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What Deferred Tax Means to Your Business

Deferred tax can relate to a positive or negative asset and the entry can be found on a balance sheet. This entry refers to the tax that has been overpaid or is owed due to a few differences. This article aims to explore what deferred tax is and when it is useful.

deferred tax
If you take a look at your balance sheet, you might come across deferred tax. Read this article to find out, what this means! (© unsplash.com)

What Is Deferred Tax?

As we have already seen, deferred tax can relate to a positive or negative asset and the entry can be found on your balance sheet. It is often considered to be one of the following categories:

  • Liabilities
  • Assets

Both of these categories will appear on a balance sheet as entries. They will represent the positive and negative tax that is owed. Please note, there can be a positive without a negative, and vice versa. When it comes to working out what tax is paid or owed it will be determined by whether it is a liability or asset.

What is Deferred Tax Liability?

Deferred tax liability occurs when a company has a specific amount of income for a specific accounting period. The amount in question is different to the taxable amount that is found on their tax return. When this is less than the amount of estimated tax, a liability is entered on the balance sheet.

Deferred tax usually refers to liabilities. This is where the amount that has been entered onto the balance sheet has to be paid in the future.

Example:

AA Windows and Conservatories have machinery that is considered to be an asset. The company uses a depreciation method that allows high deductions when the asset is new. It also allows low deductions the further down the line.

This is different to straight-line depreciation that the tax authorities use, which spreads the depreciation over the life of the asset. This method has an effect on how much the charges for the specific accounting period will be. The charges can be claimed under capital allowance.

As AA Windows and Conservatories use the depreciation method, it will result in a large deduction, to begin with. This deduction is not used by the tax authorities. This ultimately means that their income is higher than their taxable income. The difference will be added to the balance sheet as a liability.

What is Deferred Tax Asset?

When a business has overpaid on a tax period, this will be marked on the balance sheet as a deferred tax asset. If the taxes are paid in advance or they have been overpaid, this over-payment is considered to be an asset. It shows that the company is entitled to a small tax break the next time they file their taxes.

When you pay in advance, creating tax assets can help a business that is looking to decrease the tax liability in the next period.

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