Important Keyword: Deferred Tax Asset, DTA, Income from Business & Profession, Income Tax Act.

Deferred Tax Asset (DTA)

In the realm of financial reporting, organizations navigate the intricate landscape of compliance by preparing two distinct financial statements annually: an income statement and a tax statement. The rationale behind this bifurcation lies in the divergent guidelines governing each statement. However, this dichotomy inevitably gives rise to the concept of Deferred Tax.

Deferred Tax Liability (DTL) and Deferred Tax Asset (DTA) emerge as significant components within the Financial Statements. These entities serve as markers of the temporal misalignment between the recognition of income and expenses for financial reporting purposes versus taxation obligations.

As businesses navigate the intricacies of financial management, understanding and appropriately accounting for Deferred Tax become paramount. It’s a nuanced aspect that reflects the dynamic interplay between regulatory frameworks and fiscal realities, ensuring a comprehensive depiction of an organization’s financial health.

What is Deferred Tax Asset (DTA)?

Deferred Tax Assets (DTA), a key component of deferred tax, represent an intriguing facet of financial management. These assets materialize when a company’s reported income tax, as reflected in its income statement, falls below the amount paid to the tax authority. Essentially, DTA arises when tax payments are either settled or carried forward but have yet to be recognized in the income statement.

The quantification of the deferred tax asset hinges on a comparative analysis between book income and taxable income. This evaluation unveils the actual value attributed to the DTA, delineating the temporal misalignment between financial reporting and taxation obligations. As such, DTA stands as a testament to the intricate interplay between accounting principles and fiscal regulations, encapsulating the nuanced dynamics of corporate financial management.

How DTA is created?

Understanding how a company’s recorded income tax can diverge from its actual payments to the authority might intrigue readers. Consider this example: Suppose a company reports a profit of INR 10,000 before taxes, with INR 4,000 accounted for as bad debts incurred. Anticipating future recovery, the company defers recognition of this bad debt. Consequently, its taxable income increases to INR 14,000. Assuming a tax rate of 30%, the company now owes INR 4,200 (14,000 * 30%).

However, if the bad debts were not considered, the company’s tax liability would have been INR 3,000 (10,000 * 30%). This marginal difference of just INR 1,200 manifests as a deferred tax for the company.

Several scenarios can lead to the creation of Deferred Tax Assets (DTA) for a company:

1. Depreciation Method Discrepancy: DTA arises when a company’s method of calculating depreciation on its assets differs from the prescribed method by the tax authority. For instance, if a company depreciates a computer valued at INR 50,000 over 5 years, applying a 30% tax rate, it might calculate:
   • For its records: INR 50,000 / 5 = INR 10,000 depreciation, resulting in INR 3,000 tax.
   • For tax filing: INR 50,000 * 40% = INR 20,000 depreciation, leading to INR 6,000 tax. This tax disparity creates a DTA for the company.
2. Depreciation Rate Variance: Companies may use different depreciation rates for their financial statements compared to those mandated for tax filings. For instance, employing a 10% depreciation rate internally and a 15% rate for tax purposes can generate a DTA due to the resulting difference in taxable income.

Expenses 

Under the Income Tax Act, certain expenses are disallowed when calculating income from a business. Consequently, this disparity between financial reporting and tax regulations can lead to the creation of Deferred Tax Assets (DTAs) in company accounts. For instance:

The variance in tax payments results in a Deferred Tax Asset (DTA) of INR 600 reflected in the company’s balance sheet.

Bad debts and carry forward of losses are two factors that can contribute to the creation of Deferred Tax Assets (DTA).

Bad debts are not accounted for until they are written off, leading to a difference in taxable income between a company’s financial records and its tax documents, thus creating a DTA.

Similarly, losses carried forward from previous accounting periods can be claimed as assets in subsequent periods, reducing the company’s tax liability and resulting in a DTA.

To calculate DTA manually, companies need to:

1. List all assets and liabilities.
2. Calculate the tax bases.
3. Determine temporary differences.
4. Calculate the tax liability rate.
5. Identify the tax assets and enter them into the accounts.

The primary benefit of a Deferred Tax Asset is that it reduces a company’s future tax liability, functioning as a pre-paid tax that helps mitigate future obligations. While not recognized in financial statements, DTAs add value to companies by representing deferred tax payments.

Read More: Section 36 of Income Tax Act, 1961

Web Stories: Section 36 of Income Tax Act, 1961

Official Income Tax Return filing website: https://incometaxindia.gov.in/