As per Accounting Standard (AS) – 22, Accounting for Taxes on Income, which is also known as Deferred Tax calculation is the most commonly used in preparation of Financial Statements. While making annual reports during the Financial Year, the calculation of deferred tax is made as per the difference as per the Companies Act and as per Income Tax Act.
A. Types of Differences:
The differences between profits as per Companies Act and Income Tax Act can be classified into two types:
1. Permanent Difference: These types of differences are those items of Expense/income that make difference between Accounting Income and Taxable Income of a period but doesn’t make any difference between Accounting Income and Taxable Income of subsequent period (s).
Once they are disallowed, they can’t be allowed in subsequent years and no tax benefit can be obtained from them.
E.g. of permanent difference are donations made but not allowed under section 80G. This is permanently disallowed by IT Dept and hence no future tax benefit can be derived from this. This is permanent difference.
2. Timing Difference: These 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.
Illustration to Explain Timing Difference:
A asset is purchased of Rs. 1,00,000 having useful life of 5 year and allowed 100% depreciation under Income Tax Act. Profit before depreciation is Rs. 2,00000.
Rs. 20,000 (100,000/5) is allowed as depreciation while computing the Accounting Income and Rs. 1,00,000 is allowed as full depreciation in year of purchase while computing the Taxable Income.
Accounting Income is Rs. 1,80,000 (2,00,000-20,000)
Taxable Income is Rs. 1,00,000 (2,00,000-1,00,000)
Therefore, difference between Accounting Income and Taxable Income is created in this year and shall be created in subsequent 4 year (by the balance depreciation of Rs. 80,000=1,00,000-20,000) because in subsequent years, while computing the accounting income entity shall deduct the depreciation of Rs. 20,000 but nil depreciation shall be allowed while computing the Taxable Income. This is called timing difference.
In Accounting Standard 22 Deferred Tax is defined as Effect of Timing differences.
Some examples of Timing Differences are:
- Provision for Bad and Doubtful debts (because this is deducted 100% when computing the accounting income but disallowed while computing taxable income).
- Expenditure disallowed u/s.43B of Income Tax Act (expenses are allowed on accrual basis while computing the accounting income but some expense are allowed on payment basis while computing the taxable income.)
- Allowance of Excessive depreciation (at the time of computing the taxable income excess depreciation is allowed u/s 32 and 32AC of income tax act but for the purpose of accounting income no such excessive depreciation is allowed)
- Incomes recognised for accounting purpose but postponed to next year(s) for taxation purpose. The reason for doing this could be Tax Accounting Standards’ guidelines.
- Preliminary Expenditure are fully deductible as expense in first year for computing the accounting income but same expense is allowed in the five installment u/s 35D of income tax act while computing the taxable income.
- Unabsorbed depreciation and carried forward losses.
B. Deferred Tax Asset/Liability:
C. Treatment in Financial Statements:
DTA is in the nature of Tax Saving and DTL is in the nature of provision. Accordingly given effect in Statement of Profit and Loss at Tax Expense as Deferred Tax.
Net of DTA and DTL is DTL shown under the head NON CURRENT LIABILITIES , if it is DTA then shown under the head NON CURRENT ASSETS in Statement of Balance Sheet.
And while calculating Deferred Tax (asset / liability) for Statement of Balance Sheet, previous year DTA or DTL shall also be considered to get the net DTA or DTL. The same is explained in the format of DT given at the end of this article for download.
Separate disclosure in notes to accounts to be made for arriving DTA/DTL as it is required by AS 22.
D. Prudence to be considered in Deferred Tax Asset Recognition:
As per para 15, deferred tax assets should be recognised and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable income will be available against which such deferred tax assets can be realised.
As per para 16, While recognizing the tax effect of timing differences, consideration of prudence cannot be ignored. Therefore, deferred tax assets are recognised and carried forward only to the extent that there is a reasonable certainty of their realisation. This reasonable level of certainty would normally be achieved by examining the past record of the enterprise and by making realistic estimates of profits for the future.
As per para 17, Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realized.
Determination of virtual certainty that sufficient future taxable income will be available is a matter of judgment based on convincing evidence and will have to be evaluated on a case to case basis.
E. Re-Assess at every Balance Sheet Date:
At each balance sheet date, an enterprise re-assesses unrecognized deferred tax assets. The enterprise recognizes previously unrecognized deferred tax assets to the extent that it has become reasonably certain or virtually certain, as the case may be (see paras 15 to 18 explained above), that sufficient future taxable income will be available against which such deferred tax assets can be realized.
F. Other Points:
- MAT does not create any difference between accounting income and taxable income since it comes in the scene after computation of accounting income & taxable income. Therefore MAT credit is not a deferred tax asset.
- Rate of Deferred Tax may change from year to year due to surcharge effect and the policy followed by the company. If surcharge is calculated at 10% (last year 5%) for domestic company on the current year rates and it is assumed by the company that the same rates will be applicable for the subsequent years, it can change the rate.
Click here to Download Deferred Tax Calculation Format