A company keeps two sets of profit figures, entirely legally. One follows accounting standards and appears in the annual report; the other follows the Income Tax Act and determines what is actually paid. They differ on timing — when a cost may be recognised, how fast an asset may be depreciated — and deferred tax is the accounting entry that reconciles the two.
A business runs on the financial year and a family runs on the festival calendar. Both are describing the same twelve months and both are correct; they simply start and end at different points, so any comparison has to account for the offset.
Accounting profit and taxable profit describe the same business under two rulebooks. Deferred tax is the entry that keeps the two reconciled while the timing differences unwind.
The two directions
| Deferred tax liability | Deferred tax asset | |
|---|---|---|
| What it means | Tax deferred to later years | Tax already paid, or losses available to offset later |
| Typical cause | Tax depreciation faster than book depreciation | Carried-forward losses; provisions not yet allowed for tax |
| Where it sits | A liability on the balance sheet | An asset |
| What it signals | Ordinary in capital-intensive businesses | Depends entirely on whether future profits will exist to use it |
| When it reverses | As the asset ages and book depreciation catches up | When the company earns enough profit to absorb the losses |
The effective tax rate, and what it discloses
Every annual report contains a reconciliation between the statutory tax rate and the rate the company actually bore. It is one small table in the notes, and it explains more about a company's economics than most of the ratios people compute.
Where it becomes a warning
- A large deferred tax asset written off is management conceding that the future profits it depended on will not arrive. It is a non-cash charge and it is a genuine statement about the business.
- A deferred tax asset growing while losses continue deserves scrutiny of the assumptions behind it. The auditor's report and the key audit matters section frequently discuss exactly this.
- An effective rate far below peers, with no disclosed reason, is worth chasing into the notes. There is always an explanation; the question is whether it is durable.
- A sudden jump in the effective rate usually means a benefit ended. If reported profit growth slowed that year, this may be the whole story rather than an operating problem.
A company has reported losses for four years and carries a large deferred tax asset that keeps growing. What does that tell you?
Dhandha financial year pe chalta hai aur ghar tyohaar ke calendar pe. Dono sahi hain, bas shuru-khatam alag jagah hote hain. Accounting profit aur taxable profit bhi wahi do calendar hain — deferred tax dono ko milaata hai, aur notes wali chhoti tax table batati hai ki munaafe ka kitna hissa waqti chhoot se aaya hai.
- Deferred tax reconciles accounting profit with taxable profit over timing differences.
- A deferred tax asset is a claim on future profits that management asserts will exist.
- The effective tax rate reconciliation in the notes shows which profits have an end date.
- Tax holidays, accelerated depreciation and carried-forward losses all expire.
- A written-off deferred tax asset is a concession about the future, not just a charge.
Mark it done to track your progress through the curriculum.
Common questions
Short, direct answers to what people ask about this topic.
- deferred tax liability meaning in balance sheet
- A deferred tax liability is tax a company will pay in later years because it has already claimed something for tax purposes that its accounts have not yet recognised. The commonest cause is depreciation being claimed faster under the Income Tax Act than it is charged in the books, which lowers tax paid now and raises it later as the difference unwinds. It is ordinary in capital-intensive businesses and is not on its own a warning sign.
- a difference between accounting profit and taxable profit that reverses in a later period is called
- A temporary difference — and it is precisely what deferred tax exists to account for. Timing items such as differing depreciation rates, provisions allowed only when paid, and carried-forward losses all unwind eventually, so the accounts record their future tax effect now as a deferred tax asset or liability. Differences that never reverse are permanent differences and create no deferred tax entry.
- why is a company’s effective tax rate lower than the statutory rate
- Because of incentives, disallowances and past losses — and every annual report carries a small reconciliation table in the notes that spells out exactly which. The usual reducers are tax holidays on units in specified zones, accelerated depreciation on new capex, and carried-forward losses being absorbed. All three expire, so a persistently low effective rate has a lifespan, and modelling future profit at the current rate is one of the commonest errors in otherwise careful analysis.
- what is the concessional corporate tax rate under section 115BAA
- Section 115BAA lets a domestic company elect a 22% base rate, which comes to roughly 25.17% once surcharge and cess are added. In exchange the company gives up most exemptions and incentives, and the election is irreversible once made. Companies that switched under the 2019 regime show a visible one-time adjustment to their deferred tax balances in that year, which is worth remembering when comparing a multi-year series across the change.
- what happens when a deferred tax asset is written off
- It produces a large non-cash charge in the profit and loss account, and it is management conceding that the future profits the asset depended on will not arrive. A deferred tax asset is only an asset if there is future taxable profit to set it against, so recognising one is a forecast recorded on the balance sheet. The auditor is required to assess that assumption, and for a loss-making company it frequently turns up in the key audit matters section.