Deferred Tax

Basic background

The profit per the accounts is different to the profit per the tax computation due to adjustments such as entertaining, depreciation and so on.

The adjustments in the tax computation can be split into two types:

Permanent - for example, entertaining. This is never going to be tax deductible in this or any other period so the difference between the accounting profit and the tax profit is permanent.
Timing difference – for example, the difference between depreciation in the accounts and the capital allowance in the tax computation. Both capital allowances and depreciation will reduce the asset value to nil but they will do so by different amounts over a different time period. These differences are known as accelerated capital allowances and the difference will reverse over time, see the example 1 below.

Deferred tax is not provided on Permanent differences, only timing differences.

Capital Allowances and Depreciation

Example 1 - Reversal of timing differences:

A business buys an asset for £1,000
It depreciates it at 15% reducing balance in the accounts
The asset is entitled to a 40% FYA for corporation tax.

	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Depreciation at 15% reducing balance	150	128	108	92	78	67	57	48	41	35
WDA at 40% FYA then 25%	400	150	133	84	63	47	36	27	20	15
Difference between WDA and depreciation	-250	-23	-4	8	15	19	21	21	21	20

	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
NBV per accounts	850	722	614	522	444	377	320	272	231	196
WDV per tax	600	450	337	253	190	143	107	80	60	45
Difference between WDA and depreciation	250	272	277	269	254	234	213	192	171	151

Initially the allowances in the tax computation will be higher than the depreciation in the accounts. Over time this reverses and the depreciation figure becomes higher than the allowances.

Why Deferred Tax?

If the above company had a profit of £400 its accounting and tax profits would look like this:

	Accounts	Tax
Profit before depreciation / WDA	400	400
Less: depreciation / WDA	150	400
	250	Nil
Taxation	-
Profit after tax	250

This is confusing for the reader of the accounts, if there is a profit why isn’t there a tax charge?

It isn’t prudent, if there’s going to be a liability in the future we should provide for it.

Good news / bad news approach (asset or liability?)

Deferred tax can be an asset or a liability depending on the nature of the timing difference. You can work out which it will be using the good news / bad news approach.

Basically if something is GOOD NEWS NOW then this must mean BAD NEWS LATER and vice versa.

If it is bad news later you provide a liability
If it is good news later you provide an asset

Good news / bad news example:

In the early years of an asset’s life the capital allowance is often higher than the depreciation. (See the earlier example above where the 25% allowance is higher than the 15% depreciation).
This means that initially the tax profit will be lower than the accounting profit, this is GOOD NEWS NOW because then the company gets charged less tax.

BUT

As we saw above this will slowly reverse so the tax profit will be higher than the accounting profit, this will be BAD NEWS LATER as the tax charge will be higher.
Prudence dictates that a deferred tax liability is provided.

Business Tax can calculate the timing differences on fixed assets automatically for the client as it:

knows the NBV of the assets in Accounts Production
knows the WDV of the assets in Business Tax
can deduct one from the other and multiply by the tax rate to calculate the deferred tax liability / asset.

Accelerated capital allowances screen

Bad news later – make a provision

The accelerated capital allowances of 250 x 19%

So now the accounts look like this:


Profit before depreciation	£400
Less : depreciation	£150
Profit before tax	£250
Deferred tax provision	£49
Profit after tax	£201

This is because you enter a journal in Accounts Production as follows:

Dr Deferred Tax (A/c 450) £49
Cr Deferred Tax (A/c 932) £49

Let’s skip ahead to 2005

As Example 1 showed in 2005 the timing difference starts to reverse.

So we need to start decreasing the provision:

Cr Deferred Tax (A/c 450) 2
Dr Deferred Tax B.S (A/c 932) 2

There will still be a credit in the balance sheet but it’s starting to reduce.

Short term timing differences

There are other types of timing difference, usually regarding provisions in the accounts, examples are the pension provision or general bad debt provision. These are called short term timing differences. Business Tax can work out the movement on these accounts and therefore the deferred tax from the trial balance.

To nominate accounts that cause short term timing differences use the Details, Deferred Tax, Short Term Timing Difference screen.

Short term timing differences screen

This screen allows users to add short term timing differences
The user has the choice of:
picking up a trial balance item; or
adding a freeform item
Business Tax then calculates the movement for the deferred tax report.