Important Keyword: Deferred Tax, Deferred tax liability, Income from Business & Profession, Income Tax Act.
Table of Contents
Deferred Tax Liability
Understanding deferred tax liability in India requires grasping the complexities of the country’s tax system, which is characterized by various elements. To comprehend deferred tax liability better, it’s crucial to recognize that organizations in India prepare two distinct financial reports each fiscal year: an income statement and a tax statement. The divergence in guidelines governing these statements creates the scope for deferred tax.
These two reports serve different purposes and adhere to separate sets of regulations. While the income statement reflects the financial performance of a company, including revenues and expenses, the tax statement focuses on computing the tax liability based on the applicable tax laws and regulations.
The misalignment between the income statement and the tax statement stems from differences in accounting principles and tax laws. For instance, certain expenses or revenues may be recognized differently in financial accounting compared to tax accounting, leading to variations in taxable income. These variations give rise to deferred tax liability, which represents the taxes that will be payable in future periods due to temporary differences between the financial and tax accounting treatment of certain items.
In essence, the existence of deferred tax liability underscores the need for organizations to navigate the intricacies of India’s tax landscape, ensuring compliance with regulatory requirements while effectively managing their tax obligations.
What is Deferred Tax Liability (DTL)?
Deferred tax liability (DTL) arises when a tax obligation accumulates in one financial year but is not due until a subsequent year. It signifies that the organization may have to pay more tax in the future for a transaction that occurred in the current period. The deferral occurs due to the disparity in timing between when the tax is accrued and when it is actually paid.
One common scenario leading to the creation of DTL is depreciation. When the depreciation rate specified by the Income-tax Act exceeds that prescribed by the Companies Act, especially in the initial years, the organization pays lower tax in the current period. As a result, deferred tax liability is recorded in the books to account for the tax that will be payable in future periods when the depreciation expenses catch up.
How is Deferred Tax Liability created?
Variance in Depreciation Methods and Rates:
Deferred tax liability can arise when there is a variance between the depreciation methods and rates used by a company and those prescribed by the tax authorities. This difference creates a temporary incongruity between the depreciation figures reported in the company’s financial statements and those in its tax filings.
For instance, let’s consider a hypothetical scenario involving Company XYZ, which assumes a manufacturing machine worth INR 4,00,000 with a depreciation rate of 15%. However, for financial reporting purposes, the company applies a depreciation rate of 10%. In a given year, Company XYZ generates revenues of INR 10 lakh and incurs expenses of INR 6 lakh, excluding depreciation on assets.
The following table illustrates the comparison between the depreciation figures reported in the company’s financial statements and those in its tax filings:
Financial Statements | Tax Filings
Depreciation Expense: INR 40,000 | Depreciation Expense: INR 60,000
Gross Profit: INR 4,00,000 | Gross Profit: INR 3,40,000
As depicted, the depreciation expense reported in the financial statements is INR 20,000 lower than that in the tax filings. This results in a higher gross profit reported in the financial statements compared to the tax filings. Over subsequent years, this disparity is expected to diminish as the depreciation catch-up aligns the figures more closely.
| Particulars | For books (in INR) | For tax purposes (in INR) | Difference (in INR) |
| Revenues | 10,00,000 | 10,00,000 | Nil |
| Expenses | (6,00,000) | (6,00,000) | Nil |
| Depreciation | (40,000) | (60,000) | 20,000 |
| Gross Profit | 3,60,000 | 3,40,000 | 20,000 |
| Tax @ 25% | (90,000) | (85000) | 5000 |
| Net Profit | 2,70,000 | 255000 | 15000 |
Treatment of Revenues and Expenses
Discrepancies in the treatment of revenues and expenses between a company’s income statement and tax reports can lead to deferred tax liabilities. This occurs when tax is levied based on revenues that have not yet been realized by the company, creating a temporary difference in tax obligations between reporting periods.
Consider the example of Company X in the fiscal year 2019-20. The company sold goods totaling INR 12 lakh on credit, of which only INR 6 lakh was received during the year, with the remaining amount expected to be received from debtors in the subsequent year. Meanwhile, expenses incurred during the year amounted to INR 4 lakh. The tax calculations for both the income statement and tax report are outlined below:
| Particulars | Income Statement (in INR) | Tax report (in INR) | Difference (in INR) |
| Sales | 12,00,000 | 6,00,000 | 6,00,000 |
| Expenses | (4,00,000) | (4,00,000) | Nil |
| Gross Profit | 8,00,000 | 2,00,000 | 6,00,000 |
| Tax @ 25% | 2,00,000 | 50,000 | 1,50,000 |
In this scenario, the company’s income statement reflects a net profit of INR 8,00,000, while the taxable income reported for tax purposes is INR 2,00,000. Consequently, the tax liability differs between the income statement (INR 2,40,000) and the tax report (INR 60,000), resulting in a deferred tax liability of INR 1,80,000 for the company, which it must account for in subsequent years.
