Chairman, Chartered Institute of Taxation of Nigeria, Abuja District
LEARNING OBJECTIVES
At the end of this paper, participants are expected to:
- Understand the concept of Deferred Tax
- Know the accounting treatment of deferred tax
- Prepare deferred tax computation
- Understand some practical issues with respect to deferred tax CONTENTS
1.0 Introduction / Definition of Terms
2.0 Deferred Tax Asset
3.0 Deferred Tax Liabilities
4.0 Accounting for Deferred Tax
Conclusion
1.0 Introduction / Definition of Terms
What is Deferred Taxation?
SAS 19
Deferred tax is the tax (liability or asset) attributable to timing differences.
IAS 12
Deferred tax is the tax consequences of the future recovery/settlement of the carrying amount of assets/liabilities in a company’s statement of financial position if it is probable that recovery or settlement of that carrying amount will make future tax payments larger/smaller than they would be if such recovery or settlement were to have no tax consequences.
Deferred tax is the future tax effects of differences between items in the financial statements and their equivalent values for tax purposes.
Accounting profit is the net profit or loss for a period before deducting tax expense.
Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable).
Tax expense (tax income) is the aggregate amount included in the determination of net profit or loss for the period in respect of current tax and deferred tax.
Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.
Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax base. Temporary differences may be either:
- 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
- Deductible Temporary Differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.
| For assets | For liabilities | |
| If carrying amount>Tax Base | Taxable temporary difference = Deferred taxliability (DTL) | Deductible temporary difference = Deferred taxasset (DTA) |
| If carrying amount<Tax Base | Deductible temporary difference = Deferred taxasset (DTA) | Taxable temporary difference = Deferred taxliability (DTL) |
- Example of taxable difference – Higher NBV for fixed assets compared to TWDV as a result of accelerated capital allowance.
- Example of deductible difference: Provisions disallowed for tax purposes until payment is made, e.g., gratuity provision.
IAS 12: Timing differences are differences between taxable profit and accounting profit that originate in one period and reverse in one or more subsequent periods.
SAS 19: Timing Differences are differences between the accounting income and taxable income which arise because the periods in which some items of revenue and expense are included in accounting income differ from the periods in which they are included in taxable income. Such differences originate in one period and are expected to reverse in one or more subsequent periods. While all timing differences are temporary differences, not all temporary differences are timing differences.
SAS 19: Permanent differences are differences between taxable and accounting items for a period that are not expected to reverse in subsequent periods.
Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences.
Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
- Deductible temporary differences;
- The carry forward of unused tax losses; and
- The carry forward of unused tax credits.
The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.
2.0 What is a deferred tax asset?
A deferred tax asset (DTA) is an entry on the Statement of Financial Position that represents a difference between the company’s internal accounting and taxes owed. For example, if your company paid its taxes in full and then received a tax deduction for that period, that unused deduction can be used in future tax filings as a deferred tax asset.
For example, in 2017, USA Congress passed the Tax Cuts and Jobs Act, which reduced the corporate tax rate from 35% to a maximum of 21%. If a business had paid that year’s taxes in advance, they would have overpaid by 14%. This difference in tax payment and liability creates a deferred tax asset.
- What type of asset is a deferred tax asset? A deferred tax asset is considered an intangible asset because it’s not a physical object like equipment or buildings. It only exists on the Statement of Financial Position.
- Is a deferred tax asset a financial asset? Yes, a DTA is a financial asset because it represents a tax overpayment that can be redeemed in the future.
- Where are deferred tax assets listed on the Statement of Financial Position? They are listed on the Statement of Financial Position as “noncurrent assets.”
- When does a deferred tax asset have to be used? Deferred tax assets never expire, and can be used whenever it’s most convenient to the business.
- Note: While deferred tax assets can always be carried forward to future tax filings, they cannot be applied to tax filings in the past.
What causes a deferred tax asset?
Whenever there is a difference between the income on the tax return and the income in the company’s accounting records (income per book), a deferred tax asset is created.
Examples of deferred tax assets
- Net operating loss: The business incurred a financial loss for that period. Tax overpayment: You paid too much in taxes in the previous period.
- Business expenses: When expenses are recognized in one accounting method but not the other.
- Revenue: Instances where revenue is collected during one accounting period, but recognized in another.
- Bad debt: Before an unpaid debt is written off as uncollectible, it’s reported as revenue. When the unpaid receivable is finally recognized, that bad debt becomes a deferred tax asset.
3.0 What is a deferred tax liability?
A deferred tax liability (DTL) is a tax payment that a company has listed on its balance sheet but does not have to be paid until a future tax filing. A payroll tax holiday is a type of deferred tax liability that allows businesses to put off paying their payroll taxes until a later date. The tax holiday represents a financial benefit to the company today but a liability to the company down the road.
