Deferred Tax Liability : Meaning, Work, Calculation & Example

What is Deferred Tax Liability?

Deferred tax liability is the notional tax liability that the company is required to compute and disclose in its financial statements as per the applicable regulatory and statutory requirements. Deferred tax suggests that the tax is either paid in advance or has been carried forward, but the treatment of such an advance or carrying forward is yet to be recognized in the profit and loss account. Deferred tax liability is a tax that is payable in the future due to the different treatment in accounting and as per income tax laws on the items of income or expense. The deferred liability arises when, due to a temporary timing difference, the profit tends to go on the higher side when compared with the accounting books than taxable profit as per the applicable provisions of the Income Tax Act.

Geeky Takeaways:

• A deferred tax asset is a form of tax liability that a company has yet to pay.
• Deferred tax liability is an item found on the balance sheet due to a short payment or overdue taxes.
• Deferred tax liability is usually found when there is a difference between the tax rules and the accounting rules.
• Deferred tax liability represents increased tax payments in the future.
• The value of a deferred tax liability is subject to change depending on future financial performance and changes in tax laws.

How Deferred Tax Liability Work?

1. A deferred tax liability is usually formed when payment of taxes is accumulated in a financial year but is due in a subsequent year.

2. Due to the difference in timing between when certain items are recognized for financial accounting purposes and when they are considered for tax purposes, deferred tax liabilities are created. DTL arises when there is a difference in timing between when the tax was accrued and when it is payable.

3. For example, If a corporation has an obligation to pay taxes for a financial year but the same has not yet been concluded in a particular year, such an obligation will be carried forward to the next year or to the year in which such transaction shall be completed.

4. The deferred tax increases the company’s tax liability in the upcoming period. DTL might be compared to rent accrued but not paid, and the liability is already due to the company.

6. Deferred tax liabilities are crucial to understanding the financial health of the company, and they have relatable value that needs to be incorporated in their financial statements.

How is a Deferred Tax Liability Created?

1. Tax Rules Allowance: Sometimes tax rules allow companies to increase their future taxable earnings when they face book profits and reduce expenses; this creates a potential tax increment.

2. Future Tax Increment: Although this tax liability cannot be recognized on an immediate basis by the company, it recognizes a future obligation that is due for future tax due to their differences in accounting and tax laws.

3. Deferred Tax Liability Entry: This probable tax payment is recorded by the corporation as a deferred tax liability on its financial accounts. In essence, it’s admitting that it has a future tax obligation that is due as a liability.

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

5. Adjusted in Upcoming Years: It is expected that the deferred tax liability will be paid in the coming period. However, this doesn’t mean that the company has not fulfilled its tax obligations.

6. Monitoring and Adjustments: Corporations keep track of the possibility of recording the deferred tax liability. The value of the deferred tax liability may be adjusted if certain conditions are met.

Examples of Deferred Tax Liability

A deferred tax liability is a record of tax that has been incurred by the entity but has not been paid and is due. This liability is known as a deferred tax liability. In a case where a business experiences profits during a particular fiscal year, it is liable to pay taxes on the earned profits as per the applicable tax rules and laws. Profits here attract tax liabilities that are to be met by the company at the end of the assessment year.

In another case, when there is a difference between the accounting rules and tax rules, this can also lead to the creation of a deferred tax liability. Suppose that when a company’s expenses are recognized in their financial statements prior to recognition by the tax authorities or when the earnings of the company are subject to taxes before they are taxable in the income statement, then these deferred taxes come into being.

Also, when the tax rules and regulations for assets or liabilities differ at any given time, this deferred tax liability is created. Actually, there is no time limit for these liabilities. They are due whenever the company incurs tax liabilities. Deferred tax liabilities result in a cash outflow.

How is Deferred Tax Liability Calculated?

For example, a company holds an asset with a value of ₹5,00,000. The company uses the straight-line depreciation method in the books of accounts and charges depreciation at the rate of 20%, which comes to ₹1,00,000. Whereas, the income tax laws provide that the depreciation shall be charged at 15%, which stands at ₹75,000. Now the company has to create a DTL of ₹25,000.

Deferred Tax Liability vs Deferred Tax Asset

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

Deferred Tax Liability – FAQs

Why do deferred tax liabilities occurs?

• Firstly, a deferred tax liability in a balance sheet depicts that the company has out standing tax tax payment.
• Further, due to difference in the timing of company paying its taxes and the timing when the tax authority recognizes it.
• Sometimes, companies underpay their taxes which are adjusted in the future by tax increments.

Can deferred tax liabilities be netted off against deferred tax assets?

If the company can recognize the loss on a future tax return, the loss is considered as a deferred tax asset. For companies, deferred tax liabilities can be netted off against deferred tax assets and reported on the balance sheet.

When should a company record a deferred tax asset or liability?

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.

What are timing differences?

Timing differences occur because the period in which some revenue and expenses are included in taxable income does not correspond with the period in which such items of revenue and expenses are included or evaluated in arriving at accounting income.

What are permanent differences?

Those differences among book income and tax income are unable to be restored in a subsequent period.