IAS 12: Deferred tax · Trial Balance

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What it is: Deferred tax is tax that will be paid, or saved, in a future year because of something that has already happened.

Why you need it: The tax rules and the accounting rules sometimes put the same item in different years. Without deferred tax, the tax charge would not match the profit shown in the accounts.

What you do: Find the difference between an asset’s carrying amount (in the accounts) and its tax base (in the tax rules). Multiply the difference by the tax rate. That is the deferred tax balance.

Example. A machine is in the accounts at £80,000. Its tax base is £50,000. Difference = £30,000. Tax rate 25%. Deferred tax liability = £30,000 × 25% = £7,500. This is tax the company will pay in future years.

Key words

Current tax: The tax a company must pay on this year’s taxable profit.Example: Taxable profit £401,900 × 25% = £100,475 of current tax.
Deferred tax: Tax that will be paid (or saved) in future years because the accounts and the tax rules count some items in different years.Example: Tax relief on a machine was given all in year 1, but the accounts spread the cost over 5 years. More tax will be paid later, so a deferred tax liability is recorded.
Tax base: The value of an asset or liability according to the tax rules, which can be different from its value in the accounts.Example: A machine is £80,000 in the accounts, but all its cost has already been claimed for tax, so its tax base is £0.
Temporary difference: The difference between an item’s value in the accounts and its value for tax (its tax base). The difference will reverse in future years.Example: Accounts value £80,000 − tax base £0 = temporary difference of £80,000.
Permanent difference: An item that is treated differently in the accounts and for tax, and the difference never reverses. No deferred tax arises.Example: A parking fine is an expense in the accounts but is never allowed for tax.

Learn

The tax expense in the accounts has two parts:

Current tax: the tax to pay on this year’s taxable profit.
Deferred tax: tax that will be paid (or saved) in future years. It happens because the accounts and the tax rules put some items in different years.

Temporary differences

Temporary difference = Carrying amount − Tax base

The tax base is the value the tax rules give an item. A common cause of a difference: the tax rules give tax relief on a machine faster than the accounts depreciate it. The company pays less tax now, so it will pay more tax later.

Situation	Type of difference	Result
An asset’s carrying amount is higher than its tax base	Taxable temporary difference	Deferred tax liability
A liability’s carrying amount is higher than its tax base (for example, a provision that gets tax relief only when paid)	Deductible temporary difference	Deferred tax asset
Tax losses not used yet, which are expected to be used	Deductible	Deferred tax asset
Items that are never taxed or never get tax relief (for example, fines)	Permanent difference	No deferred tax

Deferred tax balance = Temporary difference × Tax rate

Example: Carrying amount £60,000. Tax base £40,000. Difference £20,000. Tax rate 25%. Deferred tax liability = £20,000 × 25% = £5,000. Last year it was £4,000. So the tax expense goes up by £1,000.

Rules for measuring it

Use the tax rate expected when the difference reverses. Only use rates already set in law (enacted, or substantively enacted) at the year end.
Only include a deferred tax asset if future taxable profits are probable.
Deferred tax is never discounted.
The change in the balance goes to profit or loss. The exception: if the item itself went to other comprehensive income (OCI), such as a revaluation, the deferred tax goes to OCI too.

Journal

If a deferred tax liability goes up: debit Income tax expense, credit Deferred tax liability. If it goes down, do the opposite.

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Worked example

A company buys machinery for £100,000. It depreciates it over 5 years (£20,000 a year). For tax, it claims the annual investment allowance of 100% in year 1. The tax rate is 25%.

End of year 1	£
Carrying amount (100,000 − 20,000)	80,000
Tax base (100,000 − 100,000 allowance)	0
Taxable temporary difference	80,000
Deferred tax liability at 25%	20,000

Journal: Dr Income tax expense £20,000, Cr Deferred tax liability £20,000. The company paid less tax this year because of the allowance. The liability shows that tax will be higher in later years, when depreciation continues but no more allowances are available.

Practice questions

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