Deferred tax liability is a term that is frequently used in the world of finance and accounting. It is a concept of tax planning that arises from differences between accounting methods used for financial reporting and the way taxes are levited from businesses by tax authorities. These differences could lead to discrepancies in the income tax expense reported in the income statement and the actual amount of tax owed to the tax department, thus creating a deferred tax liability. Through this article, we will explore the details of deferred tax liability and its implications for businesses and individuals.
What is Deferred Tax Liability?
Deferred tax liability, in simple terms, can be thought of as future taxes that a company expects to pay. It arises from situations where the tax expense on an income statement is less than the tax payable calculated using the tax rules. This difference results from temporary differences that arise due to the diverse ways of treating certain income and expense items for accounting and tax purposes.
Illustration:
Assuming the tax rate to be 30%, the tax on profits (as per books) of, say, Rs. 10 lakhs would amount to Rs. 3 lakhs. However, as per tax provisions, the profits might only be Rs. 9 lakhs, resulting in a tax payable of Rs. 2.7 lakhs. The difference of Rs. 30,000 is recorded as deferred tax liability, which implies that it is a future tax obligation.
These discrepancies are temporary and reverse over time. Essentially, when a company has a deferred tax liability, it is expected to pay more tax in the future. This is because, over time, the profit for tax purposes will become more than the book profits as the benefits derived from higher depreciation, etc., diminish.
However, deferred tax liabilities also have an impact on a company’s balance sheets and can affect its market value. Companies with large deferred tax liabilities need to carefully plan their future activities to ensure that they have sufficient liquidity to meet these future tax obligations when they become due.
Conclusion
In summary, deferred tax liability is a crucial aspect in the realm of financial accounting and tax planning. It allows businesses to strategically plan and manage their future tax obligations, thereby ensuring financial stability and sustainability. However, they must carefully manage these future tax obligations to avoid any negative impacts on their financial and market position.
Disclaimer:
This article is for informational purposes only and does not, in any way, constitute financial advice. Investors must take into consideration all the risks associated with investing in the Indian financial market and seek professional advice before making any investments.
Summary:
Deferred tax liability is a concept that arises due to the temporary differences between the accounting methods used for financial reporting and the way taxes are calculated as per tax rules. These differences can result in a situation where the tax expense reported in the income statement is less than the actual tax owed to the tax authority, thereby creating a deferred tax liability. It is essentially future tax that a company expects to pay and plays a critical role in tax planning. Understanding this concept allows businesses to manage their future tax obligations strategically. However, it is important for companies to plan their activities wisely to ensure sufficient liquidity to meet these future obligations. This article gives an overview of deferred tax liability, its implications, and its role in strategic tax planning.
