1. What is Deferred Tax and Why Does it Arise?
Every company prepares two sets of numbers: accounting profit (as per IND AS) and taxable profit (as per the Income Tax Act, 1961). These two numbers are almost never the same — and that gap is the root cause of deferred tax.
The gap arises because accounting standards and tax laws recognise income and expenses in different periods. For example, a company may depreciate an asset over 10 years for books but claim it fully in 3 years for tax. In early years, tax profit is lower (more deduction), so the company pays less tax now — but will pay more later. That "pay more later" obligation is a Deferred Tax Liability (DTL).
Similarly, when a company books an expense (say, a provision for doubtful debts) that is not yet allowed for tax, it overpays tax now and will recover it later — creating a Deferred Tax Asset (DTA).
Core principle of IND AS 12: Recognise the tax consequences of recovering or settling the carrying amount of assets and liabilities — not just the taxes on current period profit. This is the balance sheet approach (vs. the income statement timing difference approach of old AS 22).
2. Key Definitions
| Term | What it means | Example |
|---|---|---|
| Carrying Amount | Net book value of an asset/liability as per financial statements | Plant at ₹6,00,000 after 4 years of SLM depreciation on ₹10,00,000 cost |
| Tax Base | The amount attributed to an asset/liability for income tax purposes | Same plant at ₹1,00,000 WDV after aggressive tax depreciation |
| Temporary Difference | Carrying Amount minus Tax Base (for an asset) | ₹6,00,000 − ₹1,00,000 = ₹5,00,000 taxable temporary difference → DTL |
| Taxable Temporary Difference | Will result in taxable amounts in future periods → creates DTL | Book depreciation less than tax depreciation in early years |
| Deductible Temporary Difference | Will result in deductible amounts in future periods → creates DTA | Provision for bad debts booked but not yet allowed for tax |
| Current Tax | Tax payable on taxable income for the current period | ₹3,42,000 per return |
| Deferred Tax | Tax effect of all temporary differences | DTA or DTL arising from book vs tax differences |
3. DTA vs DTL — When Does Each Arise?
The rule is straightforward once you understand what each temporary difference means for future cash flows:
| Situation | Type of Difference | Creates | Why |
|---|---|---|---|
| Book depreciation < Tax depreciation (early years, WDV vs SLM) | Taxable | DTL | Higher tax deduction now → higher tax bill later |
| Provision for doubtful debts (not yet allowed for tax) | Deductible | DTA | Tax paid now on income that may not be collected → recover later |
| Bonus payable — accrued in books, allowed for tax only on payment | Deductible | DTA | Higher tax now → deduction next year when paid |
| Unearned revenue (taxed upfront but recognised in books over time) | Deductible | DTA | Tax paid in advance on future income → offset later |
| Revaluation of asset upward (IND AS 16) | Taxable | DTL | Higher carrying amount → higher future taxable gain on disposal |
| Carry-forward of unused tax losses (if future profit probable) | Deductible | DTA | Losses will reduce future taxable income |
4. The Deferred Tax Formula
For an ASSET:
Taxable Temp. Diff (CA > TB) → DTL
Deductible Temp. Diff (CA < TB) → DTA
For a LIABILITY:
Taxable Temp. Diff (CA < TB) → DTL
Deductible Temp. Diff (CA > TB) → DTA
DTA / DTL = Temporary Difference × Applicable Tax Rate
Which tax rate? Use the rate that will apply when the temporary difference reverses — typically the enacted (or substantively enacted) rate at the balance sheet date. For most Indian domestic companies this is 25.17% (22% base + surcharge + cess) or 34.944% for companies in the higher bracket.
5. Step-by-Step Worked Example — Depreciation Difference
Scenario: ABC Pvt. Ltd. purchases machinery on 1 April 2021 for ₹10,00,000. Useful life for accounting (SLM) = 5 years. Tax depreciation under Income Tax Act (WDV @ 15% for plant) results in a different written-down value each year. Tax rate = 25.17%.
Step 1 — Calculate Book Depreciation (SLM)
Annual depreciation = ₹10,00,000 ÷ 5 = ₹2,00,000 per year.
Step 2 — Calculate Tax WDV (WDV @ 15% p.a.)
Opening WDV each year reduced by 15%. This is the Tax Base of the asset.
