Deffred Tax Liability arise when Profit as per Income Tax Act is low where as accounting Profit is more.So in order to neutralise this Deffered Tax Liabilty is provided which is to be adjusted in the forthcoming year/years.
One thing is to be noted that Deferred Tax Liability is Recognised only for Timing Difference and not for Permanent differece.
Timing Difference means treatment of an item based on the different time for example if an item which comes under Sec 43 B is recognised in accounting year itself when it incurred irrespective of payment made but in Income Tax it is recognised only when actual payment is made,which may may be made in the next year.Hence there will arise time difference.
Permanent differene arise which can not be adjusted in any subsequent year.For example if an item is treated as revenue expenditure in Account books but which is compelety disallowed in the Income Tax Act then it is Called Permanent difference.
In order to encourage investments the tax code is liberal and allows for a higher rate of depreciation versus the accounting rules. For Eg: Buildings can be depreciated at 10% on the written down value (WDV) as per tax rules while accounting permits depreciation of the same building at 1.63% on a straight line basis (SLM). Simply put if tax rules allow the charging of a higher expense then the taxable income calculated as per the tax law would be lower than that calculated as per accounting rules. And therefore the company would actually pay a lower tax in that financial year. It is as if the company was allowed to postpone or "defer" its tax to the future. That is why in such cases a deferred tax liability is created in the company's balance sheet.
This is a real benefit to companies that are able to defer the tax liability into the future. It is offered by the government to encourage investments and avail of faster depreciation rates on assets. In the US this is called the Accelerated Cost Recovery System (ACRS)
Until 2000 companies were not required to dislose sources and details of deferred tax to the public. In 2001 accounting standard 22 (AS-22) was incorporated that requires companies to disclose all taxes that have been deferred.
For anyone interested in the actual application of Deferred Tax can refer to the PDF attachment that explains the mechanics of deferred tax through an example of a simple company.
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