Deferred Tax Asset (DTA)

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

Deferred Tax Asset (DTA)

In the dynamic landscape of financial reporting and taxation, Deferred Tax Assets (DTA) play a crucial role in reflecting the true financial health of an organization. While often misunderstood or overlooked, DTAs are a key component under Indian Accounting Standards (Ind AS) and Income Tax Act, influencing both compliance and strategic planning.

What is Deferred Tax Asset (DTA)?

A Deferred Tax Asset arises when a company pays more taxes in the current period than it actually owes, leading to an overpayment that can be recovered in future periods. In essence, it represents future tax benefits resulting from timing differences between accounting income and taxable income.

For example, certain expenses may be recognized in the books of accounts in the current year but allowed as a deduction for tax purposes in future years. This creates a temporary difference that forms the basis of a DTA.

Key Conditions for Recognizing a DTA

According to Ind AS 12, a Deferred Tax Asset can be recognized only when it is probable that future taxable profits will be available against which the temporary differences can be utilized. This ensures prudence and avoids overstating the asset.

Common sources of DTAs include:

• Carry forward of business losses or unabsorbed depreciation
• Provision for doubtful debts or gratuity recognized in books but deductible later
• Difference in depreciation rates between books and tax laws

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:

Particulars	As per company books (INR)	As per taxes (INR)
Income	12,000	12,000
Expense	6,000	6,000
Any particular expense	2,000	0
Taxable income	4,000	6,000
Tax (30%)	1,200	1,800

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.

Impact of Deferred Tax Assets and Liabilities on Minimum Alternate Tax (MAT)

Minimum Alternate Tax (MAT) ensures that companies with substantial book profits cannot avoid paying taxes entirely by using various exemptions or deductions under the Income Tax Act. Under Section 115JB, if the regular tax payable (excluding surcharge and cess) is lower than a prescribed percentage of book profits, the company must pay MAT instead. The excess tax paid over regular tax becomes MAT credit, which can be carried forward and set off against future tax liabilities for up to 15 assessment years.

The computation of MAT is based on the company’s book profit, which is adjusted for specific inclusions and exclusions. Key adjustments include:

Additions to book profit:

• Any provision for income tax
• Amounts transferred to reserves
• Deferred tax or its provision
• Provisions for unascertained liabilities

Deductions from book profit:

• Withdrawals from reserves or provisions
• Depreciation (excluding that on revalued assets)
• Notional gains
• Deferred tax credited to the Profit and Loss account

The treatment of deferred tax in MAT calculations was long debated. In the case of Prime Textiles Ltd, the Chennai Tribunal ruled that deferred tax liabilities should be added back to book profit. However, the Kolkata Tribunal, in Balrampur Chini, held a contrary view.

To resolve this ambiguity, the Finance Act, 2008 amended Section 115JB to provide clarity. As per this amendment:

• If deferred tax or its provision appears on the debit side of the Profit and Loss account, it must be added back to book profit.
• Conversely, if deferred tax appears on the credit side, it must be deducted from book profit.

This ensures consistency in MAT computation and aligns deferred tax treatment with the broader principles of book profit adjustments under Indian tax laws.

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/