ALL ABOUT DEFERRED TAX LIABILITY

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  • Last Updated on 14 July, 2022

WHAT IS DEFERRED TAX LIABILITY?

Deferred tax liability refers to the liability that arises when profit as per books of account is more than taxable profit due to timing differences.
 
While computing taxable income as per the provisions of Income Tax Act, 1961, there may be certain expenditures that are allowed for deduction wholly in the year in which such expenditures were incurred, but in the financial books such expenditures are allowed over a period of time. The timing difference of amortizing such expenditures brings differences in book profit and taxable profit (i.e. the book profit becomes more than taxable profit). However, the benefit of such deduction while calculating taxable income gets reversed in the subsequent years where financial books amortise such expenditure and no treatment is done for such expenditures while calculating taxable income for the obvious fact that benefit of same has already been availed in the previous year. The accounting for such probable reversal of tax, taking into consideration the concept of MAT, leads to creation of deferred tax liability. 
For example,
 
Substantial Advertisement expenses – The benefit of expenses incurred on the advertisement of products/services extents to subsequent years also. Since, their benefit extends to subsequent years, they are amortized accordingly in the books of account. However, while computing taxable income as per tax laws, the amount of expenses incurred are allowed wholly for deduction. Such expenses are known as Deferred Revenue Expenditure that are accountable for time differences.

Illustration: (Deferred Tax Liability calculation):

Mr. X spent Rs. 3 Crores on advertisement of a newly launched product in the year 2017-18. His team forecasts that this advertisement will earn them benefit for 3 years. This amount of Rs. 3 crores shall be treated as: 

 

Year I

Year II

Year III

Expenses as per Income Tax Laws

Rs. 3 Crores

0

0

Expenses as per Financial Books

Rs. 1 Crore

Rs. 1 Crore

Rs. 1 Crore

 

Assuming, the tax rate to be 30%, Mr. X has to pay Rs. 60,00,000/- (Rs. 2 Crores * 30%) less year I. However, in Year II he shall not get the benefit of tax on the expenses of Rs. 1 Crore amortized in Year II and Year III subsequently because the benefit of same was availed in Year I wholly. This benefit of amount of Rs. 60,00,00/- will get eliminated in the Year II and Year III and has to be accounted for in Year I by way of creating deferred tax liability account. 
 

Also ReadDeferred Tax Asset

Deferred Tax Liability in case of loss:

When the books of accounts reflect profit for the period under consideration but there is loss as per the provisions of tax laws due to timing difference, then in that case also, the deferred tax liability is required to be recognized and carried forward to subsequent years.

No consideration to time value of money:

It is important to note that as per deferred tax accounting standard, amount of deferred tax shall not be discounted to its present value. Hence, while doing deferred tax calculation, the time value of money is ignored. 

 

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