by Deferred Tax is the income tax that will be payable or recoverable in future accounting periods due to temporary differences between the carrying amount of assets and liabilities in the financial statements and their corresponding tax bases. It represents the future tax consequences of transactions and events that have already been recognised in the current financial statements.
Deferred tax arises because accounting standards and income tax laws often recognise income and expenses in different accounting periods. These timing differences create either a Deferred Tax Liability (DTL) or a Deferred Tax Asset (DTA). A Deferred Tax Liability arises when taxable temporary differences result in higher taxes payable in future periods. A Deferred Tax Asset arises from deductible temporary differences, unused tax losses, or unused tax credits, provided it is probable that sufficient future taxable profits will be available to utilise these benefits.
Objectives of Deferred Tax under Ind AS 12
- To Recognise Future Tax Consequences
The primary objective of deferred tax is to recognise the future tax consequences of transactions and events already recorded in the financial statements. Temporary differences between the carrying amount of assets and liabilities and their tax bases may result in future tax payments or tax savings. Ind AS 12 requires these future tax effects to be recognised through deferred tax assets and deferred tax liabilities. This ensures that financial statements present not only current tax obligations but also future tax implications, providing users with a complete and realistic view of an entity’s financial position.
- To Match Tax Expense with Accounting Profit
Deferred tax aims to match tax expenses with the accounting profit of the same reporting period. Since accounting standards and tax laws often recognise income and expenses at different times, tax effects may arise in future periods. Recognising deferred tax ensures that these future tax effects are recorded in the period in which the related transactions occur. This matching principle improves the accuracy of profit measurement and provides a fair presentation of financial performance by avoiding distortion caused by timing differences.
- To Ensure Accurate Financial Reporting
Another objective of deferred tax is to improve the accuracy of financial statements by recognising future tax assets and liabilities arising from temporary differences. Without deferred tax accounting, assets, liabilities, profits, and tax expenses may be misstated. Recognising deferred tax provides a more complete representation of the financial consequences of transactions. This enables users to understand the future tax impact of current business activities and enhances the reliability and credibility of financial reporting under Ind AS 12.
- To Recognise Deferred Tax Assets and Liabilities
Ind AS 12 aims to ensure proper recognition of deferred tax assets and deferred tax liabilities. Deferred tax liabilities arise from taxable temporary differences, while deferred tax assets arise from deductible temporary differences, unused tax losses, and unused tax credits. Recognising these items ensures that future tax obligations and future tax benefits are reflected appropriately in financial statements. This objective prevents understatement or overstatement of financial position and promotes faithful representation of an entity’s tax-related assets and liabilities.
- To Improve Comparability of Financial Statements
Deferred tax accounting promotes consistency and comparability among financial statements prepared by different entities. Ind AS 12 provides uniform principles for recognising and measuring deferred taxes arising from temporary differences. Applying the same accounting treatment enables investors, creditors, and regulators to compare the financial performance and tax position of different organisations more effectively. Improved comparability enhances the usefulness of financial statements and supports informed economic decision-making by stakeholders.
- To Enhance Transparency and Disclosure
Deferred tax accounting improves transparency by requiring entities to disclose information about deferred tax assets, deferred tax liabilities, temporary differences, and related tax expenses. These disclosures help users understand how future tax obligations and tax benefits affect an entity’s financial position. Transparent reporting reduces uncertainty and increases stakeholder confidence in financial statements. It also enables investors, lenders, and regulators to evaluate the long-term tax implications of current transactions and assess the overall financial health of the entity.
- To Ensure Compliance with Accounting Standards
An important objective of deferred tax accounting is to ensure compliance with the requirements of Ind AS 12. The standard prescribes detailed rules for recognising, measuring, presenting, and disclosing deferred taxes. Compliance with these principles promotes consistency in financial reporting and aligns Indian accounting practices with international standards. Following Ind AS 12 also helps entities prepare financial statements that are legally compliant, reliable, and acceptable to regulators, auditors, investors, and other stakeholders.
