13 Oct, 2025
4 mins read
Taxes often feel like a puzzle where the pieces don’t always fit perfectly. Companies may show strong profits on paper but pay less tax today, or the opposite, due to the timing differences between accounting rules and tax laws. Deferred tax is the key to understanding this gap. It gives a peek into the future, showing how today’s financial choices will affect taxes down the road.
Deferred tax represents a future tax adjustment, either an amount a company will owe or a benefit it expects to claim later. The difference arises because accounting standards and tax rules often treat income and expenses differently in timing.
There are two sides to this concept:
Deferred Tax Liability (DTL): When a company’s taxable income is temporarily lower than its accounting income, it creates a future tax payment obligation.
Deferred Tax Asset (DTA): When a company pays more tax today than required due to timing differences, it generates a future tax benefit.
For instance, a business using lower depreciation for accounting but higher depreciation for tax pays less tax today. This difference reverses in future periods, creating a deferred tax liability. Understanding deferred tax meaning is essential to see how timing differences affect future cash flows and profits.
Deferred tax can be broadly divided into two categories: assets and liabilities.
Occurs when accounting income is higher than taxable income due to temporary differences. Common causes include:
Accelerated depreciation for tax but straight-line for accounting
Revenue recognised earlier in books than for tax
Certain expenses recognised earlier in accounting than tax
Example: A company reports ₹10 lakh as accounting profit, but taxable profit is only ₹8 lakh. At a 30% tax rate, the ₹2 lakh difference creates a deferred tax liability of ₹60,000.
Occurs when taxable income is higher today, leading to a future benefit. Common causes include:
Carry-forward of unused tax losses
Provisions not yet deductible for tax
Expenses recorded in books before being deductible for tax
Example: A ₹1 lakh provision for warranties is not deductible until paid. At 30% tax rate, a deferred tax asset of ₹30,000 is recorded.
The calculation of deferred tax involves identifying temporary differences between accounting and tax values of assets and liabilities.
Deferred Tax Formula:
|
Deferred Tax = (Carrying Amount – Tax Base) × Tax Rate |
Steps for deferred tax working:
Identify temporary differences.
Classify as DTA or DTL.
Multiply the difference by the applicable tax rate.
Deferred Tax Liability Example:
Machine with accounting depreciation ₹1,00,000, tax depreciation ₹1,50,000.
Temporary difference = ₹50,000
Tax rate = 30%
→ Deferred Tax Liability = ₹15,000
Deferred Tax Asset Example:
Provision for doubtful debts ₹80,000, not yet deductible.
Temporary difference = ₹80,000
Tax rate = 30%
→ Deferred Tax Asset = ₹24,000
These differences reverse over time, aligning accounting and taxable profits.
The deferred tax benefits go beyond compliance.
Accurate Profit Reporting: Ensures income and expenses are reflected in the correct period.
Tax Planning: Helps manage future cash flows and plan for tax liabilities.
Transparency: Investors see both current and future tax impacts.
Compliance: Mandatory under Ind AS and IFRS, aligning with global standards.
Better Valuation: Differentiates accounting profit from actual cash flow, aiding analysts.
Deferred tax adds clarity to financial statements, making them a more reliable tool for decisions.
Deferred tax is like a financial time machine. It shows how decisions made today will affect future tax payments or savings. By understanding deferred tax assets and liabilities, companies can plan strategically, present transparent financials, and maintain a realistic view of cash flows. It turns accounting entries into a guide for informed business decisions, giving both management and investors a clearer picture of financial health and what lies ahead.
Deferred tax is the difference between tax paid today and tax expected in the future. It arises from timing differences between accounting income and taxable income.
Deferred tax assets occur when a company pays more tax today due to timing differences, including unused losses, provisions, or expenses recognised in accounts but not yet deductible for tax.
A deferred tax asset should be recognised when it is likely that the company will earn sufficient taxable income in the future to utilise the deductible differences or losses. Recognition is limited if future profits are uncertain.
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