Can somebody please explain me why an extension in tax loss carryforward period wil lead to decrease of valuation allowance for DTA? I thought it will impact future taxes (i.e. the company will not pay income tax because of previous negative financial results). How exactly such extension increase the probability that the company will realize the DTA? Thanks!
I believe it is like this.
Extension of tax-loss carryforward means that it is likely that the company will be profitable for the foreseeable future.
The valuation allowance is like a contra account (like bad debts) that reduces the DTA. As the company will be profitable, the valuation allowance decreases and the company will be able to fully utilize the DTA to reduce taxes payable.
Not sure if this is 100% correct though
I continue thinking on this question. The question is from CFAI Mock Exam so I’m a little worried I can’t get to their answer.
Let’s examine the following hypothetical example:
year 1: Paid taxes = 200 Income tax = 100 => DTA = 100
year 2: NI = - 1,000
year 3: NI = -500
Because we are not sure whether in future there will be positive NI we create valuation allowance, let’s say = 100. For the purpose of the example, let’s the initial tax loss carryforward period to be 2 years and the tax rate to be 25%.
year 4: NI = 300 ( no taxes because of the previous loss)
year 5: NI = 400 (again no taxes payable)
year 6: NI = 600 Taxes payable = 25%*600 = 150. We have DTA = 100 => Taxes payable = 50
Now if the tax loss carryforward period is extended to 4 years, for year 6 we have:
year 6: NI = 600 (previous loss -1,500 + next positive NI 300+400+600 > 0 => no taxes payable)
=> if we can use DTA it will be in year 7 or 8 etc.
So extension of the tax loss carryforward period postpones the realization of DTA. Then why such extension decreases the valuation allowance?
TripleMinor, thank you for your answer. Isn’t extension of tax loss carryforward period determined by the local tax laws (for example, in my country it is 5 years)? Is so, such extension does not apply anything for the company’s prospectus, it’s just a regulation valid for all companies in the country.
PS: I hate taxes 
Isn’t it just as simple as: an extension in a tax loss carryforward is a grater sign of profitibility in the future thus reducing valuation allowance, and subsequently increasing DTA?