- To Support Better Decision-Making
The ultimate objective of deferred tax accounting is to provide relevant and reliable information that supports better decision-making. By recognising future tax obligations and tax benefits, deferred tax enables users to assess an entity’s future cash flows, profitability, and financial stability more accurately. Investors, creditors, management, and regulators can make informed decisions based on complete tax information. Proper deferred tax accounting enhances confidence in financial statements and contributes to sound financial planning and strategic business decisions.
Scope of Deferred Tax under Ind AS 12
- Covers Temporary Differences
The scope of deferred tax under Ind AS 12 includes all temporary differences arising between the carrying amount of assets and liabilities in the financial statements and their corresponding tax bases. These differences occur because accounting standards and income tax laws often recognise income and expenses at different times. Deferred tax ensures that the future tax consequences of these differences are recognised. By accounting for temporary differences, the standard presents a more accurate financial position and ensures that future tax obligations and benefits are reflected appropriately in the financial statements.
- Covers Taxable Temporary Differences
Deferred tax applies to taxable temporary differences that will result in taxable amounts in future periods when the carrying amount of an asset is recovered or a liability is settled. Such differences generally give rise to Deferred Tax Liabilities (DTLs). Ind AS 12 requires recognition of these liabilities unless a specific exemption applies. Recognising taxable temporary differences ensures that future tax obligations are reflected in the financial statements before they become payable. This improves the completeness and reliability of financial reporting.
- Covers Deductible Temporary Differences
The scope of deferred tax also includes deductible temporary differences. These differences will result in deductions while calculating taxable profits in future periods. They generally give rise to Deferred Tax Assets (DTAs), provided it is probable that sufficient future taxable profits will be available to utilise the deductions. Recognition of deductible temporary differences ensures that future tax benefits are reflected in the financial statements. This approach provides a balanced view of both future tax obligations and future tax savings.
- Covers Unused Tax Losses and Tax Credits
Ind AS 12 includes unused tax losses and unused tax credits within the scope of deferred tax accounting. These items may create Deferred Tax Assets when it is probable that future taxable profits will be available against which they can be utilised. Recognition of such tax benefits helps entities reflect future economic advantages arising from previous tax losses or available tax credits. This improves the completeness of financial reporting and provides stakeholders with information about potential future tax savings.
- Covers Business Combinations
Deferred tax under Ind AS 12 also applies to temporary differences arising from business combinations. When assets and liabilities are recognised at fair value during acquisition, differences may arise between their carrying amounts and tax bases. These differences create deferred tax assets or deferred tax liabilities. The standard provides guidance for recognising such tax effects to ensure that business combinations are accounted for accurately. This treatment improves consistency and provides a realistic presentation of future tax consequences resulting from acquisitions.
- Covers Transactions Recognised Outside Profit and Loss
The scope of deferred tax extends to transactions recognised outside the Statement of Profit and Loss. When items are recognised in Other Comprehensive Income (OCI) or directly in equity, the related deferred tax must also be recognised in the same component. This ensures consistency between the accounting treatment of the transaction and its tax effect. Recognising deferred tax in the appropriate section improves transparency and provides a true and fair presentation of financial statements under Ind AS 12.
- Covers Domestic and Foreign Income Taxes
Deferred tax applies to both domestic and foreign income taxes that are based on taxable profits. Entities operating in multiple countries may have temporary differences arising under different tax jurisdictions. Ind AS 12 requires deferred tax accounting for such differences using the applicable enacted or substantively enacted tax rates. Including both domestic and foreign income taxes within its scope ensures uniform accounting treatment and enhances the comparability of financial statements prepared by multinational entities.
- Exclusions from the Scope of Deferred Tax
Although deferred tax has a broad scope, Ind AS 12 excludes certain items from recognition in specific circumstances. Examples include some temporary differences arising from the initial recognition of goodwill and certain assets or liabilities in transactions that are not business combinations and do not affect accounting or taxable profit at the time of the transaction. In addition, deferred tax does not apply to taxes that are not based on income, such as Goods and Services Tax (GST), customs duties, and other indirect taxes. These exclusions help maintain the focus of Ind AS 12 on income tax accounting.
