These two items comprises an important part of financial statements.The changes made at the year end closing of books of account impacts the income tax out go of the business for that year and years to come.
The following will be discussed in this article :
- Difference timing
- Deferred tax (DT)
- Virtual certainty examples
- Deferred tax asset and liability examples
- DTA/DTL calculations illustration
- Effect of tax holiday w.r.t DTA/DTL
- Effect on MAT w.r.t DTA/DTL
- Whether MAT credit can be considered as a Deferred tax assets per AS 22
Timing Difference
Based on provision of the incomes tax act ,the company calculates its taxable profit and derives its books profits from the financial statements .
Due to certain items which are uniquely allowed and disallowed for tax purposes ,there is a comparison between books profit and taxable profit.And this comparison can either be in :
- Temporary difference – this is the differentiation between tax income and books income which are reversing in subsequent duration
- Permanent difference -this is the differentiation between tax income and book income and where they aren’t capable of reversing in subsequent duration.
Deferred Tax (DT)
This tax is recognized on all timing difference temporary and permanent. It means that Deferred tax is the tax effect on the timing differences.
DTA is acknowledged only if there is any virtual assurance of the future ,with the corresponding time difference related to depreciation .When a company estimates enough future taxable income, only then DTA can be realized.
The test should be performed yearly and if its not done, such DTA/DTL should be written off.This should be considered as business and professional profit while computing future taxable income.
Example for Virtual certainty
The example of virtual certainty include sales estimation, future returns projections prepared by an entity on the future reformation ,future expenditure ,past experience etc. Where they are submitted to bank for loan is a strong evidence for virtual assurance .But when its based only on binding exports order which probably has the risk of cancellation at anytime then the virtual certainty cannot be convincing.
Example of Deferred tax assets and liabilities
DTA – Provision for bad debt of Rs 200 plus book profit of an entity before taxes is Rs 1000 because of bad debt,tax profit will be accepted in future when its written off. After dis-allowance of income it will be Rs 1200,and example tax rate is 20% then the entity will pay taxes on Rs 1200 that is (1200*20%) Rs 240 .
If bad debt were allowed entity would pay Rs 1000 I.e (1000*20%)Rs 200.For the extra Rs 40 we have to create DTA .DTA is under
- Deferred tax expense cr 40
- Deferred tax assets dr 40
DTL -An example of this would be depreciation. When the depreciation per company acts is less that the depreciation rate per income tax the businessman shall be liable to pay less tax for that time .This will create Deferred tax liability.
For permanent difference there is no DTA or DTL provision made .eg fines ,or penalties which includes in the book of profit but don’t allow tax purposes ,in that it will be permanent difference .
DTL is found in head non- current liability and DTA is found under non current assets .Both can be changed with each other but by following the legal processes and if there is a reason to settle the assets and liabilities on a net basis.
Effect of tax Holiday w.r.t DTA/DTL
Tax Holiday in a free trade zone is a benefits provided to new undertaking .The government removes specific taxes for a temporary duration so that it can encourage production or consumption of certain items .
Effect on MAT w.r.t DTA/DTL
The meaning of MAT is Minimum alternative tax that a company needs to pay if the tax to pay in normal provision of the income tax act is lower than the tax computed @18.5% of the profit books .MAT is under section 115 B of the income tax act and its calculated using the books profit as per :
Book profit is increased by the following :
- Provided income tax or (tax paid)
- Deferred tax provision
- An amount brought to any reserves
- Entity made for uncertainty
And is decreased by the following
- Any amount that is withdrawn
- Loss that is brought in or absorbed depreciation
- Deferred tax that is credited
- Debited depreciation
If the Deferred tax liability that is debited is added to the books for MAT calculations reasons then some controversies will occur .
“Deferred tax charge is not a provision for tax but is a provision for tax effect for difference between taxable income and accounting income and further that deferred tax charge cannot be termed as income-tax paid or payable, which has to be paid out of the profit earned. Reserves mentioned in Section 115JB is different, it can be unilaterally transferred back to P&L account or can be utilized for issuing bonus shares etc. However, amounts created towards deferred tax charge cannot be so transferred or utilized”
“The Chennai Tribunal observed that AS-22 is mandatory as per Section 211(3) of the Companies Act, however, the same is not notified by the Central Government under Section 145(2) of the IT Act. Moreover, the deferred tax liability cannot be considered as ascertained liability and therefore, assessing officer has every power to make adjustment on this account as it cannot be termed as tinkering of audited accounts prepared in accordance with the provisions of the Companies Act.”
According to the government statements there are some different conflicting judgments on this act.
Is MAT credit considerable as a Deferred tax assets per AS 22
As in AS 22 the difference between books income and taxable income is the one that brings about Deferred tax assets and liabilities arises. Minimum alternate tax don’t affect any difference between books income and taxable ,so its safe to say that you cannot refer MAT credit as a Deferred tax assets in accordance with AS 22.
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