Question

What is the difference between a deferred tax asset and a deferred tax liability?

Explain the difference between a permanent difference and a timing (or temporary) difference as related to tax and financial accounting, and how those differences relate to deferred tax assets and deferred tax liabilities

Answer 1

Deferred tax is Tax expense calculated on Timing difference based on rates enacted by Law in force.

Deferred Tax Assets: Whenever in any future period, an item which shall accrue benefits to us by reducing our taxable income are known as Deferred Tax assets

Deferred Tax Liability: Whenever in any future period, we shall be paying tax or anybtransaction causing increase in taxable income of future period are known as Deferred Tax liability.

Timing Differences are difference between accounting income (calculated as per US GAAP or IFRS) and Taxable Income (calculated as per Law) which are expected to be reversed in subsequent periods. They are considered for calculation of Deferred tax.

Permanent differences are those difference which are not capable of reversal, or we can say any difference other than timing difference is called as Permanent difference. They are not considered for calculation of Deferred tax.

EXPLANATION (Simple Language)

Books of accounts are prepared as Per US GAAP (US) or IFRS (UK,INDIA,FRANCE etc) and on the basis of such standards, accounting Income is calculated.

But tax laws of country like IRC(US), Income Tax Act(India,UK) have their own ways to calculate taxable Income. Now accounting Income and Taxable Income for a same financial year does not match because of various differences. Such differences can be classified into two broad categories ie Permanent Difference and Temporary Difference.

Expenditures such as Personal Expenses which are not allowable deduction are known as permanent differences as they shall never be allowed as deduction in future. As they wont be reversed in future, Deffered Tax shall not be calculated on them. Hence they are outside the virtue of Deferred Tax

Expenditures such as Provisions for Doubtful debts, which are not allowable as deduction. however in future when the actually bad debts happen, they shall be allowed as deduction. Hence they are known as Timing(Temporary Difference). They are to be reversed in future as shown in example, hence they shall be included for calculation of deferred tax.

Now any provision made during year shall not be allowed as deduction but in future wheneven actual bad debts happen, they shall be allowed as deduction thus reducing our taxable income and thus saving tax, hence they will create a Deferred Tax Asset.

Some items are allowed as 100% deduction in year 1 itself under Tax laws while they continue to depreciate under SLM/SYD/MARCS in accounts. 100% deduction has been allowed in Tax but it shall not be allowed in future for the same asset, hence depreciation claimed under accounts in future period will be disallowed thus increasing tax liablity in future, hence they will create a Deferred Tax Liability.