Deferred tax

An asset that may be used to reduce any subsequent period's income tax expense. Deferred tax assets can arise due to net loss carry-overs, which are only recorded as asset if it is deemed more likely than not that the asset will be used in future fiscal periods.

Temporary differences are differences between the carrying amount of an asset or liability recognized in the statements of financial position and the amount attributed to that asset or liability for tax or reductible temporary differences, which are temporary differences that will result in deductible amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.

The basic principle of accounting for deferred tax under a temporary difference approach can be illustrated using a common example in which a company has fixed assets that qualify for tax depreciation.

The following example assumes that a company purchases an asset for $1,000 which is depreciated for accounting purposes on a straight-line basis of five years of $200/year. The company claims tax depreciation of 25% per year on a reducing balance basis. The applicable rate of corporate income tax is assumed to be 35%, and the net value is subtracted.

As the tax value, or tax base, is lower than the accounting value, or book value, in years 1 and 2, the company should recognize a deferred tax liability. This also reflects that the company has claimed tax depreciation in excess of the expense for accounting depreciation recorded in its accounts, whereas in the future the company should claim less tax depreciation in total than accounting depreciation in its accounts.

In years 3 and 4, the tax value exceeds the accounting value, therefore the company should recognise a deferred tax asset (subject to it having sufficient forecast profits so that it is able to utilise future tax deductions). This reflects that the company expects to be able to claim tax depreciation in excess of accounting depreciation.

In many cases the deferred tax outcome will be similar for a temporary difference or timing difference approach. However, differences can arise such as in relation to revaluation of fixed assets qualifying for tax depreciation, which gives rise to a deferred tax asset under a balance sheet approach, but in general should have no impact under a timing difference approach.

Deferred tax is relevant to the matching principle.

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