Deferred Tax

Tax authorities treat income, expenses, assets and liabilities differently to the way a business treats them for accounting purposes.

The differences in treatment result in the accounting profit being different to the taxable profit, and therefore the accounts tax charge being different to the actual tax charge made by the tax authority. This difference is referred to as deferred tax.

Deferred Tax Calculation

As a simple example, suppose a business has bought a long term asset for 3,000 and decides it has a useful life of 3 years. The depreciation expense each year will be 3,000 / 3 = 1,000.

If the business has profits before depreciation of 6,000, then its accounts profit will be 6,000 – 1,000 = 5,000, and if the tax rate is 25% then the accounts tax charge will be 5,000 x 25% = 1,250.

From the tax authorities point of view, assuming they do not allow depreciation as an expense, but they do allow an 80% of the cost (2,400) allowance in the year of purchase.

The taxable profits will be 6,000 – 3,000 x 80% = 3,600, and the actual tax charge will be 3,600 x 25% = 900, referred to as the current tax.

The difference in the accounts tax and the actual tax charge is the deferred tax of 1,250 – 900 = 350.

This is effectively the tax on the difference in treatment of the asset by the business and by the tax authority. The tax authority gave an allowance of 2,400 on the asset, and the business charged a depreciation expense of 1,000, the difference of 1,400 at the tax rate of 25% is the deferred tax of 350.

The mdct.ru journal to post the deferred tax liability would be as follows:

Deferred Tax
Account Debit Credit
Income tax expense 1,250
Deferred tax 350
Current tax 900
Total 1,250 1,250

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Deferred Tax February 10th, 2016Team

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