Deferred taxation giving rise to deferred tax assets or liabilities. It stems:

• either from differences in periods in which the income or cost is recognised for tax and accounting purposes;
• or from differences between the taxable and book values of assets and liabilities.

On the income statement, certain revenues and charges are recognised in different periods for the purpose of calculating pre-tax accounting profit and taxable profit.

In some cases, the difference may be temporary due to the method used to derive taxable profit from pre-tax accounting profit. For instance, a charge has been recognised in the accounts, but is not yet deductible for tax purposes (e.g., employee profit-sharing in some countries); or vice versa.

The same may apply to certain types of revenue. Such differences are known as timing differences. In other circumstances, the differences may be definitive or permanent; i.e., for revenue or charges that will never be taken into account in the computation of taxable profit (e.g., tax penalties or fines that are not deductible for tax purposes). Consequently, there is no deferred tax recognition.

On the balance sheet, the historical cost of an asset or liability may not be the same as its tax base, which creates a temporary difference. Depending on the situation, temporary differences may give rise to a future tax charge and thus deferred tax liabilities, while others may lead to future tax deductions and thus deferred tax assets. For instance, deferred tax liabilities may arise from:

• assets that give rise to tax deductions that are lower than their book value when sold or used. The most common example of this derives from the revaluation of assets upon the first-time consolidation of a subsidiary. Their value on the consolidated balance sheet is higher than the tax base used to calculate depreciation and amortisation or capital gains and losses;
• capitalised financial costs that are deductible immediately for tax purposes, but that are accounted for on the income statement over several years or deferred;
• revenues, the taxation of which is deferred, such as accrued financial income that becomes taxable only once it has been actually received.

Deferred tax assets may arise in various situations including charges that are expensed in the accounts but are deductible for tax purposes in later years only, such as:

• provisions that are deductible only when the stated risk or liability materialises (for retirement indemnities in certain countries);
• certain tax losses that may be offset against tax expense in the future (i.e., tax loss carryforwards, long-term capital losses).

Finally, if the company were to take certain decisions, it would have to pay additional tax. These taxes represent contingent tax liabilities; e.g., stemming from the distribution of reserves on which tax has not been paid at the standard rate.

How are they accounted for?

It is mandatory for companies to recognise all their deferred tax liabilities in consolidated accounts. Deferred tax assets arising from tax losses should be recognised when it is probable that the deferred tax asset can be used to reduce tax to be paid.

Deferred tax liabilities are not recognised on goodwill where goodwill depreciation is not deductible for tax purposes, as is the case in the UK, Italy or France. Likewise, they are not recorded in respect of tax payable by the consolidating company on distributions (e.g., dividend-withholding tax) since they are taken directly to shareholders’ equity.

In some more unusual circumstances, the temporary difference relates to a transaction that directly affects shareholders’ equity (e.g., a change in accounting method), in which case the temporary difference will also be set off against the company’s shareholders’ equity. IAS do not permit the discounting of deferred tax assets and liabilities to net present value.

Deferred tax is not the same as contingent taxation, which reflects the tax payable by the company if it takes certain decisions. For instance, tax charges payable if certain reserves are distributed (i.e., dividend-withholding tax), or if assets are sold and a capital gain is registered, revenues qualifying for a lower rate of tax provided they are not distributed to shareholders (long-term capital gains in some countries, etc.). The principle governing contingent taxation is straightforward: it is not recorded on the balance sheet and no charge appears on the income statement.

Deferred taxation is the product of accounting entries triggered by differences between accounting values and tax bases (on the balance sheet) or between accounting and tax treatments (on the income statement). The corresponding double entry is made either on the income statement or to shareholders’ equity. For instance, a company that posts a loss for a given period owing to exceptional circumstances will recognise a deferred tax asset in its consolidated accounts, the double entry to which will be a tax benefit that reduces the amount of the after-tax reported loss. Please note that the deferred tax asset does not represent an amount due from the State, but only a future tax saving assuming positive net income in the near future.

Accordingly, we would advise treating deferred tax assets due to past losses as an intangible asset or to deduct it from shareholders’ equity to arrive back at the original amount of the nonrecurrent loss for the year.

For deferred tax assets linked to provisions that are not tax-deductible, we would advise deducting the related deferred tax asset from the provision (which will appear after tax on the balance sheet) or deducting it from shareholders’ equity. We recommend adding the deferred tax assets linked to assets with a different tax and accounting base (a frequent case after an acquisition booked under purchase accounting3) to goodwill (as goodwill was initially reduced by accounting for their deferred tax assets which has no real value). We advise adding deferred tax liabilities created by differences between tax and accounting base to shareholders’ equity.