Have been reading Income Tax for the past few days and I must say it’s quite a challenge to visualize some of the concepts.
I understand from Schweser’s Notes (“ SN ”) that deferred tax arises due to temporary differences. As defined in SN,
DTA arises when tax payable (tax return) is greater than income tax expense (income statement) whereas;
DTL arises when tax payable (tax return) is lesser than income tax expense (income statement)
As far as the definitions are concerned, I’m fine with it. The problems come when application is required and this is how I tackle the questions:
Question: Let’s consider hypothetically, a machine for example. Under tax reporting, the machine is depreciated at 20K per annum. Under financial reporting, the same machine is depreciated at 10K per annum. Will a DTA/DTL be formed?
My thoughts:
Since machine is depreciated at a greater amount than it would have been under financial reporting, the resulting taxable income (tax return) will be lower than resulting income before tax (financial reporting). This will automatically translate to lower tax this period under tax reporting as compared to tax under financial reporting. In another words, tax payable < income tax expense; a DTL is formed.
I totally make no reference to tax base; am I wrong to see things this way?
providing the difference between tax reporting and financial reporting is indeed temporary and not permament, this approach should serve you just as well.
Many people find it more intuitive to think of the consequences of accelerated tax depreciation (relative to the depreciation recorded for financial reporting purposes) in terms of less tax payable today but more tax to be paid in the future, hence a deferred tax liability is created. Of course this logic may also be extended to other cases.