Step 3 — Compute Temporary Difference and DTL
| Year | Carrying Amount (Book WDV) ₹ | Tax Base (Tax WDV) ₹ | Temp. Difference ₹ | Closing DTL @ 25.17% ₹ | DTL Movement ₹ |
|---|---|---|---|---|---|
| FY 2021-22 (Yr 1) | 8,00,000 | 8,50,000 | — (DTA of 50,000) | 12,585 (DTA) | Create DTA 12,585 |
| FY 2022-23 (Yr 2) | 6,00,000 | 7,22,500 | — (DTA of 1,22,500) | 30,833 (DTA) | Increase DTA 18,248 |
| FY 2023-24 (Yr 3) | 4,00,000 | 6,14,125 | — (DTA of 2,14,125) | 53,875 (DTA) | Increase DTA 23,042 |
| FY 2024-25 (Yr 4) | 2,00,000 | 5,22,006 | — (DTA of 3,22,006) | 81,049 (DTA) | Increase DTA 27,174 |
| FY 2025-26 (Yr 5) | — | 4,43,705 | — (DTA of 4,43,705) | 1,11,681 (DTA) | Increase DTA 30,632 |
| Note: Here tax depreciation (WDV 15%) is lower than book depreciation (SLM 20%) → Tax Base exceeds Carrying Amount → Deductible Temporary Difference → DTA throughout. | |||||
Intuition check: WDV @ 15% gives smaller depreciation than SLM @ 20% in early years. So tax profit is higher than book profit → company overpays tax now → DTA. The asset's tax WDV exceeds book WDV throughout, confirming deductible temporary difference.
Now let's look at a more classic DTL example — machinery depreciated faster for tax:
Revised scenario for DTL: Same ₹10,00,000 machinery. Tax depreciation = 40% WDV (e.g., computers or certain equipment under IT Act). Book = SLM 20%. Here tax WDV falls faster than book WDV in early years → Carrying Amount > Tax Base → Taxable Temporary Difference → DTL.
| Year | Book WDV (CA) ₹ | Tax WDV (TB) ₹ | Taxable Temp. Diff ₹ | Closing DTL @ 25.17% ₹ | DTL Movement ₹ |
|---|---|---|---|---|---|
| FY 2021-22 (Yr 1) | 8,00,000 | 6,00,000 | 2,00,000 | 50,340 | +50,340 (create) |
| FY 2022-23 (Yr 2) | 6,00,000 | 3,60,000 | 2,40,000 | 60,408 | +10,068 (increase) |
| FY 2023-24 (Yr 3) | 4,00,000 | 2,16,000 | 1,84,000 | 46,313 | −14,095 (reverse) |
| FY 2024-25 (Yr 4) | 2,00,000 | 1,29,600 | 70,400 | 17,720 | −28,593 (reverse) |
| FY 2025-26 (Yr 5) | — | 77,760 | — | — | −17,720 (fully reversed) |
| Total DTL created = Total DTL reversed | Net effect over asset life = Zero | ||||
The DTL created in early years fully reverses by end of asset life — this is the fundamental characteristic of temporary differences (unlike permanent differences which never reverse).
6. Journal Entries — Creating and Reversing DTL
Using the DTL example above (40% WDV tax depreciation), here are the journal entries for each year:
Year 1 — FY 2021-22: Creating DTL of ₹50,340
DTL created: book depreciation (₹2,00,000) is less than tax depreciation (₹4,00,000) → taxable temp. diff. of ₹2,00,000 × 25.17% = ₹50,340.
Year 2 — FY 2022-23: Increasing DTL by ₹10,068
DTL increases from ₹50,340 to ₹60,408. The incremental deferred tax expense for the year is ₹10,068.
Year 3 — FY 2023-24: DTL Starts Reversing (₹14,095)
In Year 3, book depreciation (₹2,00,000) exceeds tax depreciation (₹86,400 on ₹3,60,000 WDV @ 24%). The DTL reverses — this credit to P&L reduces the total tax expense for the year.
Key presentation point: The total tax expense line in P&L = Current tax + Deferred tax. When DTL reverses (as in Years 3–5 above), deferred tax is a credit to P&L — reducing total tax expense even as the company pays more current tax.
Journal Entry for DTA (e.g., Provision for Doubtful Debts)
ABC Ltd books a provision for bad debts of ₹5,00,000 in FY 2024-25. This is not deductible for tax until the debt is actually written off. Tax rate 25.17%.
DTA = ₹5,00,000 × 25.17% = ₹1,25,850
DTA reduces tax expense this year. When the bad debt is written off next year and allowed for tax, the DTA reverses: Dr Tax Expense / Cr DTA.
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| Item in Books | Tax Treatment | Difference | Creates |
|---|---|---|---|
| Provision for doubtful debts | Allowed only on actual write-off (Sec 36(1)(vii)) | Deductible | DTA |
| Bonus/leave encashment accrued | Deductible only on actual payment (Sec 43B) | Deductible | DTA |
| Gratuity provision (unfunded) | Allowed only on actual payment or approved fund contribution | Deductible | DTA |
| Warranty provision | Not deductible until claims are paid | Deductible | DTA |
| Mark-to-market loss on investments (FVTPL) | Loss not recognised for tax until realised | Deductible | DTA |
| Unabsorbed depreciation / business losses carried forward | Will reduce future taxable income if profitable | Deductible | DTA (if probable) |
| Accelerated tax depreciation (WDV > SLM) | Higher deduction now, lower later | Taxable | DTL |
| Revenue recognised in advance for tax purposes | Taxed before earning in books | Deductible | DTA |
8. Recognition Criteria for DTA — The "Probable" Test
Unlike DTL (which is recognised for all taxable temporary differences), DTA is recognised only when it is probable that sufficient future taxable profit will be available to utilise it — per IND AS 12, Para 24.