Certain tax incentives will create a deferred tax liability journal entry, giving the business some temporary tax relief that will be collected later. Depreciation expenses—like the annual devaluation of a fleet of company vehicles—can generate deferred tax liabilities.
- Is deferred tax liability a debt? A deferred tax liability journal entry represents a tax payment that, due to timing differences in accounting processes, the payment can be postponed until a later date.
- Where are deferred tax liabilities listed on the balance sheet? They are listed on the balance sheet as “non-current liabilities.”
- Are deferred tax liabilities good or bad? A deferred tax liability is neutral or good, depending on your situation. It means you owe money, but don’t have to pay it right away. The downside is that your business needs to have money set aside in order to pay this debt off in the future.
What causes a deferred tax liability?
Any temporary difference between the amount of money owed in taxes and the amount that is required to be paid in the current accounting cycle creates a deferred tax liability.
How do deferred tax liabilities work?
To illustrate the concept of a deferred tax liability, imagine you’re at a bar with an open tab. At the end of the night, you go to the bar to pay off your tab, but the bartender has mistakenly closed out the register and can no longer process your tab. You agree to return to the bar and pay off your tab on your next visit. You make a note to yourself of the outstanding balance and keep cash on hand to pay it off.
This timing difference between you owing a debt and the bartender understanding that it won’t be paid until a future time is similar to a deferred tax liability. A business has a tax balance that needs to be paid, but not until some point in the future.
Deferred tax liability examples
- Depreciation of assets: The IRS uses an advanced asset depreciation model which results in a difference between the company’s balance sheet value and the value of it for tax purposes. This is the most common example of a deferred tax liability.
- Tax underpayment: The company didn’t pay enough tax in the previous cycle, and will have to make up for it in the next cycle.
- Installment sale: When a product is paid for in installments, the company lists the full value of the sale in their balance sheet, but only pays taxes for each annual installment. The company recognizes that they have a deferred tax liability for future payments on that sale.
4.0 ACCOUNTING FOR DEFFERED TAX?
Four (4) steps to be taken as basic approach for deferred taxes
Step 1: Identify temporary differences. There are two categories of temporary differences: (1) taxable temporary differences that will generate future tax (i.e., deferred tax liabilities) and (2) deductible temporary differences that will reduce future tax (i.e., deferred tax assets). Temporary differences are most commonly identified and quantified by (1) preparing a tax balance sheet and comparing it with the financial statement balance sheet and (2) reviewing the reconciliation of book income with taxable income.
Step 2: Identify tax loss carryforwards and tax credits. A reporting entity may have US federal, state and local, and foreign tax loss carryforwards and certain tax credits. Tax loss carryforwards typically include net operating losses (NOLs) and capital losses, which, depending on the relevant jurisdiction’s applicable tax law, may be carried back to prior periods and/or forward to future periods to offset taxable income. Tax credits may include research and development credit (R&D credit), foreign tax credits, the US federal corporate alternative minimum tax credit (CAMT credit), investment tax credits, and other tax credits. Tax credits generally provide a “dollar-for-dollar” benefit against taxes payable.
Step 3: Determine the tax rate to apply to temporary differences and loss carryforwards. The applicable tax rate is the rate based on enacted tax law that will be in effect in the period in which temporary differences reverse or are settled.
Step 4: Calculate deferred tax assets and liabilities. For gross temporary differences and tax loss carryforwards, this entails multiplying the gross balance by the applicable tax rate. Tax credits generally provide a “dollar-for-dollar” benefit and therefore are already tax-effected.
