”

Deferred tax is brought into accounts to make the clear picture of current tax and future
tax. If we take some advantage of Income Tax sections and pay less tax in current year,
we may have to pay tax in future on that advantage being reverse. In the same way if we
have to pay more tax by not allowing any expense in current year, it will be allowed in
future and in that year tax will be reduced. So, we may get some benefit or loss on
account of difference in book profit and taxable profit.

Expenses amortized in the books over a period of years but are allowed for tax purposes
wholly in the first year. (e.g. substantial advertisement expenses to introduce a product,
etc. treated as deferred revenue expenditure in the books). Expenses paid without
deducting TDS will not be allowed for tax purpose and will be allowed after deducting
TDS on that. Expenditure of the nature mentioned in section 43B (e.g. taxes, duty, cess,
fees, etc.) accrued in the statement of profit and loss on mercantile basis but allowed for
tax purposes in subsequent years on payment basis. If we make provision of bonus
payable, provident fund contribution, Provision for staff leave encashment, etc. but do
not pay before filing of return they are disallowed in that year but will be allowed in the
year of payment. If we make part payment out of this before filing of return that amount
actually paid will be allowed for tax purpose and the remaining amount will be allowed in

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the year of payment. This is called temporary timing difference. But if we pay cash above
Rs.20000/- this expense will not be allowed for tax purpose any time. So this is
permanent difference.

We should keep in mind that Deferred Tax Liability or Deferred Tax Assets are created
only for temporary timing difference. For permanent difference it is not created as they
are not going to be reversed.

The book entries of deferred tax is very simple. We have to create Deferred Tax liability
A/c or Deferred Tax Asset A/c by debiting or crediting Profit & Loss A/c respectively.

The Deferred Tax is created at normal tax rate.

[1] Profit & Loss A/c Dr

To Deferred Tax Liability A/c

[2] Deferred Tax Asset A/c

To Profit & Loss A/c

Please, note that both the entries are not passed but only liability or asset is created for
net amount of deferred tax.

If book profit is greater than taxable profit, create deferred tax liability.

If book profit is less than taxable profit, create deferred tax asset.

If there is loss in the books of accounts but profit as per income tax and the difference
(e.g. disallowance of exp.) subject to adjustments in future, create deferred tax asset.

If there is profit in the books of accounts but loss as per income tax and carry forward of
loss is allowed, (we have to pay MAT), create deferred tax liability.

Thus it is understood that, Deferred Tax Asset and Liability arising on account of timing
differences and which are capable of reversal in subsequent periods are recognized
using the tax rates and laws that have been enacted or substantively enacted as of
Balance sheet date. Deferred Tax Asset is not recognized unless there is virtual certainty
that sufficient future taxable income will be available which such deferred tax asset will
be realized.

In other words, DTL is recognized for temporary differences that will result in taxable
amount in future years, Whereas DTA is recognized for temporary differences that will
result in deductible amounts in future years and for carry forwards. It is to be noted that
DTA is created in case of certainty only.

Example to understand Deferred Tax concept.

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But the calculation is more important. Let us take one simple example of Depreciation
difference in books of accounts and taxable income.

Suppose, one company purchases a machine costing Rs. 300000/- on 1 ST April. The
salvage value is assumed at zero. The working life is assumed at 3 years. The company
uses straight line method for depreciation in books of accounts but this machine is of
that type which can be depreciated fully in the first year for tax purpose. Suppose tax
rate is 30% for 3 years. For simplification profit before depreciation and tax is assumed
Rs.500000/-.

YEAR I II III

PROFIT BEFORE DEPRECIATION AND TAXES 500000.00 500000.00 500000.00

DEPRECIATION IN BOOKS OF ACCOUNTS 100000.00 100000.00 100000.00

PROFIT BEFORE TAXES 400000.00 400000.00 400000.00

TAXABLE INCOME 200000.00 500000.00 500000.00

=PROFIT – ALLOWABLE DEPRECIATION
(500000-300000, 500000-0, 500000-0)

CURRENT TAX @ 30 % ON TAXABLE INCOME 60000.00 150000.00 150000.00

DEFERRED TAX LIABILITY 60000.00 0.00 0.00

DEFERRED TAX ASSETS 0.00 30000.00 30000.00

(BEING REVERSAL OF LIABILITY)

TAX EXPENSE 120000.00 120000.00 120000.00

= 30% OF PROFIT BEFORE TAXES
OR CURRENT TAX+DTL-DTA

NET TIMING DIFFERENCE 200000.00 100000.00 0.00

BALANCE OF DEFERRED TAX LIABILITY 60000.00 30000.00 0.00

ENTRIES FOR THIS EXAMPLE :

In year I

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Profit & Loss A/C DR 60000/-

To Provision for Income Tax A/C 60000/-

(Being provision made for tax payable for current year)

Profit & Loss A/C DR 60000/-

To Deferred Tax liability A/C 60000/-

(Being Deferred Tax liability created on account of timing difference)

In Balance sheet Deferred Tax liability will be reflected by Rs.60000/-

In year II

Profit & Loss A/C DR 150000/-

To Provision for Income Tax A/C 150000/-

(Being provision made for tax payable for current year)

Deferred Tax Asset A/C DR 30000/-

To Profit & Loss A/C 30000/-

(Being deferred tax liability reduced on reversing timing difference)

In Balance sheet Deferred Tax liability will be reflected by Rs.30000/-

In year III

Profit & Loss A/C DR 150000/-

To Provision for Income Tax A/C 150000/-

(Being provision made for tax payable for current year)

Deferred Tax Asset A/C DR 30000/-

To Profit & Loss A/C 30000/-

(Being deferred tax liability reduced on reversing timing difference)

Deferred Tax liability is zero so there is no question to reflect it in Balance sheet.

