In the world of International Financial Reporting Standards (IFRS), deferred taxes are a crucial topic for understanding the true financial position of a company.
Often, companies record their income and expenses differently for accounting and tax purposes, creating temporary differences that affect their future tax liabilities.
This article aims to explain the concept of deferred tax assets and liabilities in a simple and educational manner, using everyday examples and avoiding complex jargon.
Additionally, relevant IFRS standards will be addressed, and a practical case will be presented to better illustrate the topic.
What are deferred tax assets and liabilities?
Imagine you own a company that sells furniture.
You record the depreciation of your furniture at a faster rate for accounting purposes than for tax purposes.
This means that, on the books, your furniture shows a lower value than it does for tax purposes.
This difference between the book value and tax value of your furniture creates a taxable temporary difference.
In the future, when you sell your furniture, you will have to pay taxes on the fiscal gain you obtain, even if you have already recorded the complete depreciation at the accounting level.
To anticipate this future tax payment, IFRS requires the recognition of a deferred tax liability.
This liability represents the amount of taxes that the company expects to pay in the future as a result of taxable temporary differences.
On the other hand, deductible temporary differences may also exist.
These occur when the company records an expense on an accounting level before it can be deducted for tax purposes. In this case, the company has a deferred tax asset, as it expects to recover taxes in the future by deducting the expense for tax purposes.
Practical example deferred tax assets and liabilities.
Suppose a company purchases a machine for $100,000. At the accounting level, the company depreciates the machine at a rate of 10% annually, which means its book value decreases by $10,000 each year.
However, at the tax level, the company can only depreciate the machine at a rate of 5% annually.
This means that its tax base (the value used to calculate taxes) decreases by $5,000 each year.
Taxable temporary difference:
In this case, there is a taxable temporary difference because the book value of the machine is less than its tax base.
This means that the company will have to pay taxes on the difference of $15,000 in year 3, when it sells the machine.
Deferred tax liability:
The company must recognize a deferred tax liability for the amount of the taxable temporary difference multiplied by the tax rate.
In this example, the tax rate is 25%, so the deferred tax liability increases by $1,250, $2,500, and $3,750 in years 1, 2, and 3, respectively.