Determining the Tax Rate (Law) under Ind AS 12
Under Ind AS 12, deferred tax assets and deferred tax liabilities are measured using the tax rates and tax laws that have been enacted or substantively enacted by the end of the reporting period.
- Use Enacted Tax Rates
Deferred tax is measured using tax rates that have been officially enacted by the government before the reporting date.
- Use Substantively Enacted Tax Rates
If a tax law has completed almost all legislative procedures and its enactment is virtually certain, it is considered substantively enacted and may also be used for measurement.
- Expected Rate at Reversal
The tax rate applied should be the rate expected to be in force when the temporary difference reverses, that is, when the asset is recovered or the liability is settled.
- No Use of Proposed Tax Rates
Proposed tax rates or draft legislation that have not been enacted or substantively enacted should not be used in measuring deferred tax.
- Review at Every Reporting Date
Deferred tax balances should be reviewed at each reporting date. If tax rates or tax laws change before the reporting date through enactment or substantive enactment, deferred tax should be remeasured using the revised rates.
- Consistency with Tax Law
The measurement of deferred tax must always be consistent with the provisions of the applicable income tax law in force at the reporting date.
Example
- Temporary Difference = ₹5,00,000
- Enacted Tax Rate = 30%
Deferred Tax Liability = ₹5,00,000 × 30% = ₹1,50,000
Thus, under Ind AS 12, the applicable enacted or substantively enacted tax rate is used to determine the amount of deferred tax. This ensures that financial statements reflect the expected future tax consequences accurately and consistently.
Measurement of Deferred Tax
Measurement of deferred tax refers to determining the amount of Deferred Tax Asset (DTA) or Deferred Tax Liability (DTL) arising from temporary differences between the carrying amount of assets and liabilities and their tax bases. Under Ind AS 12, deferred tax is measured based on the tax consequences expected when assets are recovered or liabilities are settled. Proper measurement ensures that future tax obligations and future tax benefits are accurately reflected in financial statements. It improves the reliability of financial reporting and provides stakeholders with a realistic view of the entity’s future tax position.
- Measurement Using Enacted Tax Rates
Ind AS 12 requires deferred tax to be measured using tax rates and tax laws that have been enacted or substantively enacted by the end of the reporting period. The tax rate used should be the rate expected to apply when the temporary difference reverses. Future proposed tax rates that have not been enacted are not considered. Using enacted tax rates ensures consistency, legal compliance, and reliability in deferred tax measurement. It also prevents frequent changes based on uncertain future tax legislation and improves comparability among financial statements.
- Measurement Based on Temporary Differences
Deferred tax is measured by identifying the temporary differences between the carrying amount of assets and liabilities and their tax bases. Taxable temporary differences result in Deferred Tax Liabilities, while deductible temporary differences result in Deferred Tax Assets. The amount of deferred tax is calculated by applying the applicable tax rate to the temporary difference. This method ensures that deferred tax reflects the future tax consequences of existing assets and liabilities. Accurate identification of temporary differences is essential for proper deferred tax measurement under Ind AS 12.
- Measurement of Deferred Tax Liabilities
Deferred Tax Liabilities are measured as the amount of income tax expected to be payable in future periods when taxable temporary differences reverse. These liabilities arise when the carrying amount of an asset exceeds its tax base or when the tax base of a liability exceeds its carrying amount. The applicable enacted tax rate is applied to the taxable temporary difference to determine the Deferred Tax Liability. Proper measurement ensures that future tax obligations are recognised accurately and prevents understatement of liabilities in financial statements.
- Measurement of Deferred Tax Assets
Deferred Tax Assets are measured based on deductible temporary differences, unused tax losses, and unused tax credits. However, they are recognised only when it is probable that sufficient future taxable profits will be available to utilise these tax benefits. The applicable enacted tax rate is applied to determine the amount of the Deferred Tax Asset. Proper measurement prevents overstatement of assets and ensures that only realistic future tax benefits are recognised. This approach follows the principle of prudence and improves the reliability of financial statements.