Please note that net of deferred tax liability and asset will be reflected in Balance Sheet.

There are so many reasons for which allowable depreciation for tax purpose and
depreciation booked in accounts differs. The rate of depreciation may differ in law and
in books. The method of depreciation may differ in law and in books. The method of
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calculation may differ as in books we may depreciate the assets individually account wise
whereas for tax purpose depreciation may be calculated block wise.

First time introduction of Deferred Tax in Books of accounts.

(Transitional Provisions)

As per AS 22 “On the first occasion that the taxes on income are accounted for in
accordance with this Standard, the enterprise should recognise, in the financial
statements, the deferred tax balance that has accumulated prior to the adoption of this
Standard as deferred tax asset/liability with a corresponding credit/charge to the
revenue reserves, subject to the consideration of prudence in case of deferred tax assets
(see paragraphs 15-18). The amount so credited/charged to the revenue reserves should
be the same as that which would have resulted if this Standard had been in effect from
the beginning.”

To introduce deferred tax first time in the books, we have to find Difference between
the Value of Assets as per Books of Accounts and the Value of Assets as per Income
Tax Act. To simplify if we have fixed assets in the books as gross block Rs.250 lacs
and accumulated depreciation Rs.150 lacs, the net value in the books is Rs.100 lacs.
Suppose, the net block value as per Income Tax calculation (as per tax audit) Rs.80
lacs. It means that in future we shall calculate depreciation on Rs.100 lacs whereas
as per Income Tax Act, the depreciation will be calculated on Rs.80 lacs. This will
result in less allowable depreciation creating more tax liability in future.
Therefore, we have to create Deferred Tax liability for this future Tax liability. The
timing difference is Rs.20 lacs on which we have to create Deferred Tax Liability of
Rs.6 lacs at the assumed I.tax rate of 30%. In the same way we have to introduce
for all differentiating assets and liabilities.

Suppose, a firm has the following positions as on 31st March,

Asset / Liability as per as per difference DTL

books I.tax. (+)
DTA
(-)
@
30%

Assets :

Net fixed assets-written down value. 100.00 80.00 20.00 6.00

( In future more tax has to be paid on less
allowable depreciation as per tax law)

Liabilities:

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 Provision for gratuity 40.00 0.00 -40.00 -
(when paid in future it will reduce tax at that time) 12.00

Provision for staff leave encashment 30.00 0.00 -30.00 -9.00

(when paid in future it will reduce tax at that time)

Total -50.00 -
15.00

The entry to be passed in books for Rs. 15.00 lacs DTA newly introduced.

Deferred Tax Asset A/C DR 1500000/-

To Revenue Reserve A/C 1500000/-

ANNUAL CALCULATION

It may be noted that we don’t have to calculate deferred tax on each and every
transactions related to it. The Deferred Tax is calculated annually from comparison of
book profit and taxable profit. The Deferred Tax Liability or Deferred Tax Asset is derived
from the comparison of Profit & Loss A/c of Balance sheet and Computation of Total
Income for Income Tax purpose. If any amount is expensed out in Profit & Loss A/c but
not deducted for Income tax purpose, it will create Deferred Tax Asset. If any amount
claimed in Income Tax is more than expensed out in Profit & Loss A/c, it will create
Deferred Tax Liability.

The net difference of DTA / DTL is computed and transferred to Profit & Loss A/c. The
Balance of Deferred Tax Liability / Asset is reflected in Balance sheet. For that the
following simple statement may be used.

For the above example, Suppose in next year, the firm makes payments from
provision and makes new provisions from P/L A/c.

Details P/L Computation of difference DTL(+) /

A/c Income DTA(-)
@ 30%

Opening balance of -15.00

DTL(+) / DTA (-)

Comparison of P/L A/c and

Computation of Income

payment of staff leave encashment 10.00 10.00 3.00

from provision

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 payment of gratuity from provision 15.00 15.00 4.50

new provision for staff leave made 5.00 -5.00 -1.50

from P/L A/c

new provision for gratuity made from 5.00 -5.00 -1.50

P/L A/c

depreciation as per books and tax 20.00 16.00 -4.00 -1.20

audit

Total of comparison 3.30

Closing Balance of DTL(+) / DTA (-) -11.70

Or using Balance sheet approach also we can derive same figure as under :

The closing balance of assets assuming depreciation rate of 20% will be Rs.80 & 64
lacs respectively. The closing balance of Gratuity provision will be 40-15+5=30 lacs
and for Provision of Leave Encashment will be 30-10+5=25 lacs. The calculation will
be as under.

Asset / Liability as per books as per I.tax. difference DTL (+)

DTA (-)
@ 30%

Assets :

Net fixed assets 80.00 64.00 16.00 4.80

Liabilities:

Provision for gratuity 30.00 0.00 -30.00 -9.00

Provision for staff leave encashment 25.00 0.00 -25.00 -7.50

total -39.00 -11.70

Last year Deferred Tax Assets were of Rs. 15 lacs which arrived at 11.70 lacs current
year. So there is a deferred tax liability of Rs. 3.30 lacs for current year.

The only one entry will be passed in books for Rs. 3.30 lacs DTL newly calculated.

Profit & Loss A/C DR 330000/-

To Deferred Tax Liability A/C 330000/-

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The balance of RS 11.70 lacs DTA will be reflected at asset side in Balance sheet.

As per revised schedule VI, DTL/DTA will be shown under “ Non Current Liabilities / Non
Current Asset ”.

The readers are requested to consult their Tax Consultant before implementing.
The writer does not take any responsibility for views reflected in the article.

By DIPESH SHAH

SOURCE = : OWN SOURCE (PERSONAL VIEWS)

Tags: section 43B

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