Carry Forward of Current Profits
Companies frequently have the opportunity to carry forward their profits from one fiscal year to the next, allowing them to reduce their tax liabilities effectively. However, since the company will be obligated to pay taxes on the carried-forward profits in the subsequent year, a deferred tax liability is created.
Comparison between Deferred Tax Asset (DTA) and Deferred Tax Liability (DTL):
Deferred tax assets and liabilities stem from differences in accounting standards and tax regulations. To illustrate the variances between DTA and DTL, a detailed comparison is provided in the table below:
| Parameters | Deferred Tax Asset | Deferred Tax Liability |
| Basis of recognition | When tax accrues in a later period, however, it is paid in advance in the current year, it is recorded as a deferred tax asset. | When tax accrues in the current year but is paid in a later period, it is considered a deferred tax liability. |
| Creation | When profits in a company’s income statement are lower than the one mentioned in the tax reports. | When profits in a company’s income statement are higher than what is mentioned in its tax reports. |
| Treatment | It appears in the Balance Sheet under Non-current assets. | It appears in the Balance Sheet under Non-current liabilities. |
Frequently Asked Questions
1. What is Deferred Tax Liability (DTL) under Indian accounting and tax laws?
Answer: Deferred Tax Liability (DTL) arises when taxable income is lower than accounting income due to temporary timing differences. It represents future tax payments arising from current financial transactions, usually caused by differences in depreciation, revenue recognition, or expense treatment between accounting standards and tax laws.
2. When does DTL typically arise in a company’s financials?
Answer: DTL often arises due to:
- Higher depreciation under tax laws than in books (especially in early asset life).
- Advance revenue recognized for tax but not yet in books.
- Disallowed expenses that will be allowed later for tax.
Example: Using 60% depreciation under Income Tax Act and 40% in Companies Act will reduce taxable profit today, but increase tax burden later.
3. Can DTL occur due to advance income recognition?
Answer: Yes. If a company receives income in advance and pays tax on it now (e.g., credit sales or subscription revenue), but recognizes it in books over multiple periods, a DTL is created, since tax is paid before book income is realized.
4. In case of depreciation differences, how is DTL computed?
Answer: Let’s say:
- Book depreciation = ₹40,000
- Tax depreciation = ₹60,000
- Difference = ₹20,000
- Tax rate = 25%
Then, DTL = ₹20,000 × 25% = ₹5,000, which the company must disclose in its balance sheet.
5. Does DTL affect cash flow or only accounting treatment?
Answer: DTL is a non-cash liability. It does not affect current year cash flow, but reflects future tax payable when the temporary difference reverses.
6. Is DTL always payable in future or can it reverse without tax outflow?
Answer: DTL will reverse when the timing difference reverses (e.g., lower depreciation in future years). If the reversal coincides with losses or exemptions, the actual tax outflow may not occur, but the accounting reversal must still be done.
7. Can deferred tax liability be set off against deferred tax asset (DTA)?
Answer: Yes, netting off DTA and DTL is allowed if the entity has a legal right to offset and intends to settle on a net basis. This is common in companies with both timing differences and carried-forward losses.
8. How should a company report DTL in its financial statements under Ind AS 12?
Answer: DTL should be shown under non-current liabilities in the balance sheet and detailed in the notes to accounts. The computation, basis of recognition, and changes must also be disclosed as per Schedule III and Ind AS 12.
9. Is there any impact of DTL on MAT (Minimum Alternate Tax) calculations?
Answer: Yes. Deferred tax expense debited to the Profit & Loss account must be added back to the book profit for MAT under Section 115JB. Conversely, deferred tax income must be deducted while computing book profit for MAT.
10. A company recognizes DTL of ₹1.5 lakh due to advance income. What happens next year?
Answer: In the subsequent year, when the advance income is recognized in books but no longer taxable (already taxed), the DTL reverses. This reversal reduces tax expense in the P&L, and the DTL balance on the balance sheet is adjusted accordingly.
Read More: Deferred Tax Asset (DTA)
Web Stories: Deferred Tax Asset (DTA)
Official Income Tax Return filing website: https://incometaxindia.gov.in/
