1. Introduction: Matching concept is a very significant concept of accounting. According to this concept income and expense must be recognised in the period to which they relate. In India, Profit & Loss is computed in accordance with two different sets of provision one set is Profit & Loss as per Companies Act, 2013 (earlier it was Companies Act, 1956) and second one is Profit & Loss as per Income Tax Act, 1961 (for the purpose of computing taxable income). Generally there is difference between Profit & Loss computed as per above mentioned two different set of provisions. The root cause of this difference is different treatment of some items of expenditure/income under both set of provisions (i.e. Companies Act, 2013 and Income Tax Act, 1961). Some expenditure which are allowed to be deducted under Companies Act, 2013, may not be allowed to be deducted under Income Tax Act, 1961 while computing the taxable income. Matching concept of accounting and different treatment of expenditure/income under above mentioned both Act gives rise to the concept of Deferred Tax and accordingly ICAI issues an Accounting Standard-22 “Accounting for Taxes on Incomeâ€, to prescribe the accounting treatment for taxes on income since it is a very significant item in the Statement of profit & Loss of an entity.
2. Analysis of AS-22: Deferred Tax is the tax effects of Timing Difference. The whole concept of deferred tax is depend on timing difference. Before proceeding further we need to understand the meaning of Accounting Income and Taxable Income.
Accounting income (loss) is the net profit or loss for a period, as reported in the statement of profit and loss, before deducting income tax expense or adding income tax saving.Taxable income (tax loss) is the amount of the income (loss) for a period, determined in accordance with the tax laws, based upon which income tax payable (recoverable) is determined. As per AS-22 Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods.In Simple words, Timing Difference is those items of Expense/Income which creates difference between Accounting Income and taxable Income of a period and subsequent period. Items creating the difference between Accounting Income and Taxable Income can be categorized into Permanent difference and Timing difference.Permanent difference: Permanent differences are those items of Expense/income that make difference between Accounting Income and Taxable Income of a period but does not make any difference between Accounting Income and Taxable Income of subsequent period (s). Eg:- Donation made (F.Y. 2014-15) to a person (not permissible u/s 80G of Income tax Act) is allowed as expense while computing accounting income but does not allowed as expense while computing taxable income (because not permissible u/s 80G) for that period and hence it makes difference between Accounting Income and Taxable Income of that period. This donation is permanently disallowed by Revenue authority, hence it shall not make any difference between Accounting Income and Taxable Income of subsequent period.Timing Difference: Timing Difference is those items of Expense/Income which creates difference between Accounting Income and taxable Income of a period and subsequent period. Eg:- A asset is purchased of rs. 1,00,000 having useful life of 5 year and allowed 100% depreciation under Income Tax Act. Profit before depreciation is rs. 2,00000.
Rs. 20,000 (100,000/5) is allowed as depreciation while computing the accounting income and rs. 1,00,000 is allowed as full depreciation in year of purchase while computing the taxable income. Hence, Accounting Income is rs. 1,80,000 (2,00,000-20,000)
Taxable Income is rs. 1,00,000 (2,00,000-1,00,000)
Therefore, difference between Accounting Income and Taxable Income is created in this year and shall be created in subsequent 4 year (by the balance depreciation of rs. 80,000=1,00,000- 20,000) because in subsequent years, while computing the accounting income entity shall deduct the depreciation of rs. 20,000 but nil depreciation shall be allowed while computing the taxable income. This is called timing difference.
Some example of timing difference with explanation:
1. Provision for Bed/Doubtful debts (because this is deducted 100% when computing the accounting income but disallowed while computing taxable income.)
2. Expense on payment basis, like expense u/s 43B of Income tax Act (expenses are allowed on accrual basis while computing the accounting income but some expense are allowed on payment basis while computing the taxable income.)
3. Allowance of Excessive depreciation (at the time of computing the taxable income excess depreciation is allowed u/s 32 and 32AC of income tax act but for the purpose of accounting income no such excessive depreciation is allowed)
4. While computing the income for accounting purpose some income is recognised in the given period but same income is recognised in subsequent period for computing the taxable income.
