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What is Deferred Tax Liability

What is Deferred Tax Liability? Meaning, Calculation with Example

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Deferred tax liability represents the future tax a company owes due to temporary differences between accounting income and taxable income. It impacts cash flow, financial planning, and business decisions, making it important for business owners and investors to understand. Let’s know the meaning of deferred tax liability and how you can calculate it. show less ...Read More

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Written byAbhishek Chakravarti

Taxation & Finance Writer

Published 10th December 2025

Reviewed byAlok Mishra

Last Modified 10th December 2025

Taxation & Finance Expert

Understanding Deferred Tax Liability

Deferred tax liability is a future tax obligation that arises when the profit reported in a company’s financial statements differs from the profit calculated for tax purposes. In simple terms, it reflects the portion of direct tax that is postponed for payment to a future time due to temporary differences in the way income and expenses are recognised under accounting standards and the Income Tax Act, 1961.

Let's understand with an example. Let's assume you run a small manufacturing company. Accounting-wise, you write off your machinery after ten years due to depreciation. However, when it comes to taxes, the Income Tax Act allows you to write off depreciation at a faster rate, let’s say, within 5 years.

This implies that your current tax deduction will be higher, reducing your taxable income. However, you will have to pay more tax as your accounting depreciation expires, so your taxable income increase in the later years, as you will no longer be able to claim higher depreciation. Overall, the deferred tax liability is the future tax that you will have to pay.

The main point is that deferred tax liability does not arise from permanent differences due to fines or disallowed expenses, which cannot be reversed. Instead, it stems only from timing differences, meaning items of income or expense are recognised in different periods for taxation and accounting purposes.

How to Calculate Deferred Tax Liability

Deferred tax liability calculation follows a clear process that links accounting profit, taxable profit, and the applicable tax rate. The goal is to identify the portion of tax that has been postponed to a future year because of timing differences. Below is a step-by-step guide on how to calculate deferred tax liability in practice.

Step 1 – Find the Temporary Difference

Calculate the difference between the carrying amount of an asset or liability in the financial statements and its corresponding tax base under the Income-tax Act, 1961. This difference, when it is expected to reverse in the future, is called a temporary difference.

Step 2 – Calculate the Exact Temporary Difference.

Now that you have determined the temporary difference, find the precise amount of difference. Let's use an example to grasp this better. If your machinery has a book value of ₹10 lakh, but the tax base is ₹8 lakh due to accelerated tax depreciation, then the temporary difference is ₹2 lakh.

Step 3 – Apply the Relevant Tax Rate

Once the taxable temporary difference is calculated, the next step is to apply the tax rate applicable to the company. This rate should be the one that has been enacted or substantially enacted by the balance sheet date. The standard formula for deferred tax calculation is:

Deferred Tax Liability = Temporary Difference × Tax Rate

From the above example, the temporary difference was ₹2 lakh. Assuming a tax rate of 30%, deferred tax liability = 2 lakh x 30% = ₹60,000.

Step 4 – Record in the financial statements.

The calculated deferred tax liability is shown under non-current liabilities on the company’s balance sheet. Companies must also disclose the nature and amount of temporary differences in the notes to accounts.

It reflects a future outflow of resources that must be recalculated at the end of each reporting period to capture any changes in timing differences or tax rates. As you can see, this mechanism is significantly different from the income tax slab and rates mechanism applicable to individual tax payers.

Deferred Tax Calculation Example

Below is the deferred tax calculation example for better understanding.

Particulars	For book (₹)	For tax (₹)	Temporary difference (₹)	Deferred tax liability @30% (₹)
Profit before depreciation	1,000,000	1,000,000	0	0
Depreciation on fixed assets	100,000	150,000	50,000	15,000
Provision for doubtful debts	50,000	0	- (50,000)	- (15,000)
Sales tax payable	20,000	0	- (20,000)	- (6,000)
Leave encashment provision	30,000	15,000	- (15,000)	- (4,500)
Total temporary differences	-	-	15,000	- (10,500)

Explanation for deferred tax liability example.

Book vs. tax depreciation: Accounting depreciation is ₹100,000, whereas tax depreciation is ₹150,000. This creates a taxable temporary difference of ₹50,000.
Other timing differences: Provisions for doubtful debts, sales taxes, and leave encashment are recognised differently in books and tax calculations.
Calculate the tax: Multiply each temporary difference by the tax rate for the company (30% in this case) to calculate the deferred tax.
Net deferred tax liability: Summing up the deferred taxes gives the total deferred tax liability of ₹10,500. It shows how much the business will owe in taxes in the future because of timing differences.

Causes and Factors Of Deferred Tax Liability

The deferred tax liability causes are listed below.

1. Differences in depreciation methods

Companies may use accounting depreciation based on the useful life of assets under the Companies Act, 2013. But depreciation under the Income Tax Act, 1961, may allow higher deductions in the early years. This timing difference produces deferred tax liability, as the profit is lower than the accounting profit.

2. Revenue recognition timing differences

Income may be recorded in financial statements when earned. But for tax purposes, it might be recognised only when it is received. Examples may include credit sales or accrued interest. Such discrepancies cause taxable temporary differences, and deferred tax liability is presented until the revenue is taxed in a later period.

3. Expense recognition variations

Some expenses may be recorded in the books of accounts before they are deductible for tax purposes. Provisions for doubtful debts, leave encashment, or prepaid expenses are some examples. They lower the accounting profit as compared to taxable profit, which causes deferred tax liability.

