What is Deferred Tax? Types & Calculations

Deferred tax calculation is an integral part of a company’s financial statements. It is basically an adjustment made during the closing of accounts each financial year that affects the income tax liability of that company for the current as well as the next fiscal year.

Timing Difference

While preparing the financial report at the end of the financial year, a company can often find that the book profit reported in the financial statements does not match the taxable profit. This happens because different guidelines are used to prepare these statements. 

While a company’s taxable profits are calculated per the IT Act, the book profits are prepared as per the Companies Act. 

Furthermore, the applicability of taxes on certain items can change every year, further increasing the differences between the book profit and the taxable profit. This difference is called a timing difference, and it can be of two types.

  • Temporary Difference

These are differences between the book and taxable profits that can be reversed or carried forward in the subsequent year.

  • Permanent Difference

These are differences between the book profit and taxable profit that can’t be reversed or carried forward in the subsequent year.

Deferred Tax

Deferred tax is the effect on taxes due to the timing differences that can be known by calculating the difference between the gross profit in the profit and loss account and the profit reported in the tax statement of the company.

You must note that the time differences arising from permanent differences such as tax penalties or fines, etc., can’t be covered under the deferred tax. 

Types of Deferred Tax

  • Deferred Tax Asset

Suppose the company pays its tax liabilities for the upcoming year in advance or reduces its tax liabilities for the same period. In that case, the difference between the tax paid and the actual tax is recorded as a deferred tax asset.

  • Deferred Tax Liability

Suppose a company has accumulated some tax liability due to the timing differences it has to pay in the subsequent year. In that case, the amount is reflected on the balance sheet as deferred tax liability.

Calculation of Deferred Tax

Consider the following simple example to understand the calculation of deferred tax where the income statement and the tax statement of a company named ABC ltd for FY 2020-21 

Sr. No. Particulars As Reported in Income Statement

(In Rs)

As Reported in Tax Statement 

(In Rs)

1. Gross Income 5,00,00,000.00 5,00,00,000.00
2. Total Expenses 1,00,00,000.00 1,00,00,000.00
3. Profit Before Depreciation and Taxes (Sr. No. 1 – Sr. No.2) 4,00,00,000.00 4,00,00,000.00
4. Depreciation Charges 30,00,000.00 25,00,000.00
5. Profit After Depreciation      (Sr. No. 3 – Sr. No. 4) 3,70,00,000.00 3,75,00,000.00
6.  Tax Payable (30% of Sr. No. 5) 1,11,00,000.00 1,12,50,000.00

In the above example, there is a difference between the payable taxes where the tax payable as per the tax statement is higher than that reported in the income statement. Therefore, the difference of Rs 1,50,000.00 is the company’s deferred tax asset for FY 2020-21 because the company paid more taxes than it was liable to pay.

If the tax payable under the income statement would be less than that reported in the income statement, then the difference amount would be the company’s deferred tax liability.

While there is no direct benefit of deferred tax, it is instrumental in clearing a company’s accounts before beginning with the new financial year.