Library / Comprehensive Guide to Indian Accounting Standards (Ind AS)

PART 3: DEEP DIVE Deferred Taxes (Ind AS 12)

IFRS Equivalent: IAS 12 | Old AS Equivalent: AS 22 (Accounting for Taxes on Income)

Deferred Tax is widely considered the most confusing topic in accounting. Many CA students, MBA students, and even experienced finance professionals struggle with it. But the core concept is actually quite simple once you understand the fundamental reason why it exists. In this section, we will build your understanding from absolute zero.

3.1 Why Does Deferred Tax Exist? (Explained from Scratch)

The fundamental reason for deferred tax is deceptively simple: the rules for calculating ACCOUNTING PROFIT (under Ind AS) and TAXABLE PROFIT (under the Income Tax Act) are DIFFERENT. Because they are different, the tax you pay to the government in a given year is often different from the tax that your financial statements “should” show for that year based on your accounting profit.

Let us understand this with a very simple example before getting into technical details:

🏢 The Simplest Possible Deferred Tax Example

Suppose Maruti Suzuki buys a machine for ₹100 crore. Maruti’s accounting policy (under Ind AS 16) is to depreciate it using Straight-Line Method over 10 years = ₹10 crore per year.

The Income Tax Act allows Written Down Value depreciation at 15% per year. So in Year 1, tax depreciation = 15% × ₹100 crore = ₹15 crore.

Now, assume Maruti has revenue of ₹1,000 crore and no other expenses.

Accounting Profit = ₹1,000 − ₹10 (accounting depreciation) = ₹990 crore.

Taxable Profit = ₹1,000 − ₹15 (tax depreciation) = ₹985 crore.

Tax at 25%: Accounting suggests tax should be 25% × ₹990 = ₹247.5 crore. But actual tax payable = 25% × ₹985 = ₹246.25 crore.

Maruti is paying ₹1.25 crore LESS tax now because tax depreciation is higher. But this benefit is TEMPORARY over the full 10-year life of the machine, total depreciation under both systems is the same (₹100 crore). The extra ₹5 crore tax depreciation taken now means ₹5 crore less will be available later. So the ₹1.25 crore tax saved now will have to be paid later.

This ₹1.25 crore is a Deferred Tax Liability (DTL). It represents taxes that have been postponed to the future.

3.2 Temporary Differences The Foundation of Ind AS 12

Under Ind AS 12, deferred tax is calculated using the BALANCE SHEET APPROACH. This means you compare the CARRYING AMOUNT (book value under Ind AS) of every asset and liability with its TAX BASE (the amount recognised for income tax purposes). The difference between these two is a TEMPORARY DIFFERENCE.

Carrying Amount: The amount at which an asset or liability appears on the Ind AS Balance Sheet. For the machine in our example: after 1 year, carrying amount = ₹100 − ₹10 = ₹90 crore.

Tax Base: The amount of the asset or liability for income tax purposes. For the machine: after 1 year, tax base = ₹100 − ₹15 = ₹85 crore.

Temporary Difference: Carrying Amount − Tax Base = ₹90 − ₹85 = ₹5 crore. This is a TAXABLE temporary difference because the carrying amount of the asset is HIGHER than the tax base, meaning the company will pay more tax in the future when it recovers (uses up) this asset.

The Two Types of Temporary Differences

1. Taxable Temporary Difference → Creates a Deferred Tax LIABILITY (DTL):

This arises when: (a) Carrying amount of an ASSET > Tax Base (the asset is “bigger” in the books than in tax records more will be taxed later), OR (b) Carrying amount of a LIABILITY < Tax Base (the liability is “smaller” in the books less deduction available later). DTL = Taxable Temporary Difference × Tax Rate.

2. Deductible Temporary Difference → Creates a Deferred Tax ASSET (DTA):

This arises when: (a) Carrying amount of an ASSET < Tax Base (the asset is “smaller” in the books more deduction available later), OR (b) Carrying amount of a LIABILITY > Tax Base (the liability is “bigger” in the books more deduction coming later). DTA = Deductible Temporary Difference × Tax Rate.

