Tax expense

A company's tax expense, or tax charge, is the income before tax multiplied by the appropriate tax rate. Generally, companies report income before tax to their shareholder under generally accepted accounting principles (GAAP). However, companies report income before tax to their government under tax law.

As a result, the computation of the tax expense is considerably more complex. Tax law may provide for different treatment (from GAAP) of items of income and expenses as a result of tax policy. The differences may be of permanent or temporary nature. Permanent items are in the form of non taxable income and non taxable expenses. Things such as expenses considered not deductible by taxing authorities ("add backs"), the range of tax rates applicable to various levels of income, different tax rates in different jurisdictions, multiple layers of tax on income, and other issues.

For example, a government trying to promote savings may exempt interest income from tax or provide a lower rate for long term investments -such as capital gains. Conversely, a government trying to balance its foreign trade may disallow the deduction of international travel expenses or purchases made abroad.

An example of temporary items may be depreciation expense; sometimes governments provide for "accelerated" depreciation of particular items of interest to tax policy. Another common temporary difference refers to bad dedt write-off where the governments may generally have a stricter standard requiring the filing of claims in court.

Historically, in many places, a revenue-expense method was used, in which the income statement was seen as primary, and the balance sheet as secondary. Under International Financial Reporting Standards, as well as many other accounting principles, tax expense is the result of computing current and deferred tax payable using the asset-liability method in which the balance sheet is seen as primary and the income statement as secondary. The approach in United States Generally Accepted Accounting Principles was codified in SFAS 96 published in December 1987, and updated in February 1992 with SFAS 109, accounting for income taxes from a balance-sheet approach. See List of FASB Pronouncements.

Current tax payable is computed by multiplying the taxable income number, as reported to the tax authorities, by the appropriate tax rate. As with tax expense, the computation is made more complex by the range of tax rates that are applicable to various levels of income and the various deductions and adjustments that the tax authorities allow.

In the United States, the U.K. and elsewhere, companies are permitted to report one pre-tax income number (also called income before tax, profit before tax or earnings before income tax) to shareholders, and another, called taxable income, to the tax authorities. Differences between taxable income and the pre-tax income or profit number reported for financial statements are either temporary or permanent in nature. Permanent differences result when deductibility rules differ in perpetuity between accounting and tax law. Temporary differences result when the recognition of deductions for tax and accounting standards differ in their timing. The result is a gap between tax expense computed using income before tax and current tax payable computed using taxable income. This gap is known as deferred tax. If the tax expense exceeds the current tax payable then there is a deferred tax payable; if the current tax payable exceeds the tax expense then there is a deferred tax receivable.

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