Deferred Tax Liability (DTL)

Important Keyword: Deferred Tax, Deferred tax liability, Income from Business & Profession, Income Tax Act.

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

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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.

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