What is Deferred Tax Liability? Meaning, Examples & Accounting Treatment
When businesses prepare their financial statements, they often face differences between accounting profits and taxable profits. These differences arise because tax laws and accounting standards follow different rules for recognising income and expenses. One important outcome of such timing differences is Deferred Tax Liability (DTL).
DTL represents the tax a company owes in the future due to income that has already been recorded in financial statements but will be taxed in later years.
What is deferred tax liability?
A Deferred Tax Liability is a tax obligation a company owes but does not pay in the current financial year. It arises when taxable income, as per the Income Tax Act, is higher than accounting income shown in financial statements due to timing differences. For example, if a company uses different methods of depreciation for tax and accounting purposes, it may end up paying less tax now but will have to pay more tax later. Hence, a DTL represents taxes postponed to future years, ensuring an accurate reflection of a company’s financial health and future tax commitments on its balance sheet.
Concept of depreciation for deferred tax liability
Under Schedule II of the Companies Act, depreciation is based on the useful life of the asset. It can be calculated using either the Straight-Line Method (SLM) or Written Down Value (WDV) method, depending on company policy.
In contrast, the Income Tax Act mandates depreciation using only the WDV method, with fixed rates for asset blocks 15% for general machinery, 10% for buildings, and 40% for computers. This divergence creates temporary timing differences in profit recognition, leading to deferred tax implications.
For example, consider a company that purchases machinery worth ₹10 lakh. Under the Companies Act, using the SLM and a 15-year useful life, the annual depreciation would be ₹66,667. However, under the Income Tax Act, applying a 15% WDV rate, the first-year depreciation would be ₹1.5 lakh. This results in lower accounting profit but higher taxable profit, triggering a DTL since the tax payable is higher than the tax expense shown in the books. Over time, as depreciation under tax laws reduces due to the declining WDV base, the timing difference reverses, and the DTL is settled.
Accurate DTL computation requires identifying the carrying amount of the asset in the books, determining its tax base and applying the prevailing corporate tax rate, which is currently 22% for domestic companies under section 115BAA, excluding surcharge and cess.
For example, if the carrying amount of the machinery is ₹8 lakh and its tax base is ₹6.5 lakh, the temporary difference is ₹1.5 lakh, resulting in a DTL of ₹33,000 (₹1.5 lakh × 22%). This liability must be disclosed in the financial statements and adjusted annually.
Treatment of revenue and expenses
The treatment of revenue and expenses for deferred tax liability is governed by Indian Accounting Standard (IND AS) 12 – Income Taxes, which mandates recognition of tax effects arising from temporary differences between accounting income and taxable income. These differences typically occur due to variations in how revenue and expenses are treated under the Companies Act versus the Income Tax Act. A DTL arises when taxable income exceeds accounting income due to timing differences, meaning the company will pay more tax in the current period but will pay less in future periods.
Common causes include accelerated depreciation under the Income Tax Act, recognition of income in tax books before it appears in financial statements, or expenses disallowed for tax purposes but recognised in accounting books.
For example, consider a company that earns ₹10 lakh in revenue and claims ₹4 lakh depreciation under the Income Tax Act, while only ₹2 lakh is charged in its financial books. The taxable income becomes ₹8 lakh (₹10 lakh – ₹2 lakh), whereas the accounting income is ₹6 lakh (₹10 lakh – ₹4 lakh). The excess ₹2 lakh depreciation claimed for tax creates a temporary difference, resulting in a DTL.
Assuming a corporate tax rate of 22%, the DTL would be ₹44,000 (22% of ₹2 lakh). This liability reflects future tax that will be payable when the temporary difference reverses, that is, when depreciation in accounting books catches up.
Revenue-related DTL can also arise when income is received in advance and taxed immediately, while in the accounting books, it is deferred and recognised only when it is earned. Similarly, expense related DTL may occur when provisions such as warranty or gratuity are recognised in books but are not deductible under tax laws until they are actually incurred. Importantly, only temporary differences are considered for DTL; permanent differences, such as fines or penalties disallowed under tax law, do not impact deferred tax.
Under IND AS 12, DTL must be recognised in the balance sheet and adjusted in the statement of profit and loss.
Key points of difference: Deferred tax liability vs deferred tax asset
Here are the key distinctions between DTL and DTA:
Point of difference
Meaning
Deferred tax liability (DTL)
A situation where a company owes more tax in the future due to temporary differences in accounting and tax treatment of income/expenses.
Deferred tax asset (DTA)
A situation where a company can save or recover taxes in the future because of temporary differences in accounting and tax treatment of income/expenses.
| Point of difference | Deferred tax liability (DTL) | Deferred tax asset (DTA) |
|---|---|---|
Meaning | A situation where a company owes more tax in the future due to temporary differences in accounting and tax treatment of income/expenses. | A situation where a company can save or recover taxes in the future because of temporary differences in accounting and tax treatment of income/expenses. |
Cause | Arises when taxable income is lower than accounting income due to timing differences. | Arises when taxable income is higher than accounting income due to timing differences. |
Example | Depreciation charged differently in accounting books and tax computation, leading to lesser tax now but more tax later. | Carry forward of losses, bad debt provisions, or excess tax paid leading to future tax benefit. |
Representation | Shown as a liability on the balance sheet under non-current liabilities. | Shown as an asset on the balance sheet under non-current assets. |
Cash flow impact | Defers the tax outflow but increases tax burden in later periods. | Reduces the tax outflow in later periods by adjusting against taxable profits. |
Impact on profit | Decreases future profits after tax due to higher payable tax. | Increases future profits after tax due to lower payable tax. |
Conclusion
Deferred Tax Liability arises due to timing differences between accounting rules and tax laws. Deferred tax liability meaning refers to the future tax that a company is obligated to pay, even though it has not yet become payable. Common reasons for its occurrence include differences in depreciation methods, revenue recognition and disallowed expenses. While DTL does not immediately affect cash flow, it plays a crucial role in accurate financial reporting and planning.
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