Deferred tax
4625207
209781388
2008-05-02T21:28:26Z
12.149.148.7
/* External links */
{{Otheruses4|deferred tax as an accounting concept|deferral of tax liabilities in cash-flow terms|tax deferral}}
{{public finance}}
'''Deferred tax''' is an [[accounting]] concept, meaning a future tax [[liability]] or [[asset]], resulting from [[#temporary differences|temporary differences]] between book (accounting) value of assets and liabilities and their tax value, or [[#timing differences|timing differences]] between the recognition of gains and losses in financial statements and their recognition in a tax computation.
== Temporary differences {{Anchor|temporary differences}}==
Temporary differences are differences between the carrying amount of an asset or liability recognised in the balance sheet and the amount attributed to that asset or liability for tax purposes (the [[#Tax base|tax base]])<ref>IAS 12.5</ref>.<br />
Temporary differences may be either:<br />
* '''taxable temporary differences''', which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or<br />
* '''deductible temporary differences''', which are temporary differences that will result in deductible amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled<ref>IAS 12.5</ref>.
=== Tax base {{Anchor|Tax base}}===
The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes:
* the tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset.
* the tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods.
=== Illustrated example ===
The basic principle of accounting for deferred tax under a temporary difference approach can be illustrated using a common example in which a company has fixed assets which qualify for tax depreciation.
The following example assumes that a company purchases an asset for $1,000 which is depreciated for accounting purposes on a straight-line basis of five years. The company claims tax depreciation of 25% per year on a [[reducing balance]] basis. The applicable rate of [[corporate income tax]] is assumed to be 35%.
{| class="wikitable"
|-
!
! Purchase
! Year 1
! Year 2
! Year 3
! Year 4
|-
! Accounting value
| $1,000
| $800
| $600
| $400
| $200
|-
! Tax value
| $1,000
| $750
| $563
| $422
| $316
|-
! Taxable/(deductible) temporary difference
| $0
| $50
| $37
| $(22)
| $(126)
|-
! Deferred tax liability/(asset) at 35%
| $0
| $18
| $13
| $(8)
| $(44)
|}
As the tax value ([[#tax base|tax base]]) is lower than the accounting value ([[net book value]]) in years 1 and 2, the company should recognise a deferred tax liability. This also reflects the fact that the company has claimed tax depreciation in excess of the expense for accounting depreciation recorded in its accounts, whereas in the future the company should claim less tax depreciation in total than accounting depreciation in its accounts.
In years 3 and 4, the tax value exceeds the accounting value, therefore the company should recognise a deferred tax asset (subject to it having sufficient forecast profits so that it is able to utilise future tax deductions). This reflects the fact that the company expects to be able to claim tax depreciation in the future in excess of accounting depreciation.
== Timing differences {{Anchor|timing differences}}==
Whereas [[International Financial Reporting Standards]] and [[US GAAP]] adopt a balance sheet approach in relation to deferred tax focused on [[#temporary differences|temporary differences]], certain [[GAAP|GAAPs]] such as [[UK GAAP]] require deferred tax to be instead recognised in respect of [[#timing differences|timing differences]].
A timing difference arises when an item of income or expense is recognised for tax purposes but not accounting purposes, or vice versa, and is therefore consistent with a profit and loss approach to deferred tax.
In many cases the deferred tax outcome will be similar for a [[#temporary differences|temporary difference]] or timing difference approach. However, differences can arise such as in relation to [[revaluation]] of [[fixed assets]] qualifying for [[tax depreciation]], which gives rise to a deferred tax asset under a balance sheet approach, but in general should have no impact under a timing difference approach.
== Justification for deferred tax accounting ==
Deferred tax is recognised as a result of the [[Matching_principle|matching principle]]. Deferred tax liabilities are provided in order that investors may understand the future tax liabilities that may arise as a result of accelerated tax relief taken to date, or income that has not yet been taxed.
