How to Calculate Deferred Tax Assets and Liability in 2023?

Calculation of deferred tax assets and liability can be complicated for businesses. Your income tax outgo can be severely affected at year-end and after that, if the calculation needs to be done correctly. Learn everything you want to know in this article.

Calculate Deferred Tax Asset and Liability

How to Calculate Deferred Tax Assets and Liability in 2023?

Deferred Tax Asset (DTA) or Deferred Tax Liability (DTL) is an important part of a business's financial statement. Your business' income tax outgo in any financial year or after that depends on the adjustments you make on deferred tax assets and liability in the Books of Accounts closing during year-end.

To understand DTA or DTL, it is important to learn the timing difference and how it leads to deferred tax.

What is the Timing Difference?

Book profits of a company are derived from the financial statements prepared per the Companies Act rules. Taxable profit is calculated based on Income Tax Act's provisions.

However, for tax purposes, certain items are allowed or disallowed every year. That is why you'll find a difference between the taxable and book profits. You'll find a difference between taxable expense/income and the book. It is called the timing difference.

There are two types of timing differences:

Permanent Timing Difference

This timing difference can't be done away with or reversed in subsequent periods. In the future, it's not allowed. A business may have to pay penalties and fines if a permanent difference remains.

Temporary Timing Difference

The differences between tax and book-income can be reversed in subsequent periods. In the future, it's allowed. If a temporary difference remains, a business must pay sales tax.

Deferred Tax (DT) and Deferred Tax Liability (DTL)

Deferred tax exists when a timing difference leads to a tax effect. DT means the postponed taxes. It can take place on all timing differences, whether permanent or temporary.

In the financial statements, the deferred taxes are effected through Deferred Tax Assets and Liability. Now, let’s explore how Deferred Tax Assets (DTA) and Deferred Tax Liability (DTL) are created.

  • DTA is created when a business entity's Taxable profit is higher than the Book Profit. It makes the company pay more taxes at present but fewer taxes in the future.
  • DTL is created when a business entity's Taxable profit is lesser than the Book Profit. It makes the company pay fewer taxes now but more taxes in the future.

Virtual Certainty

While calculating Deferred Tax Assets, it's important to consider carry-forward losses and unabsorbed depreciation. Only if future virtual certainty is there DTA will be recognised.

Tests must be carried out yearly on a balance sheet date to check virtual certainty. The DTA/DTL needs to be written off in case the condition of virtual certainty isn’t fulfilled.

It should be kept in mind at the time of calculating future taxable income that:

  • Profits generated from a business/profession will have to be considered only.
  • The income from other sources shouldn’t be considered.

Calculate Deferred-Tax-Asset and Liability in Income Tax: An Illustration

Let's suppose a company's income:

  • The book of accounts is Rs. 10,00,00,000 (Rs. 10 crores)
  • For tax is Rs. 8,00,00,000 (Rs. 8 crores)
  • The difference is Rs. 2,00,00,000 (Rs. 2 crore)

Now, let's suppose the company's depreciation:

  • The book of accounts is Rs. 1,00,00,000 (Rs. 1 crore)
  • For tax is Rs. 2,00,00,000 (Rs. 2 crores)
  • The difference is Rs. 1,00,00,000 (Rs. 1 crore)

The sales tax payable for the company:

  • The book of accounts is Rs. 50,00,000 (Rs. 50 lakhs)
  • For tax is Rs. 0 (Nil)
  • The difference is Rs. 50,00,000 (Rs. 50 lakhs)
  • In that case, (DTA)/DTL at the rate of 30% is Rs. 15 lakhs (30% of Rs. 50 lakhs)

Leave encashment for the company:

  • The book of accounts is Rs. 2,00,00,000 (Rs. 2 crores)
  • For tax is Rs. 1,00,00,000 (Rs. 1 crore)
  • The difference is Rs. 1,00,00,000 (Rs. 1 crore)
  • In that case, (DTA)/DTL at the rate of 30% is Rs. 30 lakhs (30% of Rs. 1 crore)

The closing balance of (DTA)/DTL at the rate of 30% = Rs. 15 lakhs

Now, let's first calculate the current tax on taxable income = (Rs. 8 crores) x 30% = Rs. 2.4 crore.

So, the net tax effect is Rs. 2.4 crore - Rs. 15 lakhs = Rs. 2.25 crore

This way, you can calculate Deferred Tax Asset and Liability in income tax.

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