Is there a deductible temporary difference?
If yes, a DTA may be recognised. If no, stop here — no DTA.
Is it probable that future taxable profit will be available?
Look at profit forecasts, existing DTLs that will reverse in the same period, and tax planning opportunities. "Probable" means more likely than not (> 50%).
Can the taxable profit be offset against the deductible temporary difference?
The DTA must reverse in the same period (or periods) as taxable profit will be available. Check time limits on carry-forward of losses.
Review at each Balance Sheet date
Previously unrecognised DTA is recognised when it becomes probable. Previously recognised DTA is reduced when probability of utilisation falls.
Carry-forward losses — special caution: IND AS 12 Para 35 says you need convincing evidence to recognise DTA on carry-forward losses, as the existence of unused losses is strong evidence that future taxable profit may not be available. Start-ups and loss-making companies must apply this test carefully.
9. Presentation in Balance Sheet — Netting and Classification
IND AS 12 permits netting DTA and DTL only if both conditions are met (Para 74):
- The entity has a legally enforceable right to set off current tax assets against current tax liabilities; and
- The DTA and DTL relate to income taxes levied by the same taxing authority on the same taxable entity.
In practice, most Indian companies net DTA and DTL at the entity level (same entity, same IT Act jurisdiction). Present the net amount as a single line:
| Balance Sheet Line | Where shown | When |
|---|---|---|
| Deferred Tax Asset (net) | Non-current Assets | DTA > DTL (or standalone DTA) |
| Deferred Tax Liability (net) | Non-current Liabilities | DTL > DTA (or standalone DTL) |
Always non-current: Under IND AS, DTA and DTL are always classified as non-current, regardless of when the underlying difference is expected to reverse. This differs from US GAAP which had a current/non-current split (now eliminated under ASC 740).
10. IND AS 12 vs Old AS 22 — Key Differences
| Aspect | Old AS 22 | IND AS 12 |
|---|---|---|
| Approach | Income statement (timing differences) | Balance sheet (temporary differences) |
| Scope | Only timing differences | All temporary differences, including those arising from initial recognition |
| Permanent differences | Explicitly excluded | Not separately defined; focus is on whether difference will reverse |
| DTA recognition | Virtual certainty of future taxable profit | Probable future taxable profit (lower threshold) |
| Revaluation | No deferred tax on revaluation reserves | DTL recognised on upward revaluation (even if retained in equity) |
| Business combinations | Not covered | Specific guidance on deferred tax in acquisitions |
| Undistributed profits of subsidiaries | Not covered | DTL recognised unless parent can control timing of distribution |
| Tax rate | Average rate or enacted rate | Enacted (or substantively enacted) rate expected when difference reverses |
11. Common Mistakes CAs Make
Mistake 1 — Confusing permanent and temporary differences: Disallowances under Section 40A(3) (cash payments > ₹10,000) are permanent — they never reverse and create no deferred tax. Many CAs mistakenly create DTA on these. Only differences that will reverse in a future period create DTA/DTL.
Mistake 2 — Using the wrong tax rate: DTA/DTL must be measured at the rate expected to apply when the temporary difference reverses. For a company planning to switch to the concessional 22% regime, using 30% will overstate the deferred tax balance.
Mistake 3 — Not reviewing DTA at year-end: IND AS 12 Para 56 requires the carrying amount of DTA to be reviewed at every balance sheet date. If future profit is no longer probable (e.g., a company goes into losses), the DTA must be written down. Many preparers create DTA once and never reassess.
Mistake 4 — Netting across different entities or jurisdictions: DTA of Company A cannot be netted against DTL of Company B, even in a consolidated group. Netting is allowed only within the same legal entity, same taxing authority.
Mistake 5 — Ignoring deferred tax on OCI items: When a difference arises in Other Comprehensive Income (e.g., remeasurement of defined benefit plans under IND AS 19, or fair value changes on FVOCI instruments under IND AS 109), the deferred tax on that difference is also recognised in OCI — not in P&L. This is frequently missed.
Best practice: Maintain a deferred tax workings schedule with a row for every significant balance sheet item that has a book-tax difference. Update it every quarter. This makes the year-end audit seamless and ensures no item is missed.