Question

Explain to a business owner who doesn't understand tax, in 3-5 sentences. Give examples and expand where necessary.

Explain and give an example of deferred income taxes.

Answer 1

• Income Tax in layman's terms is a levy imposed by the Government on the income gained by individuals or entities.
• Taxes are used by the Government to pay for people who work for government such as the military, police etc and to porvide services such as education, healthcare , infrastructure etc.
• For example, if the Government says that you have to pay an income tax of 30% and if you earn $10000 per month, it means you have to pay 30% on $10000*12=$120000 ie, $36000 to the Government per annum.

Deferred Tax

• Company calculates it book profit from the Financial Statements prepared as per the Companies Act and pays Income Tax based on the computation done as per the Income Tax Laws.
• There are differences between the book profit and taxable profit because of certain allowances as well as disallowances which give rise to timing differences.
• So if the difference arising is capable of reversing in the subsequent period Deferred tax asset/Deferred tax liability needs to be accounted in the books of accounts.

• S No	Status	Current situation	Future Situation	Effect
  1	Book profit higher than taxable profit	Pay less tax now	Pay more tax in future	Creates Deferred tax liability
  2	Book profit less than taxable profit	Pay more tax now	Pay less tax in future	Creates Deferred tax Asset

• Common example of DTL would be depreciation. When the depreciation rate per Income tax act is higher than the depreciation rate per companies act (generally in the initial years), entity will end up paying less tax for the current period. This will create deferred tax liability in the books.