Accounting · Intermediate & Final

What is Deferred Tax?

Tax on the difference between how an item is treated in the books and how it is treated under tax law.

What is Deferred Tax?

Deferred tax is the tax effect of temporary differences between the carrying amount of an asset or liability in the financial statements and its tax base. Because accounting profit and taxable profit are computed under different rules, the tax actually payable in a year rarely matches the tax expense that the accounting profit implies. Deferred tax bridges that gap so that the tax expense reported in the statement of profit and loss corresponds to the profit reported alongside it.

At a glance

Also known as

Deferred tax assetDeferred tax liabilityDTA / DTL

Arises from

Temporary differencesUnused tax lossesUnabsorbed depreciation

Studied in

Advanced AccountingFinancial Reporting

Think of it like…

Think of two calendars for the same set of events. Your accounting calendar recognises a cost this year; the tax calendar recognises it next year. The event is identical, only the timing differs. Deferred tax is the accounting entry that records the fact that a tax consequence has been shifted to a different year rather than avoided altogether.

How Deferred Tax works

  • Identify the temporary difference. Compare the carrying amount of the asset or liability in the books with its tax base under the Income-tax Act.
  • Classify the difference. A difference that will result in more tax in future creates a deferred tax liability; one that will result in less tax creates a deferred tax asset.
  • Apply the appropriate tax rate. Multiply the temporary difference by the tax rate expected to apply when the difference reverses.
  • Test recognition for assets. A deferred tax asset is recognised only to the extent that future taxable profit is probable — prudence governs the asset side more strictly than the liability side.

The classic depreciation difference

Worked examplestep by step
  1. 1Asset cost ₹10,00,000; books depreciate over 10 years, tax allows a higher rate
  2. 2Book depreciation year 1 = ₹1,00,000; tax depreciation year 1 = ₹1,50,000
  3. 3Taxable profit is lower than book profit by ₹50,000 this year
  4. 4The benefit reverses in later years → deferred tax liability arises
  5. 5DTL = ₹50,000 × applicable tax rate

Where it shows up

  • Depreciation rate differences. The most common source — books and tax law rarely depreciate an asset at the same rate.
  • Provisions disallowed until paid. Expenses recognised in the books but deductible only on actual payment create deferred tax assets.
  • Carried forward losses. Unabsorbed losses and depreciation can create deferred tax assets, subject to strict recognition tests.
  • Fair value adjustments. Under Ind AS, remeasurement to fair value creates differences from the tax base that must be tax-effected.

Common mistakes

  • Recognising a deferred tax asset without evidence of probable future taxable profit
  • Applying the current year's tax rate instead of the rate expected on reversal
  • Treating permanent differences as temporary — permanent differences never create deferred tax
  • Netting deferred tax assets and liabilities without meeting the offsetting conditions

Related concepts

Accrual ConceptMateriality
FAQs

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What is the difference between a temporary and a permanent difference?

A temporary difference reverses in a later period and therefore creates deferred tax. A permanent difference never reverses — a permanently disallowed expense, for example — and so creates no deferred tax at all.

When is a deferred tax asset recognised?

Only to the extent it is probable that future taxable profit will be available against which the deductible temporary difference can be utilised. The recognition test for assets is deliberately stricter than for liabilities.

Which rate should be used?

The tax rate expected to apply in the period when the asset is realised or the liability settled, based on rates enacted or substantively enacted at the reporting date.

Apply it

Understanding Deferred Tax is the start. Using it in a question is the test.

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