Depending on the internal procedures of a particular business, on a regular time (monthly, quarterly, or annually) income tax is calculated as a part of financial reporting process. In the books income tax is calculated based on accounting data, i.e. accounting profit before tax. For income tax reporting to tax authorities purposes and then payment purposes income tax is calculated based on local income tax legislation
In case there is a difference between income tax calculated in the books of the company based on the accounting data reported in its books and tax calculated based on the local income tax legislation and determined rules, deferred tax has to be estimated
In case the company will pay additional tax in the future periods, such future payment is called deferred tax liability
In case the company paid income tax in advance, such over payment is called as deferred income tax asset, which will be used as income tax decrease in the future periods
Temporary and Permanent Differences
In case there is a difference between profit before tax calculated in the books of the company and tax calculated in accordance with tax legislation, only temporary differences create deferred income tax
Such differences cover those items, which will impact future period income tax to be reported and paid to tax authorities – these are called temporary differences. Example, can be accrued expenses in the books, which for income tax purposes will be deducted only in the future periods
Permanent differences, i.e. items, which will not have any impact on future period income tax, do not impact deferred tax. For example, losses of goods, which cannot be deducted for income tax based on local tax legislation. Such expenses are permanent differences and will not impact future period income tax calculation and payment
Deferred Tax Categories
Depending on the type of temporary differences deferred tax is has two categories:
- Deferred tax asset
- Deferred tax liability