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Deferred Tax Liability: Meaning, How It is Calculated and Examples

Deferred tax liability is an important accounting concept that is used for representing the future tax obligations of a  business. It arises when the taxable and financial income of the taxpayer is different. Read on for more information!

Deferred tax liability is a concept that emerges from the differences in a company’s tax obligations and financial statements. These differences essentially arise due to factors such as varying depreciation schedules and accounting methods. 
 

It is an important concept for both investors and businesses as it directly impacts tax planning and financial statements. 
 

With that in mind, we will explore the important details of deferred tax liability, including the deferred tax liability meaning, how it is calculated, its accounting entry, and more in this blog. 

Read on!

What is Deferred Tax Liability in India?

In India, Deferred Tax Liability, or simply DTL, is a financial accounting concept that represents the income tax amount a company needs to pay in the future due to the differences in its taxable and accounting earnings. 
 

Note that these differences are temporary and arise due to different tax laws, accounting methods, and different rules for recognizing a company's assets, revenue, and expenses.

Factors Resulting in Deferred Tax Liability

As mentioned above, there are various factors that can result in Deferred Tax Liability for businesses. Let’s discuss them in brief:
 

  • Depreciation and Deferred Tax Liability Rate: Depreciation is calculated after taking into account the cost, residual value, and usefulness of an asset, as per the Companies Act.
     

    However, there are differences between the depreciation rates laid under the Companies Act and the Income Tax Act. This variation leads to a temporary difference, resulting in the deferred tax liability. 
     

  • Recognition of Expenses: When a company records certain expenses in its account statements before they are deductible for taxes, it results in deferred tax liability. 
     

    For example, expenses on advertisement are not allowed by the Income Tax Department but are recorded in the financial statements of the company. Here is what the tax and income statements in the company look like:

Income Statement of the Company

Particulars

Amount

Revenue 

1,00,000

Advertisement Expenses 

50,000

Taxable Income

50,000

Tax Rate @30%

15,000

 

Tax Statement of the Company

 

Particulars

Amount

Revenue

1,00,000

Advertisement Expenses (Disallowed by Income Tax Department)

Nil

Taxable Income

1,00,000

Tax Rate @30%

30,000

 

  • Changes in Income Tax Laws

    Variations in income tax laws can also impact the deferred tax liability for businesses. For instance, if the corporate tax rate is decreased, the deferred tax liability will be lowered. As a result, the future tax liability will be decreased. 

  • Carry Forward of Taxable Gains

    In some cases, companies carry forward their taxable gains or profits to the upcoming years with an objective to lower their tax burden. This results in the creation of deferred tax liability. If the company faces a loss, it carries it forward to offset against taxable profits in the subsequent years. 
     

    These are some of the most common factors that lead to deferred tax liability. Now that you are familiar with its causes, let’s take a look at how DTL is calculated.

How to Calculate Deferred Tax Liability 

Deferred tax liability is calculated by determining the above-mentioned discrepancies and then applying the given tax rate to estimate the taxable amount associated with them. 

 

 

Here is a deferred tax liability example for your better understanding:
 

Suppose there is a manufacturing company, ABC Ltd., which reports a financial profit of ₹1,000,000 in a given financial year. However, for tax declaration, it calculates the profit of ₹600,000 due to discrepancies in tax regulations and depreciation methods allowed by the accounting regime. 
 

In this scenario, here is how the deferred tax liability is calculated:
 

Step 1: Determine the temporary differences. 

  • In the above case, the temporary differences will be ₹400,000 (₹1,000,000 - ₹600,000). 

Step 2: Identify the Taxable Rate.

  • Let’s say that the income tax rate for the corporate taxpayer is 30%.  

Step 3: Use Deferred Tax Liability Formula.

  • Deferred Tax Liability = Temporary Differences x Relevant Tax Rate 

  • DTL in this example = ₹400,000 x 0.30% = ₹12,000.  

Thus, the DTL for ABC Ltd. will be ₹12,000 in its account statements. This is the amount the company is responsible for paying in the future when these differences become taxable.

Eligibility for Paying Deferred Tax Liability 

The deferred tax liability concept is mostly applicable to corporate organisations and related entities. However, it is also applicable to businesses that follow different accounting methods than the ones mentioned under the Indian income tax laws.
 

For instance, the accounting methods for employee benefits are completely different from those laid under income tax laws for regular businesses.

Final Words

Understanding deferred tax liability is very helpful in financial planning for companies and businesses that use different accounting methods for tax calculation. As discussed above, DTL arises due to differences in accounting methods, depreciation rates, and other factors that result in temporary differences in the reported and taxable income of the company. 
 

Besides DTL, taxpayers should also understand Section 80c of the Indian Income Tax Act. While it doesn’t directly impact the deferred tax liability, it plays a pivotal role in reducing the tax burdens on the taxpayers. 
 

That said, companies as well as individuals should consider DTL as well as tax-saving concepts like Section 80c for better tax planning and financial management.

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Tata AIA Life Insurance

A joint venture between Tata Sons Pvt. Ltd. and AIA Group Ltd. (AIA),  Tata AIA Life Insurance  is one of the leading life insurance providers in India. We post everything you need to know about life insurance, tax savings and a variety of lateral topics such as savings and investments in this space. You can access and read a host of different blogs, articles and pages at the Tata AIA Life Insurance Knowledge Center or get in touch with us with any queries or questions!

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Frequently Asked Questions

What is a deferred tax liability journal entry?

The deferred tax liability journal entry is the representation of DTL in the balance sheet. It is usually depicted as a part of a company's non-current assets in the accounting record.

Is deferred tax liability temporary or permanent?

Deferred tax liability is temporary and can change over time due to various factors like changes in tax laws, accounting policies, etc. For this reason, companies should calculate and adjust their DTL from time to time.

What is the impact of DTL on tax planning?

Corporate entities can utilise the knowledge and understanding of deferred tax liability for better tax planning and minimising the impact of taxes on their net profitability.

Disclaimer

  • Tax: *Income Tax benefits would be available as per the prevailing income tax laws, subject to fulfilment of conditions stipulated therein. Income Tax laws are subject to change from time to time. Tata AIA Life Insurance Company Ltd. does not assume responsibility on tax implications mentioned anywhere in this document. Please consult your own tax consultant to know the tax benefits available to you.

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  • This blog is for information and illustrative purposes only and does not purport to any financial or investment services and do not offer or form part of any offer or recommendation. The information is not and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.

  • Please know the associated risks and the applicable charges, from your Insurance agent or the Intermediary or policy document issued by the insurance company.

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