Deferred Tax

What is Deferred Tax?

Due to UK tax rules, some transactions of a business are recognised in one period for accounting purposes and another for tax purposes. These ‘Timing Differences’ can create both deferred tax assets and deferred tax liabilities  For example, you may have sales which are recognised this year but you may not receive the income till next year.  Technically you do not have to pay tax on the income until it is actually received. The difference between the reported amount of tax and the amount of tax due is entered in the company’s financial statements as a deferred tax liability.

The purpose of deferred tax is to ensure the tax effects of a transaction are recognised in the same period as it is for accounting purposes.

Deferred Tax Assets

Generally arise when UK tax rules stipulate that tax relief on a transaction is provided after the expense of a transaction has been deducted for accounting purposes. Examples of ‘timing differences’ which cause a deferred tax asset to occur include:

•    Where pension costs are recorded in the financial statements of a company during an employee’s working life but tax relief on this expense can not be claimed until the employee retires and the company starts to pay a pension.

•    When a company enters an accounting expense in their financial statements for the provision of bad debts but tax relief may not be obtained until the provision is utilised.
Deferred Tax Liabilities

Can arise when UK tax rules recognise tax relief in advance to an expense or where tax relief is obtained after a gain has been recognised. Examples of ‘timing differences’ which cause a deferred tax liability to occur include:

•    Where a building is revalued and results in a gain, the gain is entered in the company’s financial statements. However, the gain would not be taxed until the building is sold and the actual gain is realised.  

•    When a company depreciates fixed assets at a faster rate for tax purposes then the amount declared for accounting purposes which is based on the actual use of the fixed asset.

Please note deferred tax should be declared on a company’s financial statements for most type of ‘timing differences’.  Also deferred tax assets should not normally be offset against deferred tax liabilities.

If you would like more information or have any questions regarding Deferred Tax and the effect it would have on your company’s financial statements please contact us.

Article by Gemma Bartlett

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