5. Preliminary expenses are fully deductible as expense in first year for computing the accounting income but same expense is allowed in the five installment u/s 35D of income tax act while computing the taxable income.
6. Unabsorbed depreciation and carried forward loss is also an example of deferred tax.
7. Charging depreciation under different methods for the purpose of accounting income and taxable income.
In one line, we can describe the timing difference as
Timing Difference is those items of Expense/Income which creates difference between Accounting Income and taxable Income of a period and subsequent period.
Current Tax: Current Tax is the income tax payable (recoverable) for current year.
Tax Expense (Saving): Tax Expense is aggregate of current tax and deferred tax charged or credited to the statement of profit and loss for the period.
3. Categorization of Deferred Tax: Deferred tax is of two type i.e. Deferred tax Asset and Deferred Tax Liability. When there is a timing difference that shall result in tax saving in future period then it shall be recognised as Deferred tax Asset (DTA).
Eg. Disallowance of provision for gratuity while computing the taxable income. This disallowance shall result in DTA, since we know that once amount of gratuity is paid on subsequent year same shall be allowed as deduction for computing the taxable income.
Eg. Excess/fully depreciation allowed for tax purpose but SLM method of depreciation has adopted for accounting purpose. In such case, we have to make provision for tax {i.e. Deferred Tax Liability (DTL)} because less/nil depreciation shall be allowed for tax purpose in subsequent years this shall result in excess income tax liability. So keeping in mind the concept of prudence one shall make the provision of this excess tax liability in subsequent year.
4. Recognition: Deferred tax should be recognised for all the timing differences, subject to the consideration of prudence in respect of deferred tax assets as set out in paragraphs 15-18 of AS- 22.
As per para 15, deferred tax assets should be recognised and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable income will be available against which such deferred tax assets can be realised.
As per para 16, While recognizing the tax effect of timing differences, consideration of prudence cannot be ignored. Therefore, deferred tax assets are recognised and carried forward only to the extent that there is a reasonable certainty of their realisation. This reasonable level of certainty would normally be achieved by examining the past record of the enterprise and by making realistic estimates of profits for the future.
As per para 17, Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realised.
Determination of virtual certainty that sufficient future taxable income will be available is a matter of judgment based on convincing evidence and will have to be evaluated on a case to case basis. Virtual certainty refers to the extent of certainty, which, for all practical purposes, can be considered certain. Virtual certainty cannot be based merely on forecasts of performance such as business plans. Virtual certainty is not a matter of perception and is to be supported by convincing evidence. Evidence is a matter of fact. To be convincing, the evidence should be available at the reporting date in a concrete form, for example, a profitable binding export order, cancellation of which will result in payment of heavy damages by the defaulting party. On the other hand, a projection of the future profits made by an enterprise based on the future capital expenditures or future restructuring etc., submitted even to an outside agency, e.g., to a credit agency for obtaining loans and accepted by that agency cannot, in isolation, be considered as convincing evidence.
5. Re-assessment of Unrecognised Deferred Tax Assets: At each balance sheet date, an enterprise re-assesses unrecognized deferred tax assets. The enterprise recognises previously unrecognized deferred tax assets to the extent that it has become reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18), that sufficient future taxable income will be available against which such deferred tax assets can be realised. For example, an improvement in trading conditions may make it reasonably certain that the enterprise will be able to generate sufficient taxable income in the future.
6. Treatment in Balance sheet & Statement of P&L: a). DTA (in the nature of tax saving) is to be added to Net profit and DTL (in nature of provision) is to be deducted from Net profit.
b). If net of DTA and DTL is DTL then same shall be shown under “Non-Current Liabilities†on Liabilities side of balance sheet.
c). If net of DTA and DTL is DTA then same shall be shown under Non-Current Assets after non- current investment on Assets side of Balance Sheet.
7. Whether MAT is a DTA: The definition of asset is “anything which is expected to be provided future economic benefitâ€. MAT is income tax paid on book profit (a type of taxable income). MAT does not create any difference between accounting income and taxable income since it comes in the scene after computation of accounting income & taxable income. Therefore MAT is not a deferred tax asset.
