DEFERRED TAX (ASSETS AND LIABILITIES) [AS- 22]:

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AS- 22: Accounting for Taxes on Income:

Applicability of Accounting Standard: Applicable for all enterprises.

Main gist of accounting standard:

The need for establishing a standard arises due to difference between profit computed for accounting purpose and that for tax purpose. As per this accounting standard, the income tax-expense should be treated just like any other expenses on accrual basis irrespective of the timing of payment of tax.

Tax Expense = Current Tax + Deferred Tax

Current tax is the amount of income tax determined to be payable (recoverable) in respect of the taxable income (tax loss) for a period. Deferred tax is the tax effect of timing difference.

The difference accounts for:

a.      Treatment of revenue and expenses as appearing in the Profit and Loss Account and as considered for the tax purpose.

b.      The amount of revenue or expenses as recognized in the Profit and Loss Account and as allowed for tax purpose.

The difference as arising in the above context gives rise to ‘deferred tax’ and it needs to be ensured that the tax charges in future accounting period is not vitiated. The difference in accounting profit and taxable profit can be broadly categorized into two categories:

 

a.      Permanent difference: Permanent difference which originates in one period and do not reverse in subsequent periods. E.g. Personal expenses disallowed, interest/penalty disallowed as expense or tax-free agricultural income, various deductions under Section 10 of Income Tax Act, benefits/ reliefs under Section 80 of Income Tax Act in computing taxable income. Permanent differences do not result in deferred taxes.

b.      Timing difference: Timing difference which originates in one period and is capable of reversal in subsequent period(s):

i.        Difference in net block of fixed assets as per accounts and as per tax due to difference in the rate and method of depreciation.

ii.      Provision for doubtful debts and advances, provision for warranties, provision for Voluntary Retirement Scheme (VRS), provision for asset write-off, disallowed payments under Section 43 B of Income Tax Act, provision for excise liabilities, research expenditure (not weighted deduction which is a permanent difference), Section 350 deduction, amortization of deferred revenue expenditure, lease income.


Situations which leads to Deferred Tax:

Deferred tax is the tax effect due to timing difference. They arise due to the following reasons (situations):

a.      Accounting Income less than Tax Income.

b.      Accounting Income more than Tax Income.

c.       Income as per Accounts but loss as per Income Tax Act.

d.      Loss as per Accounts but income as per Income Tax Act.

The impact of such timing differences may lead to:

a.      Deferred Tax Liability (DTL): Deferred Tax Liability (DTL) is postponement of tax liability, which states, “Save Now, Pay Later”.

Journal Entry

Profit and Loss A/c………Dr.

To Deferred Tax Liability A/c

b.      Deferred Tax Asset (DTA): Deferred Tax Asset (DTA) is pay you tax liability in advance, which states, “Pay Now, Save Later”.

Journal Entry

Deferred Tax Asset A/c…….Dr.

To Profit and Loss A/c

In the year of reversing time difference, either Deferred Tax Liability (DTL) is written back to Profit and Loss Account or the Deferred Tax Asset (DTA) is revised by debiting Profit and Loss Account. For the recognition of Deferred Tax Asset (DTA), prudence should be applied. Such recognition is based on “reasonable certainty” that sufficient taxable income would be available in the future to realize the Deferred Tax Asset (DTA). In case of unabsorbed depreciation and carry forward losses, Deferred Tax Asset (DTA) should only be recognized to the extent that there is “virtual certainty” that in future sufficient taxable income would be available to realize the Deferred Tax Asset (DTA). Reasonable certainty shall be deemed to be in existence if the profitability of future taxable income is greater than 50%. Virtual certainty shall be deemed to be in existence only when the evidence suggests that there will be sufficient taxable income in the future.

 

Mandatory Disclosure to be made under AS-22:

a.     Break up of the deferred tax asset/liability.

b.      Deferred Tax Liability (DTL) should be shown after the head “Unsecured Loans” and Deferred Tax Asset (DTA) after the head “Investments” with a separate heading.

Taxes on Income:

a.      Income tax is computed in accordance with Accounting Standard 22 ‘Accounting for Taxes on Income (AS-22), notified by the Companies (Accounting Standards) Rules, 2006. Tax expenses are accounted in the same period to which the revenue and expenses relate.

b.      Provision for current income tax is made for the tax liability payable on taxable income after considering tax allowances, deductions and exemptions determined in accordance with the prevailing tax laws. The differences between the taxable income and the net profit or loss before tax for the year as per the financial statements are identified and the tax effect of timing differences at the end of the accounting year based on effective tax rates substantively enacted by the Balance Sheet date.

c.       Deferred tax assets, other than on unabsorbed depreciation or carried forward losses, are recognized only if there is reasonable certainty that they will be realized in the future and are reviewed for the appropriateness of their respective carrying values at each Balance Sheet date. In situations where the Company has unabsorbed depreciation or carried forward losses, deferred tax assets are recognized only if there is virtual certainty supported by convincing evidence that the same can be realized against future taxable profits.

 

Interpretation of AS – 22:

1.      There is a need for this accounting standard since there is a difference between profit computed for accounting purpose and that for income tax purposes.

2.      The income tax expense should be treated just like any other expenses on accrual basis irrespective of the timing of payment of tax.

3.      The difference in accounting profit and taxable profit can be broadly categorized into two categories:

permanent difference which originates in one period and do not reverse in subsequent periods and timing difference which originates in one period and is capable of reversal in subsequent period(s).

4.      Deferred Tax Liability (DTL) is postponement of tax liability whereas Deferred Tax Asset (DTA) is payment of your tax liability in advance.

5.      In case of Deferred Tax Liability (DTL) it should be shown with a separate heading after the head “Unsecured Loans” in the Balance Sheet.

6.      In case of Deferred Tax Asset (DTA) it should be shown with a separate heading after the head “Investments” in the Balance Sheet.

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