3.3 Common Sources of Deferred Tax (with Detailed Examples)

Source	Type	Detailed Explanation
Depreciation Difference	Usually DTL (initially)	Ind AS depreciation (SLM) is often lower than Income Tax depreciation (WDV) in early years, creating a taxable temporary difference. Reverses in later years when Ind AS depreciation exceeds tax depreciation.
Provision for Warranties	DTA	Company creates a warranty provision of ₹5 crore under Ind AS 37. Tax does not allow deduction until the claim is actually paid. Carrying amount of liability (₹5 crore) > Tax base (₹0). Deductible difference = ₹5 crore. DTA = ₹5 crore × 25% = ₹1.25 crore.
Provision for Employee Benefits (Gratuity)	DTA	Actuarial gratuity provision under Ind AS 19 may be higher than the amount allowed as tax deduction. The excess creates a DTA that reverses when the gratuity is actually paid.
Expected Credit Loss (ECL) Provision	DTA	Banks recognise ECL under Ind AS 109 on Day 1. Tax allows deduction only when the loan is actually written off. The ECL provision creates a deductible temporary difference.
Fair Value Gains on FVTPL Investments	DTL	If a FVTPL investment increases in value by ₹10 crore, this gain is recognised in accounting profit but is not taxable until actually sold. Carrying amount (₹110 crore) > Tax base (₹100 crore). Creates DTL.
Right-of-Use Asset and Lease Liability (Ind AS 116)	Net DTA or DTL	The ROU asset creates a DTL (carrying amount > tax base since tax does not recognise this asset). The Lease Liability creates a DTA (carrying amount > tax base since tax does not recognise this liability). The net effect depends on relative magnitudes.
Carried Forward Business Losses	DTA	Under Income Tax Act, business losses can be carried forward for 8 years. If a company has ₹100 crore of carried forward losses, it can recognise a DTA = ₹100 crore × 25% = ₹25 crore, but only if it is probable that future profits will be available.
Business Combination (PPA) Adjustments	Usually DTL	When fair values assigned in PPA exceed tax base (e.g., intangible assets identified at ₹50 crore with zero tax base), a DTL arises = ₹50 crore × 25% = ₹12.5 crore. This DTL increases goodwill.

3.4 Step-by-Step Deferred Tax Calculation (Complete Numerical Example)

🏢 Comprehensive Example: Deferred Tax Computation for XYZ Ltd.

XYZ Ltd. has the following balances at 31 March 2026. Tax rate = 25.168%.

(1) Factory Building: Carrying Amount (Ind AS) = ₹180 crore, Tax Base = ₹150 crore. Taxable temp diff = ₹30 crore. DTL = 30 × 25.168% = ₹7.55 crore.

(2) Computer Equipment: Carrying = ₹20 crore, Tax Base = ₹30 crore (tax allows higher depreciation). Deductible temp diff = ₹10 crore. DTA = 10 × 25.168% = ₹2.52 crore.

(3) Warranty Provision: Carrying (Liability) = ₹8 crore, Tax Base = ₹0 (not deductible until paid). Deductible temp diff = ₹8 crore. DTA = 8 × 25.168% = ₹2.01 crore.

(4) Trade Receivables (after ECL provision): Carrying = ₹45 crore, Tax Base = ₹50 crore (full original amount, tax does not allow ECL provision). Deductible temp diff = ₹5 crore. DTA = 5 × 25.168% = ₹1.26 crore.

(5) FVTPL Investment: Carrying = ₹60 crore (fair value), Tax Base = ₹50 crore (original cost). Taxable temp diff = ₹10 crore. DTL = 10 × 25.168% = ₹2.52 crore.

Summary: Total DTL = 7.55 + 2.52 = ₹10.07 crore. Total DTA = 2.52 + 2.01 + 1.26 = ₹5.79 crore. Net DTL = 10.07 − 5.79 = ₹4.28 crore (shown on Balance Sheet).

If last year’s net DTL was ₹3.00 crore, then: Deferred Tax Expense for the year = 4.28 − 3.00 = ₹1.28 crore (added to tax expense in P&L).

3.5 Recognition Rules and Management Judgement

DTL Recognition: Deferred Tax Liabilities are recognised for ALL taxable temporary differences, with very limited exceptions: (a) DTL on initial recognition of goodwill is NOT recognised (this would create a circular increase in goodwill). (b) DTL on initial recognition of an asset/liability in a transaction that is NOT a business combination and affects neither accounting profit nor taxable profit is NOT recognised.

DTA Recognition (The Critical Judgement Area): Deferred Tax Assets are recognised ONLY to the extent that it is PROBABLE (defined as “more likely than not”) that sufficient future taxable profits will be available to utilise the deductible temporary differences or carried-forward losses.

This is where significant management judgement comes in. The company must prepare future profitability projections. If a company has been consistently loss-making and there is no credible plan for turnaround, it should NOT recognise a DTA. Auditors closely examine DTA recognition overstating DTA artificially inflates equity and understates the effective tax rate.

🔍 Why is DTA Recognition Stricter than DTL? (Interview Favourite)

DTLs are recognised for virtually all taxable temporary differences because if the company earns profits, it WILL pay tax. The future tax obligation is almost certain.

DTAs, on the other hand, represent future tax BENEFITS. These benefits can only be realised if the company earns future profits. A loss-making company with ₹500 crore in carried-forward losses has a potential DTA of ~₹125 crore but if it never makes a profit, this DTA is worthless.

This asymmetry reflects the accounting principle of PRUDENCE / CONSERVATISM: recognise liabilities as soon as they are probable, but recognise assets only when they are virtually certain to be realised.

In practice, this means that when a profitable company suddenly becomes loss-making, it may need to DE-RECOGNISE (write off) previously recognised DTAs. This is exactly what happened to Vodafone Idea in India it had to write off massive DTAs when its future profitability became uncertain after the AGR (Adjusted Gross Revenue) ruling.