Where accelerated tax relief is obtained for expenditure relative to the timing of an expense recognised in a company's profit and loss account, a deferred tax charge should be recognised in the profit and loss account for the movement in the company's deferred tax liability, which will increase the company's total tax charge.
== Examples ==
=== Deferred tax liabilities ===
Deferred tax liabilities generally arise where tax relief is provided in advance of an accounting expense, or income is [[accrue|accrued]] but not taxed until received. Examples of such situations include:
* a company claims tax depreciation at an accelerated rate relative to accounting depreciation
* a company makes pension contributions for which tax relief is provided on a paid basis, whereas accounting entries are determined in accordance with actuarial valuations
=== Deferred tax assets ===
Deferred tax assets generally arise where tax relief is provided after an expense is deducted for accounting purposes.Examples of such situations include:
* a company may [[accrue]] an accounting expense in relation to a [[provision]] such as bad debts, but tax relief may not be obtained until the provision is utilised
* a company may incur [[tax loss|tax losses]] and be able to "carry forward" losses to reduce taxable income in future years
== Deferred tax in modern accounting standards ==
Modern accounting standards typically require that a company provides for deferred tax in accordance with either the [[#temporary differences|temporary difference]] or [[#timing differences|timing difference]] approach. Where a deferred tax liability or asset is recognised, the liability or asset should reduce over time (subject to new differences arising) as the temporary or timing difference reverses.
Under [[International Financial Reporting Standards]], deferred tax should be accounted for using the principles in [[IAS 12]]: Income Taxes, which is similar (but not identical) to [[SFAS 109]] under [[US GAAP]]. Both these accounting standards require a [[#temporary differences|temporary difference]] approach.
Other accounting standards which deal with deferred tax include:
* '''[[UK GAAP]]''' - [[Financial Reporting Standard 19: Deferred Tax]] ([[#timing difference|timing difference approach]])
* '''Mexican GAAP or [[PCGA]]''' - Boletín D-4, el impuesto sobre la renta diferido
* '''[[Canadian GAAP]]''' - [[CICA]] Section 3465
== Derecognition of deferred tax assets and liabilities ==
Management has an obligation to accurately report the true state of the company, and to make judgements and estimations where necessary. In the context of tax assets and liabilities, there must be a reasonable likelihood that the tax difference may be realised in future years.
For example, a tax asset may appear on the company's accounts due to losses in previous years (if carry-forward of tax losses is allowed). In this case a deferred tax asset should be recognised if and only if the management considered that there will be sufficient future taxable profit to utilise the tax loss.<ref>IAS 12.34</ref> If it becomes clear that the company does not expect to make profits in future years, the value of the tax asset has been ''impaired'': in the estimation of management, the likelihood that this [[tax loss]] can be utilised in the future has significantly fallen.
In cases where the carrying value of tax assets or liabilities has changed, the company may need to do a [[write down]], and in certain cases involving in particular a fundamental error, a [[restatement]] of its financial results from previous years. Such write-downs may involve either significant income or expenditure being recorded in the company's profit and loss for the financial year in which the write-down takes place.
== External links ==
* [http://www.iasb.org/NR/rdonlyres/8F9111CA-E665-4D18-9B2D-0B0984459847/0/IAS12.pdf Summary of International Accounting Standard 12: Income Taxes] - by the [[International Accounting Standards Board]]
* [http://www.fasb.org/st/summary/stsum109.shtml Summary of Financial Accounting Standard 109: Income Taxes] - US [[Financial Accounting Standard]]
* [http://www.frc.org.uk/images/uploaded/documents/FRS%20191.pdf Financial Reporting Standard 19: Deferred Tax] - UK [[Financial Reporting Standard]]
== Notes ==
<references/>
[[Category:Generally Accepted Accounting Principles]]
[[Category:Business terms]]
[[Category:Taxation]]
[[Category:Finance]]
[[da:Udskudt skat]]
[[de:Latente Steuern]]
[[hu:Halasztott adó]]
[[ja:繰延税金資産]]