Deferred Tax Asset (DTA) : Works, Creation, Examples & Benefits

What is Deferred Tax Asset?

A Deferred Tax Asset is defined as a form of tax credit or benefit that a company has earned but is yet to receive. This item is found in the company balance sheet that reduces its future taxable income. This type of asset is found when a company overpays its taxes. The extra amount will be eventually returned to the company in the form of tax relaxation. Thus, overpayment of taxes can turn out to be an asset to the company. Opposite to deferred tax asset is the deferred tax liability which represents an increased amount in the tax payment of the company.

Geeky Takeaways:

• A deferred tax asset is a form of tax credit or benefit that a company has earned but is yet to receive.
• It is an item found in the balance sheet due to overpayment or advance payment of taxes.
• It is usually found when a difference occurs between tax rules and accounting rules.
• It represents a way for future tax benefits by reducing the potential future tax payments.
• The value of a deferred tax asset is subject to change depending on future financial performance and changes in tax laws.
• Deferred Tax Asset arises from changes in the timing of recognizing income or expenses for accounting and tax purposes.

How Deferred Tax Asset Work?

1. A deferred tax asset is usually formed when payment of taxes is made in advance or carried forward but it is not being recognized in the financial statements of the company.

2. Due to difference in timing between when certain items are recognized for financial accounting purposes and when they are considered for tax purposes, deferred tax assets are created. These differences may arise for some reasons, such as implementing varying depreciation techniques or recording expenses in financial statements before they are tax deductible.

3. For example, a corporation incurs a substantial loss throughout a particular fiscal year. The amount of taxes the business has to pay in their profitable years might be decreased by using this loss to offset future taxable funds, as per the tax regulations.

4. If the company is not presently generating taxable income, it might not be able to immediately gain from the loss even if it happened and earned the right to have future taxes reduced. On the other hand, the corporation records this anticipated tax savings as a deferred tax asset on its balance sheet for reporting purposes.

5. The deferred tax assets allows the company to reduce their future tax liability. It might be compared to rent paid in advance or a refundable insurance premium.

6. Although the company does not have cash in hand, it has its comparable or relatable value which needs to be incorporated in their financial statements.

How is a Deferred Tax Asset Created?

A deferred tax asset can be created by recognizing a tax benefit in the future on a company’s financials. The following list represents how this form of asset be created,

1. Tax Rules Allowance: Sometimes tax rules allows the companies to reduce their future taxable earnings when the companies face losses or extra expenses that creates a potential tax benefit.

2. Future Tax Reduction: Although this tax benefit cannot be recognized on an immediate basis by the company, it recognizes the potential for future tax reduction due to their losses or expenses.

3. Deferred Tax Asset Entry: This probable tax benefit is recorded by the corporation as a deferred tax asset on its financial accounts. In essence, it’s admitting that it has a future tax benefit as an asset.

4. Accounting Recognition: This recognition belongs to the income tax accounts of the company and it is reflected in their balance sheet.

5. Usage in Profitable Years: It is expected that the deferred tax asset will be utilized when the business generates a profit and can take advantage of previously recorded losses or expenses to balance it.

6. Monitoring and Adjustments: Corporations keep track of the possibility of realizing the deferred tax asset. The value of the deferred tax asset may be adjusted if certain conditions are met, such as uncertain future profits.

Examples of Deferred Tax Asset

The carryover of losses is a deferred tax asset. In cases where a business experiences a loss during a particular fiscal year, can use that loss to reduce its taxable revenue in the subsequent years. In this case, a loss is an asset.

In another case when the accounting rules and tax rules differ, then this deferred tax asset can be created. Suppose, when company’s expenses are recognized in their financial statements prior to the recognition by the tax authorities or when the earnings of the company are subject to taxes before it is taxable in the income statement, then these deferred tax come into being.

Typcially, when the tax rules and regulations for assets and/or liabilities differ given any time, this deferred tax asset is created. Actually, there is no time limit for these asset. They are used whenever it is able to give the most value to the company. Nonetheless, deferred tax assets cannot be used with already filed income tax returns.

