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Home > Articles > Accounts > Meaning of Deferred Tax Liability & Asset in Simple Words
Meaning of Deferred Tax Liability & Asset
in Simple Words
Vignesh Killur on 21 March 2012

In Simple words, Deferred Tax Liability is a
Provision for Future Taxation.

This is in stark Contrast to Provision for
Taxation. Provision for Taxation is
basically a provision for Current year
Taxation.

Deferred Tax Liability arises due to timing
difference in the value of Assets as
per Books of Accounts and as per Income
Tax Act.

Also we can say that Deferred Tax
Liability/Asset arises due to the difference between Profit as per Books of Accounts (P&L
Account) and profit as per Income Tax Act. (Taxable Income).

Depreciation is the main reason for difference in the profits as per books of Accounts and
Taxable profits as per Income Tax Act. Both Income Tax Act and Companies Act prescribe
different rates of Depreciation for different categories of Assets.

Let me illustrate with a simple example. Suppose a Company purchases a Wind Turbine
Generator (Windmill). The Depreciation which can be claimed in the Books of Accounts in as
per Companies Act is let's say 20% (assumed). The Depreciation as per Income Tax Act is
80% for Windmill.

Now a Windmill is purchased for Rs. 10,00,00,000/- (10 Crores). The Depreciation Claimed
in the First year is:

Value of Windmill: 10,00,00,000/-
Depreciation as per Books of
Accounts:
10,00,00,000 X
20%=
2,00,00,000/-
Depreciation as per Income Tax
Act:
10,00,00,000 X
80%=
8,00,00,000/-
DIFFERENCE

-6,00,00,000/-
DEFERRED TAX LIABILITY @ 30.9% -1,85,40,000/-

(Deferred Tax Liability is created at the highest Marginal Rate of Tax i.e. 30.9%)

What is the Meaning of Creating this Deferred Tax Liability of Rs. 1,85,40,000/- (One Crore
eighty five lakhs forty thousand)
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Meaning of Deferred Tax Liability & Asset in Simple Words http://www.caclubindia.com/articles/meaning-of-deferred-tax-liability-ass...
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It simply means that the company will definitely have a tax Liability of that much in the
future years. This is because in the years to come the Depreciation as per Income Tax Act
will be lesser that the Depreciation as per Books of Accounts. Hence in these years the
Company will have to create a Deferred Tax Asset
For clarity the Following Table is provided. Let's take the figures in Lakhs for Easier
Understanding:
Let Windmill Value be Rs. 100,000/-
Year 1 2 3 4 5* TOTAL
Dep as per IT
Act
(80% OF
WDV)
80,000 16,000 3,200 640 160 100,000
Dep as per
Books
(20% SLM)
20,000 20,000 20,000 20,000 20,000 100,000
DIFFERENCE 60,000 -4,000 -16,800 -19,360 -19,840 0
DTL/DTA @
30.9%
18,540 -1,236 -5,191.20 -5,982.24 -6,130.56 0

Note * In year 5 as per Income tax act let's assume the entire Remaining Balance is written
off

CONCLUSIONS:

1. In Year 1 Deferred Tax Liability amounting to Rs. 18,540/- has to be created. This means
that in Year 1, the company has postponed its tax Liability of Rs. 18,540/- to the Future
years. This Liability will come back to the company one day or the other. (Unless 80 IA is
claimed)

2. In Year 2, as you can clearly see the Depreciation as per Books has gone up. This means
that Depreciation as per IT act will be lesser as a result the profit as per IT Act will be more
and as a result the company has to pay Rs. 1236/- more tax during this year.

3. Thus in the remaining years the company will have Deferred Tax Assets And the Deferred
Tax Liability created in the first year will be reversed in the subsequent 4 years.

4. Thus when the WDV of Assets as per Books and WDV as per IT Act both become ZERO,
there is neither Deferred Tax Liability nor Deferred Tax Asset as there is no timing
Difference

Deferred Tax is purely an accounting Concept. AS 22 - "Accounting for Taxes on Income
deals with Deferred Tax.

The following are the Accounting treatment and Tax treatment of Deferred Tax:

ACCOUNTING ENTRIES:

P&L A/c Dr 18,540.00
To Deferred Tax Liability A/c 18,540.00

(Being Deferred Tax Liability created in Year 1 at the Maximum Marginal Rate of Tax)

Deferred Tax is shown under Provisions in Balance Sheet.

Deferred Tax Asset
Dr
1,236.00
To P & L A/c 1,236.00

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(Being Deferred Tax Liability Reversed in Year 2)
Finally at the end of Year 5 the Balance Sheet will be thus:
PROVISIONS:
Deferred Tax Liability


18,540
Rs.Ps
Less: Reversed upto year 4 12409.44
Reversed in year 5 6130.56 18,540 0
TAX TREATMENT:
INCOME FROM BUSINESS:
Net Profit as per P&L A/c

XXX
Add: Deferred Tax Liability XXX
Less: Deferred Tax Asset XXX

Note: As Deferred Tax Liability is a Provision, it should be disallowed as an expense. Also
deferred tax asset should be deducted from Income.

As seen from the above, deferred tax liability/asset does not affect tax computation.

PURPOSE: The Purpose of DTA/DTL: More appropriate presentation of financial statements
and to make the various stakeholders aware of the tax situation of the company.

It may be noted that 80-IA (Section 80 IA of IT Act) exemption may be availed for Windmill.
That is if the company starts to claim 80-IA benefit after 5 years (80-IA benefit can be
claimed in any 10 Assessment years out of 15 A.Y's after buying windmill), then there will
be more benefits to the company as the Income in the first 5 years will be low and the
company can claim business loss as there will be huge Depreciation as per IT.

PART II: In the next part, I will explain the how deferred tax should be computed if
80-IA exemption is availed for Windmill having useful life of more than 5 years. Also I will
explain the other items which cause a difference in profits as per Books and IT Act. Also I
will explain how to deal with brought forward losses.

HOPE IT WAS AN INTERESTING READ.

REGARDS
VIGGI

(I work as an Articled Assistant for a firm in Mangalore and the Information gained was
during the course of my work.)
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Thank you lot for the said information.
Thanks a lot, it's very useful information.
asm
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Meaning of Deferred Tax Liability & Asset in Simple Words http://www.caclubindia.com/articles/meaning-of-deferred-tax-liability-ass...
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