8. Accounting entries for deferred tax: followings are the accounting entries for deferred tax:-
a). For creating DTA:
DTA a/c Dr.
To P&L a/c
b). For creating DTL:
P&L a/c Dr.
DTL a/c
c). For reversal of DTA in subsequent years:
P&L a/c Dr.
DTA a/c
d). For reversal of DTL in subsequent years:
DTL a/c Dr.
P&L a/c
9. Practical example of Deferred Tax: Facts: A company has a profit before depreciation & tax Rs. 2,00,000 in each of five year. Company bought a machinery of rs. 60,000 having useful life of 3 year for accounting purpose but for tax purpose 100% depreciation is allowed in first year. There is also a disallowance of rs. 80,000 in 4th year, out of which rs. 40,000 is allowed in 5th year.
Statement of Profit & Loss| Particulars | 1 years | 2 years | 3 years | 4 years | 5 years |
| Profit Before Depreciation & Tax | 200,000 | 200,000 | 200,000 | 200,000 | 200,000 |
| Less: Depreciation | -20,000 | -20,000 | - | - | - |
| Accounting Profit (PBT) (A) | 180,000 | 180,000 | 180,000 | 200,000 | 200,000 |
| Tax Expense:- | | | | | |
| Current Tax | -42,000 | -60,000 | -70,000 | -98,000 | -56,000 |
| Deferred Tax | -12,000 | 6,000 | 6,000 | 28,000 | -14,000 |
| (B) | -54,000 | -54,000 | -64,000 | -70,000 | -70,000 |
| Profit After Tax (A-B) | 126,000 | 126,000 | 116,000 | 130,000 | 130,000 |
Computation of Taxable Income| Particulars | year-1 | year-2 | year-3 | year-4 | year-5 |
| Accounting Profit (PBT) (A | 180,000 | 180,000 | 180,000 | 20,000 | 20,000 |
| Add: Depreciation as per books | 20,000 | 20,000 | 20,000 | | |
| Less: Depreciation as per income tax Act | -60,000 | | | | |
| Add: Disallowance | | | | 80,000 | |
| | | | | -40,000 |
| Taxable Profit | 140,000 | 200,000 | 200,000 | 280,000 | 160,000 |
| Tax rate | 30% | 30% | 35% | 35% | 35% |
| Current tax | 42,000 | 60,000 | 70,000 | 98,000 | 56,000 |
Computation of Taxable Income|
| Particulars | year-1 | year-2 | year-3 | year-4 | year-5 |
| Opening balance of timing difference | | -40,000 | -20,000 | | 80,000 |
| Addition | -40,000 | | | 80,000 | |
| Deletion | | 20,000 | 20,000 | | 40,000 |
| Closing Balance | -40,000 | -20,000 | | 80,000 | 40,000 |
| Tax rate | 30% | 30% | 35% | 35% | 35% |
| Deferred Tax | -12,000 | -6,000 | – | 28,000 | 14,000 |
| DTA/DTL to be shown in Balance Sheet | DTL | DTL | NIL | DTA | DTA |
| Amount for P&L | -12,000 | 6,000 | 6,000 | 28,000 | -14,000 |
| To be Debited/Credited to P&L | Debited | Credited | Credited | Credited | Debited |
| Reason for Debit/Credit | Creation of DTL | Reversal of DTL | Reversal of DTL | Creation of DTA | Reversal of DTA |
Entry for Deferred Tax in year-1:| P&L a/c | Dr. | 12,000 | |
| TO DTL a/c | | | 12,000 |
| Entry for Deferred Tax in year-2&3: |
|---|
| DTL a/c | Dr. | 6,000 | |
| To P&L a/c | | | 6,000 |
| Entry for Deferred Tax in year-4: |
| DTA a/c | Dr. | 28,000 | |
| To P&L a/c | | | 28,000 |
| Entry for Deferred Tax in year-5: |
| P&L a/c | Dr. | 14000 | |
| TO DTA a/c | | | 14000 |