Income Tax Act, 1961 includes the provisions for taxation of any kind of income earned by an in...
Deferred Tax Asset or Liability is an integral part of the financial statements. Adjustments made in the year-end in the books of accounts affect the income tax amount of the business for that year as well as for the coming years. The word Deferred is originated from the word ‘Deferments’ which means to arrange for something which will happen at a later date. Hence, deferred tax is considered as tax for those items which are accounted for in the Profit & Loss Account but not accounted in taxable income, and which may be accounted for in future taxable income and vice versa. The deferred tax may be a liability or asset depending on the case.
As prescribed in AS 22
Current tax is the amount of income tax determined to be payable or recoverable with respect of the taxable income or tax loss for a period.
Deferred tax is basically the tax effect of timing differences.
Timing differences are calculated as 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 calculated as the differences between taxable income and accounting income (Taxable Income – Accounting Income) for a period that originate in one period and do not reverse subsequently.
The tax effect on timing difference is known as deferred tax, which means taxes which will be settled in a future date. Deferred tax occurs on all timing differences, whether it is permanent or temporary. DT is introduced in accounts to make the difference clear between current tax and future tax.
Deferred taxes are mentioned in the financial statements as deferred tax asset or liability:
|S.No||Profit status of Entity||Current and Future state of the entity||Effect|
|1.||Book profit higher than the taxable value||Payless tax now and more in future||Creates Deferred tax liability|
|2.||Book profit is less than the Taxable profit||Pay more tax now and less in future||Creates deferred tax asset|
The book entries of deferred tax asset or liability are straightforward. We have to create Deferred Tax liability A/c or Deferred Tax Asset A/c by debiting or crediting Profit & Loss A/c respectively.
In case of deferred Tax Liability the journal entry would be:
– To Deferred Tax Liability A/C
If it is a deferred tax asset the journal entry will be:
– To Deferred Tax Liability A/C
Tax Holiday is a benefit provided by the Government to new undertakings established in a free trade zone, 100% export-oriented undertakings etc., as prescribed in Section 10A,10B of the Income Tax Act, 1961. The Government has introduced this provision to encourage production and consumption of certain items by removing the taxes for a temporary period. DT from the timing difference that reverses during the tax holiday period should not be recognised during the enterprise’s tax holiday period. DT related to the timing difference that reverses after the tax holiday has to be recognised in the year of origination.
MAT is Minimum Alternate Tax which a company is required to pay if its tax payable as per normal provision of the income tax act is less than the tax computed @ 15% of the book profit. Companies having their corporate tax rate cut to 22 per cent without exemptions are not applicable to pay MAT. MAT is charged under section 115JB of the Income Tax Act, 1961. Companies known as ‘zero-tax’ companies show profits as per the Companies Act, 2013 but minimise tax outgo, as they display income that is zero or negative under the provisions of the Income Tax Act. With MAT, the companies have to pay up a minimum amount of tax to the Government.MAT is calculated in the entities book of profit as under:
In Books of Accounts the profit is increased by the following:
And it is decreased by the following:
There are controversies if deferred tax liability debited to Profit & Loss should be added to the income in books of accounts for the purpose of MAT calculation related to which various judgements have been passed. There have been conflicting judgements in this regard; hence the Government must clarify on this issue.
The accounting for deferred taxes requires that a business must complete the following steps:
Identify existing temporary differences and carryforwards.
Even after understanding and applying deferred tax assets or liabilities, companies and investors need to analyse and understand the future cash flow effect of it. Future cash flow can be affected by deferred tax asset or liability. If a deferred tax liability is increasing, that means it is a source of cash and vice versa. So, by analysing this deferred tax helps in assessing where the balance is moving forward. It is purely legal for a company to show different accounts for tax purposes and accounting purposes. So, using this deferred tax functionality, a company can pay lesser taxes when it sees the lower profit turnout and can defer the tax payment for the coming years when profit will increase.
Also, Read: How to Claim Income Tax Refund Online?.