4. Changes in income tax laws

Amendments to tax rates, rules for allowable deductions, or conditions or accelerated depreciation can change the deferred tax liability. If tax rates decrease, previously recognised deferred tax liability may be adjusted downward, and vice versa.

5. Carry-forward of tax losses or gains

Companies sometimes carry forward losses or unabsorbed depreciation to offset future taxable profits. While this lessens future tax payments, it also creates timing differences if accounting recognition and tax treatment are not in the same period, which is one of the deferred tax factors.

6. Other timing differences

Any temporary mismatch between accounting income and taxable income, like differences in amortisations of intangible assets, warranty expenses, or capital allowances, can give way to deferred tax liabilities.

Deferred Tax Liability vs Deferred Tax Asset

Deferred tax is created due to timing differences between accounting profit and taxable profit. Whether the tax effect causes a future liability or an expected lower tax, it is classified as a deferred tax liability or a deferred tax asset.

Parameter	Deferred tax asset	Deferred tax liability
Basis of recognition	Occurs when tax has already been paid or is deductible now, but will lower future tax payments	Arises when tax will be payable in future periods due to temporary differences
Creation scenario	When accounting income is lower than taxable income, for example, carry-forward losses or provisions for doubtful debts	When accounting income is higher than taxable income, e.g., accelerated depreciation for tax purposes
Balance sheet classification	Shown under non-current assets	Shown under non-current liabilities
Effect on financial statements	Minimises future tax outflows, improving cash flow planning	Increases future tax obligations, alerting investors and management to future cash requirements
Reversal	Realised in future periods when temporary differences reverse, lowering taxable profit	Settled in future periods as temporary differences reverse, increasing taxable profit

Takeaways:

Both DTA and deferred tax liability are recognised only for timing differences, not permanent fines or non-deductible expenses A DTA reflects taxes paid in advance or benefits that will minimise future taxes, whereas a deferred tax liability signals taxes that a company will need to pay later
Both DTA and deferred tax liability are recognised only for timing differences, not permanent fines or non-deductible expenses

Importance of Deferred Tax Liability in Tax Planning

The importance of deferred tax liability is explained below.

1. Cash flow

A deferred tax liability indicates a future cash outflow for taxes. Anticipating this liability can help companies better handle their working capital and investment decisions. This can minimise the strain on liquidity when the tax payment becomes due.

2. Tax planning

How temporary differences that create deferred tax liabilities (e.g., accelerated depreciation for tax purposes versus straight-line depreciation for accounting) allow companies to time capital expenditures and asset disposals. This approach is important in tax planning with deferred tax. It enables the deferral of tax payments to later periods.

3. Financial statement analysis

Analysts and investors study deferred tax liability to review the quality of a company’s reported income. An increasing sum may reveal aggressive tax planning or timing differences.

4. Compliance and reporting

Proper computation and disclosure of deferred tax liability are mandatory for financial compliance under IND AS 12 – Income Taxes. Errors/omissions can cause fines, investors losing trust and other long-term impact.

5. Investment decisions

For investors, a deferred tax liability provides insight into a company’s tax burden and cash on hand for making further investments. It can help in examining the chances of tax payments in the future.

6. Understanding business performance:

Your reported income is affected by deferred tax adjustments. You can obtain a more comprehensive view of your company's actual performance by taking these adjustments into account.

FAQs

What is the difference between deferred tax liability and current tax?

Current tax is the income tax payable for the current accounting period, based on the taxable income. Deferred tax liability, on the other hand, is future tax obligations due to timing differences between accounting income and taxable income. Current tax concerns immediate cash outflow. But deferred tax impacts future periods.

Can deferred tax liabilities reduce taxable income?

No. Deferred tax liabilities do not minimise current taxable income. They show taxes postponed to future periods due to temporary differences. Only deferred tax assets can lower future income when deductible temporary differences reverse.

How often should companies reassess deferred tax liabilities?

Companies must reassess deferred tax liabilities at the end of each reporting period. Any changes in temporary differences, tax rates, or tax laws are correctly shown in the financial statements and applicable ITR forms.

Are deferred tax liabilities permanent or temporary?

Deferred tax liabilities are temporary by nature. They stem from timing differences that will reverse in future periods. One instance is differences in depreciation methods. Permanent fines or non-deductible expenses do not give rise to them.

How do the tax rate changes affect deferred tax liabilities?

Deferred tax liabilities are measured using the tax rates enacted or substantially enacted at the reporting date. Any change in tax rates needs recalculation, which can increase or decrease the liability and affect the company’s future tax planning and reported financial position.

Where are deferred tax liabilities reported in the balance sheet?

Deferred tax liabilities are reported under non-current liabilities on the balance sheet. Companies also disclose the nature, amount, and temporary differences in the notes to accounts. It provides investors, auditors, and the government with transparency.

ARN: Nov25/Bg/24K

Sources:

https://economictimes.indiatimes.com/wealth/tax/short-term-capital-gains-on-listed-equities-hiked-from-15-of-20-how-will-it-impact-your-investments/articleshow/111952832.cms

https://cleartax.in/s/asset-types

https://incometaxindia.gov.in/tutorials/14-%20stcg.pdf

https://cleartax.in/s/short-term-capital-gain-tax-on-property

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