Illustration I
| N’000 | |
| Moto Vehicle | 10,000 |
| Depreciation rate (Straight Line) for 5yrs | 20% |
| Company Income Tax Rate | 30% |
| Annual Profit before Depreciation (N’000) | 6.600 |
| Capital Allowance: | |
| Initial Allowance | 50% |
| Annual Allowance | 25% |
From the above, calculate the timing difference and deferred taxation
| Accounting | 2019 | 2020 | 2021 | 2022 | 2023 | Total | ||
| N’000 | N’000 | N’000 | N’000 | N’000 | N’000 | |||
| Profit before depr & tax | 6,600 | 6,600 | 6,600 | 6,600 | 6,600 | 33,000 | ||
| Depreciation (20%) | a | (2,000) | (2,000) | (2,000) | (2,000) | (2,000) | (10,000) | |
| Profit before tax | 4,600 | 4,600 | 4,600 | 4,600 | 4,600 | 23,000 | ||
| Tax @ 30% | b | (1,380) | (1,380) | (1,380) | (1,380) | (1,380) | (6,900) | |
| Profit after tax | 3,220 | 3,220 | 3,220 | 3,220 | 3,220 | 16,100 | ||
| Based on Tax Laws | 2019 | 2020 | 2021 | 2022 | 2023 | Total | ||
| N’000 | N’000 | N’000 | N’000 | N’000 | N’000 | |||
| Profit before depr & tax | 6,600 | 6,600 | 6,600 | 6,600 | 6,600 | 33,000 | ||
| Capital Allowance | c | (6,250) | (938) | (703) | (5,27) | (396) | (8,814) | |
| Profit before tax | 350 | 5,662 | 5,897 | 6,073 | 6,204 | 24,186 | ||
| Tax @ 30% | d | (105) | (1,699) | (1,769) | (1,822) | (1,861) | (7,256) | |
| Profit after tax | 245 | 3,963 | 4,128 | 4,251 | 4,343 | 16,930 | ||
| Timing difference | a-c | (4,250) | 1,062 | 1,297 | 1,473 | 1,604 | – | |
| Def tax @ 30% | d-b | (1,275) | 319 | 389 | 442 | 481 | – | |
Illustration II
A company has the following information regarding to her property, plant and Equipments (PPE)
| PPE | Carrying Amount | Tax Base |
| Plant and Equipment | 400,000 | 250,000 |
| Computer Equipment | 300,000 | 175,000 |
| Building | 800,000 | 950,000 |
| Moto Vehicle | 600,000 | 400,000 |
Other information includes:
Unrealized tax losses of N900,000, Unutilized Capital Allowance of N550,000, Unrealized Forex Gain is N150,000, Accrued expenses is N80,000 while gain on fair value adjustment is N50,000, deferred taxation prior year balance is N100,000
Account for deffered taxation using
- Balance sheet method
- Income statement method
Note: In all, apply 30% tax rate except gain on fair value where 10% tax rate is applied.
- Balance Sheet Method
| Carrying Amount | Tax Base | Temporary Difference | Tax Rate | Deffered TaxAsset (DTA)/Deferred tax liability (DTL) | |
| PPE | a | b | c=(a-b) | d | e=(c*d) |
| Plant and Equipment | 400,000.00 | 250,000.00 | 150,000.00 | 30% | 45,000.00 |
| computer equipment | 300,000.00 | 175,000.00 | 125,000.00 | 30% | 37,500.00 |
| building | 800,000.00 | 950,000.00 | (150,000.00) | 30% | (45,000.00) |
| Moto Vehicle | 600,000.00 | 400,000.00 | 200,000.00 | 30% | 60,000.00 |
| Accelerated Capital | |||||
| Allowance | 2,100,000.00 | 1,775,000.00 | 325,000.00 | 97,500.00 | |
| Unrelieved Tax Losses | 900,000.00 | (900,000.00) | 30% | (270,000.00) | |
| Unutilized Capital allowance | |||||
| b/f | 550,000.00 | (550,000.00) | 30% | (165,000.00) | |
| Accured Expenses | (80,000.00) | (80,000.00) | 30% | (24,000.00) | |
| Unrealized FX Gains | 150,000.00 | 1,500,001.00 | 30% | 45,000.00 | |
| Fair Value Adjust | 50,000.00 | 50,000.00 | 10% | 5,000.00 | |
| Total | (311,500.00) | ||||
| Prior Year Balance | 100,000.00 | ||||
| P or L | (211,500.00) |
- Income Statement Method
| Transaction | Tax Rate | Deffered Tax Asset(DTA)/ Deferred tax liability (DTL) | |
| PPE | a | b | c=(a-b) |
| Depreciation (P&E) | (400,000.00) | 30% | (120,000.00) |
| Amortization of intangible asset (C&E) | (300,000.00) | 30% | (90,000.00) |
| Balance Charge (Building) | (800,000.00) | 30% | (240,000.00) |
| Depr Moto Vehicle | (600,000.00) | 30% | (180,000.00) |
| (2,100,000.00) | (630,000.00) | ||
| Current Year Tax losses if any | (270,000.00) | 30% | (81,000.00) |
| Unrealized FX Gains | 150,000.00 | 30% | 45,000.00 |
| Accrued Expenses | (80,000.00) | 30% | (24,000.00) |
| Gain on Fair Value Adjustment | 50,000.00 | 10% | 5,000.00 |
| Total | (685,000.00) | ||
| Prior Year Balance | (100,000.00) | ||
| Deffered Tax charged to P or L | (585,000.00) |
CONCLUSION
Deferred taxes are typically the result of the gap between taxation and financial accounting timelines between companies and authorities. While deferred tax assets translate into reducing the taxes payable on the term, the deferred tax liabilities mark deficit tax yet to be paid before the due date. Deferred tax assets and liabilities both represent an amount of money that is owed in two different ways: deferred tax assets are owed to the company, while deferred tax liability is owed to the government. Depreciation is the one common point between deferred tax assets and liabilities that creates discrepancies in tax and accounting calculations. Apart from that, the factors impacting these figures are installment sales, warranties, expenses, revenues, etc. Deferred tax assets and revenue can be smartly managed to help a company keep balanced account statements and books.
Source: BarristerNg
