Deferred Tax Liability : Meaning, Work, Calculation & Example

What is Deferred Tax Liability?

Deferred tax liability is the notional tax liability that the company is required to compute and disclose in its financial statements as per the applicable regulatory and statutory requirements. Deferred tax suggests that the tax is either paid in advance or has been carried forward, but the treatment of such an advance or carrying forward is yet to be recognized in the profit and loss account. Deferred tax liability is a tax that is payable in the future due to the different treatment in accounting and as per income tax laws on the items of income or expense. The deferred liability arises when, due to a temporary timing difference, the profit tends to go on the higher side when compared with the accounting books than taxable profit as per the applicable provisions of the Income Tax Act.

Geeky Takeaways:

• A deferred tax asset is a form of tax liability that a company has yet to pay.
• Deferred tax liability is an item found on the balance sheet due to a short payment or overdue taxes.
• Deferred tax liability is usually found when there is a difference between the tax rules and the accounting rules.
• Deferred tax liability represents increased tax payments in the future.
• The value of a deferred tax liability is subject to change depending on future financial performance and changes in tax laws.

How Deferred Tax Liability Work?

1. A deferred tax liability is usually formed when payment of taxes is accumulated in a financial year but is due in a subsequent year.

2. Due to the difference in timing between when certain items are recognized for financial accounting purposes and when they are considered for tax purposes, deferred tax liabilities are created. DTL arises when there is a difference in timing between when the tax was accrued and when it is payable.

3. For example, If a corporation has an obligation to pay taxes for a financial year but the same has not yet been concluded in a particular year, such an obligation will be carried forward to the next year or to the year in which such transaction shall be completed.

4. The deferred tax increases the company's tax liability in the upcoming period. DTL might be compared to rent accrued but not paid, and the liability is already due to the company.

6. Deferred tax liabilities are crucial to understanding the financial health of the company, and they have relatable value that needs to be incorporated in their financial statements.

How is a Deferred Tax Liability Created?

1. Tax Rules Allowance: Sometimes tax rules allow companies to increase their future taxable earnings when they face book profits and reduce expenses; this creates a potential tax increment.

2. Future Tax Increment: Although this tax liability cannot be recognized on an immediate basis by the company, it recognizes a future obligation that is due for future tax due to their differences in accounting and tax laws.

3. Deferred Tax Liability Entry: This probable tax payment is recorded by the corporation as a deferred tax liability on its financial accounts. In essence, it’s admitting that it has a future tax obligation that is due as a liability.

4. Accounting Recognition: This recognition belongs to the income tax accounts of the company, and it is reflected in their balance sheet.

5. Adjusted in Upcoming Years: It is expected that the deferred tax liability will be paid in the coming period. However, this doesn't mean that the company has not fulfilled its tax obligations.

6. Monitoring and Adjustments: Corporations keep track of the possibility of recording the deferred tax liability. The value of the deferred tax liability may be adjusted if certain conditions are met.

Examples of Deferred Tax Liability

A deferred tax liability is a record of tax that has been incurred by the entity but has not been paid and is due. This liability is known as a deferred tax liability. In a case where a business experiences profits during a particular fiscal year, it is liable to pay taxes on the earned profits as per the applicable tax rules and laws. Profits here attract tax liabilities that are to be met by the company at the end of the assessment year.

In another case, when there is a difference between the accounting rules and tax rules, this can also lead to the creation of a deferred tax liability. Suppose that when a company's expenses are recognized in their financial statements prior to recognition by the tax authorities or when the earnings of the company are subject to taxes before they are taxable in the income statement, then these deferred taxes come into being.

Also, when the tax rules and regulations for assets or liabilities differ at any given time, this deferred tax liability is created. Actually, there is no time limit for these liabilities. They are due whenever the company incurs tax liabilities. Deferred tax liabilities result in a cash outflow.

How is Deferred Tax Liability Calculated?

For example, a company holds an asset with a value of ₹5,00,000. The company uses the straight-line depreciation method in the books of accounts and charges depreciation at the rate of 20%, which comes to ₹1,00,000. Whereas, the income tax laws provide that the depreciation shall be charged at 15%, which stands at ₹75,000. Now the company has to create a DTL of ₹25,000.

Deferred Tax Liability vs Deferred Tax Asset