- No Discounting of Deferred Tax
Ind AS 12 specifically states that deferred tax assets and deferred tax liabilities should not be discounted to their present value. Although deferred tax relates to future periods, the standard prohibits discounting because estimating the timing of reversal and applying appropriate discount rates may introduce unnecessary complexity and subjectivity. Measuring deferred tax without discounting ensures consistency in financial reporting and simplifies the accounting process. This requirement promotes comparability between entities and avoids differences arising from varying discount rate assumptions.
- Review and Re-measurement of Deferred Tax
Deferred tax assets and deferred tax liabilities must be reviewed at the end of every reporting period. If there are changes in tax laws, tax rates, temporary differences, or expectations regarding future taxable profits, deferred tax balances should be re-measured accordingly. Deferred tax assets may be reduced if future taxable profits are no longer probable, while deferred tax liabilities may change because of revised tax rates. Regular review ensures that deferred tax balances remain accurate, relevant, and consistent with current circumstances and legal requirements.
Recognition and Accounting of Deferred Tax
Recognition of deferred tax refers to recording the future tax consequences of temporary differences between the carrying amount of assets and liabilities and their tax bases. Under Ind AS 12, deferred tax is recognised as either a Deferred Tax Asset (DTA) or a Deferred Tax Liability (DTL). The purpose is to ensure that future tax effects of current transactions are reflected in the financial statements. This approach improves the matching of tax expenses with accounting income and presents a true and fair view of an entity’s financial position.
- Recognition of Deferred Tax Liability
Ind AS 12 requires a Deferred Tax Liability (DTL) to be recognised for all taxable temporary differences, except in certain specified situations such as the initial recognition of goodwill. A DTL represents income tax payable in future periods when temporary differences reverse. Recognition of DTL ensures that future tax obligations are reflected in the financial statements. This prevents understatement of liabilities and provides users with reliable information about the entity’s future tax commitments.
- Recognition of Deferred Tax Asset
A Deferred Tax Asset (DTA) is recognised for deductible temporary differences, unused tax losses, and unused tax credits only when it is probable that sufficient future taxable profits will be available to utilise these benefits. If future taxable profits are not expected, the deferred tax asset is not recognised. This requirement follows the principle of prudence and prevents overstatement of assets. Recognition of DTA ensures that only realistic future tax benefits are reported in the financial statements.
- Accounting for Deferred Tax in Profit or Loss
Deferred tax is generally recognised in the Statement of Profit and Loss as part of the income tax expense or income for the reporting period. Any increase or decrease in deferred tax assets or liabilities resulting from temporary differences is recorded in profit or loss. This treatment ensures that tax effects are matched with the accounting income of the same period. Proper accounting improves the accuracy of reported profits and enhances the reliability of financial statements.
- Accounting for Deferred Tax in Other Comprehensive Income
When a transaction or event is recognised in Other Comprehensive Income (OCI), the related deferred tax must also be recognised in OCI. Examples include gains or losses on certain financial instruments and revaluation adjustments recognised in OCI. This accounting treatment maintains consistency by ensuring that both the transaction and its related tax effect appear in the same section of the financial statements. It enhances transparency and provides a faithful representation of tax consequences.
- Accounting for Deferred Tax in Equity
If a transaction is recognised directly in equity, the related deferred tax is also recognised directly in equity rather than in the Statement of Profit and Loss. Examples include certain share issue transactions and corrections of prior-period errors recognised in retained earnings. This approach ensures consistency between the accounting treatment of the transaction and its tax effect. Recognising deferred tax in equity improves the presentation of shareholders’ equity and complies with the principles of Ind AS 12.
- Review and Adjustment of Deferred Tax
Deferred tax assets and deferred tax liabilities must be reviewed at the end of each reporting period. Changes in tax laws, tax rates, temporary differences, or expectations of future taxable profits may require remeasurement of deferred tax balances. Deferred tax assets should be reduced if future taxable profits are no longer probable, while deferred tax liabilities should be adjusted for revised tax rates. Regular review ensures that deferred tax balances remain accurate, relevant, and consistent with current legal and economic conditions.
