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The word ‘deferred’ stands for postponed or delayed, and the concept of deferred tax refers to a tax which is due for the current financial year or has been estimated, but it is not paid yet. This tax originates when the tax amount is either paid or carried forward without mentioning it on the income statement.

In simpler terms, it is negative or a positive entry in the company’s balance sheet that occurs because of due taxes or taxes overpaid. A part of deferred tax is a deferred tax asset, which is commonly known as DTA.

The benefit of a deferred tax asset is that it lowers a company’s future liability. Owing to the following reasons DTA had originated:

  • The tax department takes expenses before time.
  • Any tax on the earned revenue is imposed before time.
  • Tax rules are different for assets and liabilities.

How Deferred Tax Asset is Created

Let’s assume a company has made a profit of Rs.10,000 before taxes, and it includes Rs. 2000 as bad debts that it has suffered. Now, to make a profit on tax payment, the company will account for this bad debt for the future when it recovers the sum. Therefore, taxable income after this will be Rs. 12,000 and if the income tax rate is 30%, for example; then the company has to pay a tax of Rs. 3600 (12,000*30%).

On the other hand, if these bad debts weren’t allowed, the company would have paid a tax of Rs. 3000 (10,000*30%). Thus, for just Rs. 600 more, the company has created a deferred tax asset.

Scenarios Used to Generate DTA

Here are some situations that companies used to create a deferred tax asset.

  • Revenues

Companies mention their revenues in their tax document before they actually mention them in their books. It allows them to pay high taxes in advance and helps them in creating DTA.

  • Difference in the depreciation method

Owing to different methods used for calculating depreciation on assets, deferred tax on assets can be created. For example, a company owns a piece of machinery worth Rs. 60,000, and have a lifespan of 5 years. 30% tax is charged on this machinery. Thus the company will pay,

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  • For its own books: 60,000/5= 12,000 then 12,000*30%= 3600.
  • In their tax document: 60,000/4= 15,000 then 15,000*30%= 4500

Naturally, the company is paying more taxes upfront for their assets and creating a DTA.

  • Depreciation rate

At times, companies use a lower depreciation rate for their books compared to the one they used for filing their taxes. For example, a company uses 12% depreciation rate for their books and 15% rate for their tax purposes. It creates a difference in the final amount and generates a deferred tax asset for companies.

  • Expenses 

DTAs can be formed by mentioning a particular expense in the company accounts but leaving it out in the tax statement. For example –

For company books

Income10,000
Expense4,000
Any particular expense2,000
Taxable income4,000
Tax (30%)1200

For tax documents

Income10,000
Expense4,000
Any particular expense0
Taxable income6,000
Tax (30%)1800

This difference in tax payment will show a DTA of Rs. 600 in the balance sheet.

  • Suffers loss

A simple method of creating DTA is when a business suffers a loss. Here, the company’s loss is carried forward and then adjusted against its profit of coming years. This reduces a company’s tax liability. Hence, a loss like this can be counted as an asset owing to its benefits.

  • Bad debts

As mentioned in an earlier example, bad debts are other instruments used to create deferred tax assets. Companies do not consider bad debts until it is written off; it allows them to create a difference in the taxable income of their book and their tax documents and creates a DTA.

  • Warranties

Using warranties is a common deferred tax example. Companies list warranty expenses in their tax statement and use it to create DTA. For example, a company has Rs. 10 lakh in revenues and Rs. 6 lakh in expenses. Now, it shows this expense as Rs. 5 lakh in various costs and lists Rs. 1 lakh as expenses for future warranty and return related expenses.

Tax authorities do not consider these future expenses as specific expenses because the company or individual has yet to incur this expenditure. As a result, a company has to pay tax on this Rs. 1 lakh as well.

Calculation of DTA

DTA can be calculated manually through the following steps:

  • Make a list of all the assets and liabilities.
  • Calculate the tax bases.
  • Figure out the temporary difference.
  • Calculate the tax liability rate.
  • Figure out the tax assets.
  • Identify objects not included in the financial positions.
  • Sum up all the factors and then enter them into the accounts.

On the other hand, companies can use the calculator available on the Income Tax department of India for their deferred tax asset calculation. Using this calculator requires some essential details like the tax status of the company, assessment year, annual taxable income (pre-tax) and estimated average annual tax rate.

Benefits of Deferred Tax Assets

Deferred tax assets bring value to every company. It is viewed as a good sign in the balance sheet of a company. It represents the taxes a company has already paid, but they are not recognised in its financial statements. It is like a pre-paid tax that helps companies to reduce their future liabilities.

Difference between Deferred Tax Asset and Deferred Tax Liabilities

Deferred Tax Assets (DTA)Deferred Tax Assets (DTL)
Deferred tax assets are created when profits, according to the tax documents, are greater than profits according to the company books.Deferred tax liability is created when profits, according to the tax documents, are less than profits according to the company books.
DTA creation depends on the principle of prudenceDTL creation depends on the payment of Minimum Alternative Tax (MAT)
It is mentioned under non-current assets in the company balance sheet.It is mentioned under non-current liabilities of the company balance sheet.

FAQs

  1. What are deferred income tax assets?

Deferred income tax assets are tax assets that one can defer to a later period or date.

  • Is it mandatory to create DTA?

No, DTA creation is not mandatory. Still, companies use this method to avail its benefits in the future.

  • Is DTA a tangible or an intangible asset? 

DTAs are intangible assets in a company’s books.

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