Deferred Tax When are You Going to Pay It?

The profit and loss account gives information on the amount of income tax for the accounting period classified as tax payable and deferred tax. A lot of managers are confused by the item “deferred income tax” because of its confusing name. Are you sure about what the deferred tax means?

 

Deferred Tax

The Confusing Name in the Profit and Loss Account

When you have a look at the item “deferred tax” in the profit and loss account, you might think that it means later tax liability.

Nevertheless, the deferred tax (liability or receivable) is a genuinely accounting term and in practice, the deferred tax does not mean deferral of company obligation to pay the income tax to the state.

The amount in the item “deferred tax” does not thus mean later payment of the tax. Only the items “payable income tax on ordinary activity” and “payable income tax on extraordinary activity” are linked to tax liability in the profit and loss account.

 
Why Is the Deferred Tax Monitored?

It is a well-known fact that the accounting result and the tax base for income tax calculation are not the same. The reason for that is exercising of different taxation and accounting rules. The deferred tax makes it possible to exercise the principle of maintaining the accrual principle of costs with the accounting period. It helps to solve time differences of impacts of some accounting transactions which come delayed or in advance.

For instance: the accounting linear depreciation of the building are spread over 40 years, which corresponds to the business plan of utilization of the building. However, only the building depreciation spread over exactly 30 years is tax deductible. Moreover, you could choose accelerated tax depreciation due to tax optimization. A difference between accounting and tax comprehension of property depreciation arises.

 
Why is Deferred Tax Accounting Beneficial?

Accounting of the deferred tax liability prevents from preliminary profit distribution. That is to say that the liability lowers the economic result intended for distribution. Business associates can pay out proportionally decreased shares in the profit, and possible financial problems of the company are prevented in the period of increased tax liability.

 
How Can You Calculate the Deferred Tax?

While assessing the deferred tax, one can use the method when particular assets and liabilities are assigned with their tax value in addition to their accounting value. Both the values are compared to each other. Thus temporary differences are reported.

The deferred tax is calculated mainly from the temporary differences between accounting and tax net book values of long-term depreciated tangible and intangible assets and furthermore, for instance, from allowances on inventory or on receivables, from reserves formed beyond the applicable legislation or possible loss realization the accounting unit is going to exercise in the following period.

The actual calculation of the deferred tax is not demanding. The deferred tax is a product of the temporary difference and the tax rate applicable in the period when the deferred tax is exercised. In practice it is the tax rate which is set by the act on the income tax for the following period.