Meanings
- Current Tax: Tax Payable in Current year as per income tax.
- Deferred Tax: Temporary Savings/Temporary Additional payment of income tax which arises due to temporary differences between carrying value and tax base.
- Carrying Values: Account ledger balance as per Books Of Accounts (as per AFRF).
- Tax Base: Ledger Balance that would appear in Tax Trial Balance if we were to prepare one.
Need
Let's take an example, there are two entities engaged in manufacturing activities A ltd is a company registered in Maharashtra, while B ltd is Registered in Bihar.
Owing to the developing status of Bihar, the Indian Government has provided various tax incentives to entities registered in the state; one of the incentives is claiming 50% depreciation in the first year on capital goods purchased and installed in the state.
|
Particulars |
A ltd |
B Ltd |
||
|
Investment |
||||
|
Machinery purchased and installed (A) |
1000000 |
1000000 |
||
|
Profit and Loss Statement |
||||
|
Sales |
1500000 |
1500000 |
||
|
- Prime Cost |
850000 |
850000 |
||
|
Contribution |
650000 |
650000 |
||
|
Fixed Cost (accounting Dep @ 20%) |
200000 |
200000 |
||
|
PBT |
450000 |
450000 |
||
|
Current tax (note 1) |
120000 |
45000 |
||
|
PAT (B) |
330000 |
405000 |
||
|
ROI % (A/B) |
33% |
40.5% |
||
|
Note 1 |
||||
|
Calculation of tax @ 30% |
||||
|
PBT as per BOA |
450000 |
450000 |
||
|
+ Dep as per Companies act |
200000 |
200000 |
Normal Dep 25% Special rate for Bihar 50% |
|
|
Total |
650000 |
650000 |
||
|
- Dep as Per Income Tax law |
250000 |
500000 |
||
|
Profit as per income tax |
400000 |
150000 |
||
|
Tax on above @ 30% |
120000 |
45000 |
||
From the above we can see the reported ROE of B Ltd is higher at 40.5% while that of A ltd is just 33% even though both the companies earned same level PBT Investors would prefer to invest in B ltd owing to its higher ROE; However in the later years B ltd will pay more taxes as compared to A ltd As there would be lower depreciation expenses to be claimed by it (as IT laws already allowed 50% deduction in 1st year itself)
One could say that the tax expense of B ltd were deferred to year 2 and so on
Hence to compare the performance of two entities and give investors the insight of true profits concept of deferred tax was introduce
Concept
Difference between carrying values in BOA and Tax Base could be of two types
A. Temporary Differences
Temporary differences are the difference between the two carrying values which reverse in course of time this would typically include depreciation/ amortisation expense & Revenue expenses (Mercantile VS Cash Basis)
These differences can be further analysed into two categories
a. Taxable Temporary Difference (TTD)
These differences are the ones which would result in additional tax payments in future, for eg claiming 100% depreciation in Cy will result in higher profits in later years which would mean higher tax expense in future
We multiply TTD with expected tax rates to get Deferred tax liability (DTL)
b. Deductible temporary Difference (DTD)
These differences are the ones which would result in deduction in tax payments in future, for eg provisions are generally not allowed in income tax so when we actually incur the expenses in future years we will be able to deduct the same from our future tax profits this would result in lower tax expenses in future
We multiply DTD with expected tax rates to get Deferred tax Asset (DTA)
B. Other Differences
These differences are straight away disallowed in income tax law and won't be allowed in future years hence these difference are not temporary in nature and hence no reversal will take place in future hence these are not considered in deferred tax calculations
Calculations
Now lets calculate the deferred tax of A ltd and B ltd
A Ltd Deferred tax working
|
Machinery |
||
|
Balance as per BOA |
||
|
Purchase |
1000000 |
|
|
- Dep Cy |
200000 |
800000 |
|
Tax Base |
||
|
Purchase |
