Understanding Deferred Tax: A Complete Guide for 2025

Have you ever read a company’s financial statements and come across the term ‘deferred tax’? Or maybe you heard it in the news or at the annual general meeting of a large company. Unless you have a finance background, you may not understand the meaning of it, like most people. But wait, you don’t have to worry, we are here to help you. 

Here is good news for you: the term ‘deferred tax’ is not as complicated as it seems, and you should understand it thoroughly because indirectly it affects you whether you are an investor, a small business owner, or a finance enthusiast. 

In this blog, we are going to break down what deferred tax is and how to calculate deferred tax​ in simple terms, so are you ready? 

What Is Deferred Tax? A Simple Explanation

Deferred tax can be considered as a promise to pay (or receive) taxes in future due to the difference in the way in which businesses report their income in their books of accounts and the way in which they report such income to the tax authorities. 

The Income Tax Act, 1961, prescribes a different set of rules to compute the taxable income in India, whereas companies use accounting standards (such as Ind AS) to prepare their financial statements. These two systems do not always agree, and this is where the deferred tax comes in.

To make it clearer, it is a tax liability that a company is expected to pay or owes in the future as a result of the differences between accounting income and taxable income. We hope it makes sense now. 

Deferred Tax Assets Vs. Deferred Tax Liabilities

Now, let’s discuss the two main types of deferred tax: deferred tax assets and deferred tax liabilities. Understanding them is important because they are at the centre of the whole concept: 

Deferred Tax Liability (DTL)

Deferred tax liability occurs when a company records more profits in its accounts than it records with the tax authorities, implying that it pays less tax this year but will pay more later. This usually happens due to varying rates of depreciation.

Let’s understand with an example, 

Let us say you run a small manufacturing company in Gujarat. As far as accounting is concerned, you write off your machinery in 10 years (a straight-line method of depreciation, according to Ind AS). 

However, when it comes to the tax, the Income Tax Act enables you to write off the depreciation at an accelerated rate, e.g. in 5 years. It implies that you will have a larger tax deduction in the present, which will reduce your taxable income. 

However, you will pay more tax later as your accounting depreciation runs out, so that your taxable income is higher. The deferred tax liability is the future tax.

Deferred Tax Asset (DTA)

On the other hand, deferred tax asset occurs when a business is paying higher taxes today but anticipates paying lower taxes in future. This may occur because of losses, provisions, and expenses recorded in the books of accounts but not yet claimed as tax deductions.

Let’s dig it more deeply,

Suppose your startup, located in Bengaluru, makes a loss this year. You cannot claim a loss to lower your taxes at this moment since you do not have the income that can be taxed. 

The Income Tax Act, however, lets you carry forward this loss to future profits. Once you do make a profit in the future, you will pay less tax, and that future tax saving is recognized as a deferred tax asset.

Also, Know about the Difference between Direct Tax and Indirect Tax

How to Calculate Deferred Tax​: A Step-by-Step Guide

Since we have discussed the fundamentals of deferred tax, you probably want to know: How do you really calculate deferred tax? Don’t be afraid, it is quite simple, here it goes: 

Step 1: Identify Temporary Differences

Find the temporary difference between book value (i.e how an asset or liability is recorded in your financial statement) and the tax base (how it is treated in taxation). Generally, the common sources of temporary differences are as follows: 

Depreciation: The method of calculating depreciation is different for accounting and taxation purposes.

Provisions: As an example, you may have a provision for bad debts in your accounting books, but cannot claim tax on it until the debt is actually written off.

Losses: Carry-forward losses that are able to offset future taxable income.

Tax incentives: Such as R&D or investment in green energy deductions, which might not be recognised by accounting.

Step 2: Quantify the Difference

Now that you have identified the temporary differences, calculate the exact amount of difference. 

Here is an example: 

The book value of your machinery is ₹10 lakh, but the tax base is ₹8 lakh because of the accelerated tax depreciation; the temporary difference stands at ₹2 lakh.

Step 3: Apply the Tax Rate

The temporary difference should be multiplied by the tax rate.

Formula for Deferred Tax Calculation:

Deferred Tax=Temporary Difference×Tax Rate

From the above example, the temporary difference is ₹2 lakh.

The corporate tax rate in India for most companies is 25%

So, 

₹2 lakh x 25% = ₹50,000 

Step 4: Classify as Asset or Liability

When the temporary difference is going to increase taxes in the future (such as in the case of depreciation), then it is a deferred tax liability. When it will decrease future taxes (such as in the case of losses), it is a deferred tax asset.

Read More: Capital Gains Tax on Property

Final Notes 

Taxation can be complicated, but you can make it easier by using the right tools and understanding. We provide accounting and billing software that makes tax compliance easy. Are you all set to handle your deferred tax? Still have doubts? Your next step should be subscribing to Munim Accounting and Billing software. It will help you navigate through the complex processes of compliance easily. Sign up now! 

Frequently Asked Questions 

Are deferred income taxes operating assets​?

No, deferred income taxes are not operating assets. They are a future tax payable or receivable because of temporary differences between accounting income and taxable income, and are treated as current or long-term liabilities or assets rather than as part of the operating assets of a business.

What causes deferred tax assets and liabilities?​

The deferred tax assets and deferred tax liabilities are created because of temporary differences between the income and expenses that are used to calculate the accounting income and taxable income.