A note on Deferred Tax

Income Tax process has little to do with the reporting of financial information to shareholders and other interested parties. Income Tax Laws are formulated to encourage certain kinds of behaviour by Taxpayers on the premise that such behaviour is good for the economy as a whole. On the contrary, accounting principles have been formulated to accomplish the objective of financial reporting including providing information that is useful to investors & creditors in making rational investment and credit decisions. Computation of accounting profits as per the accounting principles differs from computation of profits as per Income Tax rules. The reasons are as follows: 1. Most companies follow accrual system while reporting the various Incomes and expenses. Income Tax laws permit deduction of some expenses on actual payment basis. Examples of such expenses are taxes, duties, cess or fee, contribution to provident funds or gratuity etc. 2. Some expenses are amortized over a period of time while under tax laws, these expenses are amortized wholly in first year of their occurrence. For ex VRS expenses. 3. The depreciation rates /methods differ in Accounting and Tax Laws. 4. For some expenses, Income Tax laws allow deduction from profit for amount more than the actual expenses incurred. Accounting reports on the actual amount basis. If the resultant to above, accounting profits are less and taxable profits are more, the firm ends up in paying more taxes. The difference of the taxes computed as per accounting profits and taxable profits where taxable profits are more, results in Deferred Tax Assets. On the contrary, where accounting profits are more and taxable profits are less, the difference of the taxes so computed results in Deferred Tax Liability.