Deferred tax

Deferred tax is an balance sheet item that is used to accrue tax to the appropriate periods. It is necessary because the tax consequences of an event in the accounts may occur in a different period from the event itself. The commonest reasons for this are:

  • losses that result in a tax credit that can only be claimed against the tax on future profits,
  • differences between depreciation or amortisation of an asset and the tax allowances that can be claimed on it during an year,
  • costs such as pensions that are accrued in the accounts, but become expenses for tax purposes only when actually paid,
  • taxes that would arise if a group company were to remit profits it has made as dividends to the parent company.

Deferred tax items may be assets or liabilities. Deferred tax liabilities are conceptually easy and highly certain. They are provisions against future tax payments that relate to current (or previous) period's profits.

Deferred tax assets are usually intrinsically less certain because there may not be future profits to claim against. Large losses lead to high deferred tax assets, which can make a weak business look as though it is backed by a stronger balance sheet than is the case. This is the major motive for the use of measures that exclude deferred tax, such as tangible common equity. Deferred tax assets are intangibles.