1000000 |
|
|
- Dep as per IT |
250000 |
750000 |
|
Difference (A) TTD |
50000 |
|
|
DTL (A* Tax Rate) |
15000 |
B Ltd Deferred tax working
|
Machinery |
||
|
Balance as per BOA |
||
|
Purchase |
1000000 |
|
|
- Dep Cy |
200000 |
800000 |
|
Tax Base |
||
|
Purchase |
1000000 |
|
|
- Dep as per IT |
500000 |
500000 |
|
Difference (A) TTD |
300000 |
|
|
DTL (A* Tax Rate) |
90000 |
Revised Income statement
|
Particulars |
A |
B |
|
PBT |
450000 |
450000 |
|
- Tax Expense |
||
|
Current Tax |
120000 |
45000 |
|
Deferred Tax |
15000 |
90000 |
|
PAT |
315000 |
315000 |
From the above we can see the PAT for both A ltd and Bltd are same the revised ROI will be 315000/100000 = 31.5% for both the entities, the above statement gives us true profits on which investors can base their judgements
INDAS 12 Logic
|
Sr |
BOA |
TAX Base |
Difference |
DTA/DTL? |
|
1 |
Expenses |
|||
|
10000 |
6000 |
4000 |
DTA |
|
|
We have claimed rs 10000 exp but IT laws allowed only 6000 in CY and CF of 4000 in next year, it will result in payment of more tax in Cy but lower tax in next year, hence its a Deductible Temporary Difference |
||||
|
2 |
Expenses |
|||
|
6000 |
60000 |
-54000 |
DTL |
|
|
We are charging expenses on pro-rata basis in accounts however IT law allowed us to claim full exp in current year, this will result in lower tax payments in current year however as no expense related to above will claimed next year our tax expense will increase in next year, hence its a Taxable Temporary Difference |
||||
|
3 |
Income |
|||
|
2000 |
10000 |
-8000 |
DTA |
|
|
We are being assessed for more income in income tax in CT hence we will pay more tax in CY, however while we amortise the income in BOA in future years the same will not be taxed again in future years, hence its a Deductible Temporary Difference |
||||
|
4 |
Income |
|||
|
100000 |
20000 |
80000 |
DTL |
|
|
We are being assessed for lower income in income tax in CY so we will pay less tax now, but in later years when the income is considered in tax laws it will increase or tax expense in next year, hence its a Taxable Temporary Difference |
||||
|
Asset/ Liability Bal |
PPE |
PPE |
Provision |
Advance Fees received |
|
Asset |
Asset |
Liability |
Liability |
|
|
BOA |
100000 |
80000 |
100000 |
5000 |
|
Tax Base |
80000 |
100000 |
50000 |
10000 |
|
Diff |
20000 |
-20000 |
50000 |
-5000 |
|
Effect |
Higher Dep Exp claimed in IT which leads to Lower Current Tax Exp which would in turn lead to Higher Tax exp in future, hence create DTL |
Less Dep Exp claimed in IT which leads to Higher Current Tax Exp which would in turn lead to Lower Tax Exp in future, hence create DTA |
Less Provision Exp claimed in IT which leads to Higher Current Tax Exp which in turn would lead to Lower Tax Exp in future, hence create DTA |
Higher Revenue Capitalised in IT which leads to Higher Current Tax Exp which in turn would lead to Lower Tax Exp in future, hence create DTA |
TIPS
- Always try to think from the viewpoint of income tax (take Tax Base as your basis)
- Solve using asset and liability approach instead of income exp approach
- Liability
BOA >Tax Base = DTA
- Asset
BOA > Tax base= DTL
Advance
- DTA should be recognized only when there are enough future Taxable Profits + Reversal of DTL + Tax planning opportunities/strategies
- For creation of DTA/DTL we will use income tax rates which are enacted/ substantially enacted up to Balance sheet date
- Recognition of tax expense,
- On Items of P/L will go to PL
- On items of OCI will go to OCI
- On Items recognized directly in Reserve
- Tax reconciliations
- Absolute Terms
|
Profit as per AFRF (a) |
XXX |
|
Applicable Tax Rate (b) |
X% |
|
Tax Expense (a*b) |
XX |
|
+ Expense not Deducted (Tax Effect) |
XX |
|
Total Tax Exp (Current + Deferred) |
XXX |
% Terms
Applicable Tax Rates X%
(+) Expenses not Deducted X%*
Avg Tax Rates X%
*Tax on Exp
Total Revenue
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