Practical Application Deferred Tax arising from a Business Combination
Deferred tax considerations are critical in business combinations, as outlined in Ind AS 103, “Business Combinations,” and Ind AS 12, “Income Taxes.” The acquisition method, used in accounting for business combinations, often results in the recognition of assets and liabilities at their fair values. This revaluation can create temporary differences between the carrying amounts of assets and liabilities for accounting purposes and their tax bases. These temporary differences may lead to the recognition of deferred tax liabilities or assets.
1. Identifying Temporary Differences
The first step is to identify temporary differences that arise from the business combination. This involves comparing the tax bases of the acquired assets and liabilities to their recognized amounts in the financial statements post-acquisition. Common areas where temporary differences arise include:
- Intangible assets: Fair value adjustments to intangible assets, such as trademarks and customer relationships, often have no tax base or a different tax base, leading to temporary differences.
- Property, plant, and equipment (PPE): Revaluations of PPE to fair value can result in temporary differences if the tax base does not change accordingly.
- Inventories: Adjustment of inventories to fair value may also create temporary differences.
2. Recognition of Deferred Tax
For each identified temporary difference, the entity must recognize a deferred tax liability or asset. The recognition criteria and measurement principles follow Ind AS 12:
- Deferred tax liabilities are recognized for taxable temporary differences, except for certain exemptions such as goodwill.
- Deferred tax assets are recognized for deductible temporary differences to the extent that it is probable that future taxable profits will be available against which the deductible temporary difference can be utilized.
3. Measurement
Deferred tax assets and liabilities arising from a business combination are measured at the tax rates that are expected to apply in the periods when the assets will be realized or the liabilities settled. The measurement reflects the entity’s expectations, based on the tax laws that have been enacted or substantively enacted by the acquisition date.
4. Goodwill
One of the complexities in business combinations is the treatment of goodwill. Under Ind AS 103 and Ind AS 12, goodwill is initially measured as the excess of the consideration transferred over the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed. If a deferred tax liability is recognized for the future taxation of excess values of identifiable assets over their tax bases, this decreases the amount of goodwill recognized. Conversely, the recognition of a deferred tax asset (for example, due to the recognition of a deductible temporary difference) increases the amount of goodwill recognized, subject to the asset’s recoverability.
Illustration
ABC Ltd. acquires XYZ Ltd. on 1 April 20X1. During the acquisition, a building is recognised at its fair value of ₹50,00,000 in the financial statements. However, for income tax purposes, the building has a tax base of ₹40,00,000.
- Carrying Amount (Fair Value) = ₹50,00,000
- Tax Base = ₹40,00,000
- Taxable Temporary Difference = ₹10,00,000
- Income Tax Rate = 30%
Calculation of Deferred Tax Liability
| Particulars | Amount (₹) |
|---|---|
| Carrying Amount of Building | 50,00,000 |
| Less: Tax Base | 40,00,000 |
| Taxable Temporary Difference | 10,00,000 |
| Tax Rate | 30% |
| Deferred Tax Liability (DTL) | 3,00,000 |
Accounting Treatment
Since the carrying amount of the building is higher than its tax base, a taxable temporary difference arises. Under Ind AS 12, ABC Ltd. recognises a Deferred Tax Liability (DTL) of ₹3,00,000 on the acquisition date. This DTL reflects the future income tax that will become payable when the carrying amount of the building is recovered through use or sale.
Journal Entry
| Particulars | Dr. (₹) | Cr. (₹) |
|---|---|---|
| Goodwill / Business Combination Adjustment A/c | 3,00,000 | |
| To Deferred Tax Liability A/c | 3,00,000 |
Practical Example
Assume Company A acquires Company B for ₹1,000,000. Among the assets acquired are patents valued at ₹200,000 for accounting purposes but with a tax base of zero. Assuming a tax rate of 30%, a deferred tax liability of ₹60,000 (₹200,000 * 30%) would be recognized. This deferred tax liability reflects the future tax consequences of recovering the patent’s carrying amount, which is higher than its tax base. The recognition of this deferred tax liability would adjust the amount of goodwill or bargain purchase gain recognized in the business combination.
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