How Deferred Tax Asset is Calculated?

Suppose, there is a mobile manufacturing company, who determines the percentage of mobiles which would be sent back to the factory due to repair and maintenance issues (within warranty period) in the coming year. The estimated rate of 5% of the total production.

Now, if the total revenue of the company in year 1 is say ₹6,000 and the warranty expense is accounted to be ₹300 (5% of ₹6,000), then the taxable income of the company will be ₹5,700 (₹6,000-₹300).

But, the tax authorities mostly do not allow enterprises to reduce expenses based on the anticipated warranties. So, the enterprise needs to pay taxes on the full amount, i.e., ₹6,000. If the tax rate is held at 30% for the enterprise, the difference of ₹90 (30% of ₹300) between the payable tax mentioned in the financial statement and the real tax which is paid to the authorities is basically the deferred tax asset.

Benefits of Deferred Tax Assets

The benefits of Deferred Tax assets can be listed as below,

1. Tax Savings in the Future: It represents potential tax benefits which a company has gained but is yet to use it. This benefit can be used in the future to offset taxable income by reducing taxes. Suppose, a company incurs losses in the past but was not able to use it immediately, then these losses are deferred tax assets. When the company makes profits, they can use this asset to reduce their taxable income and subsequently pay lower taxes.

2. Financial Flexibility: If deferred tax assets are recorded, then financial flexibility is achieved. It allows companies to acknowledge the value of tax benefits on their balance sheets, even if it can’t be used immediately. This recognition creates a positive financial status of the company.

3. Encourages Investment and Risk-Taking: Companies may be encouraged to take chances and make long-term investments by deferred tax assets. The ability to utilize these tax benefits in the future encourages businesses to grow, innovate, and overcome difficult financial times.

Difference Between Deferred Tax Liability and Deferred Tax Asset

Basis	Deferred Tax Liability (DTL)	Deferred Tax Asset (DTA)
Definition	Represents taxes that a company will likely have to pay in the future due to differences between accounting and tax rules.	Represents potential tax benefits that a company has earned but is yet to use it.
Type of Balances in Balance Sheet	Depicts a negative balance on the balance sheet of the company	Positive balance on the company’s balance sheet.
Reasons	Arises from taxable items or income mentioned in the financial statements but not yet taxable according to the tax rules.	Arises from tax-deductible items or losses that can be used to reduce taxable income in the future.
Impact of Timing Difference	Reflects a timing difference that results in higher future tax payments.	Reflects a timing difference that results in potential tax savings in the future.
Effect on Future Taxes	The future taxable income increases leading to higher taxes.	Reduces future taxable income, leading to lower taxes
Risk-taking Capacity	Depends an obligation that may make companies more cautious about certain financial decisions. So, might or might not take risk.	May encourage companies to take risks and make long-term investments.
Example	Revenue or gains recognized in financial statements but not yet taxed.	Losses carried forward, tax credits, or deductible expenses not used immediately.

Frequently Asked Questions (FAQs)

1. Why Do Deferred Tax Assets Occur?

Answer:

There are several reasons as to why a deferred tax asset occur. Firstly, a deferred tax asset in a balance sheet depicts that the company has paid taxes in advance. Further, due to difference in the timing of company paying its taxes and the timing when the tax authority recognizes it. Sometimes, companies overpay their taxes which are adjusted in the future by tax relaxation.

2. Do Deferred Tax Assets Carry Forward?

Answer:

Yes, deferred tax assets are carried forward. In US since 2018, taxpayers are able to carry forward their deferred tax assets for an indefinite period of time. Actually, these assets never expire and the companies can use them whenever they feel the need .

3. When should a deferred tax asset or liability be recognised?

Answer:

If, as per the balance sheet date, the transactions or events that offer the company the right to pay less tax or pay more tax in the future have occurred, then a deferred tax asset or liability should be recognized as an asset or liability in the accounts.