What is deferred tax? Is this the question confusing you while maintaining the accounts of your company? The tax liabilities and maintaining their accurate record is an uphill task due to the various types of taxes and the time when they are due. In this blog, we will walk you through what the deferred payments are and they are used to maintain the balance sheet of a company. Moreover, we will discuss the process of managing the deferred payments with the help of some examples.
What is Deferred Tax?
Deferred tax is a type of tax where a company has realised a tax but the due date to pay that tax has not yet arrived. As a result, this tax payment will be added to the accounts of a company as a deferred tax rather than the paid taxes and tax liabilities.
While calculating the corporate taxes, the limited companies go through many adjustments in the earned profits. For example, the depreciation of the assets allows the companies to claim the capital allowance instead of applying for the depreciation allowances.
By adjusting for the depreciation allowances and the capital allowances, the limited companies pay higher tax in the first year and then a lower tax rate in the subsequent year. This method of paying corporate tax helps the organisation avoid the overestimation of the profits on which the tax will be levied.
As a result, the deferred taxes provide an opportunity for the companies to add deferred taxes to the corporation tax and the total tax expenses will be equal to the base rate of the corporation tax when the taxes will be paid.
In simple words, the taxes paid on a later date are called the deferred taxes and the corporate tax allows for certain adjustments before the tax is paid to avoid the overestimation of profits.
How Does the Deferred Tax Work?
There are two ways to work out the deferred tax while calculating the corporate tax in the UK. Let’s suppose Company A has a profit before any taxation or the depreciation of £5,000. Now, the company purchases a piece of equipment for the office worth £1,800 with a depreciation period of three years. The value of depreciation is £600.
Now, the accounting profit of the company after using the above information and deducting the depreciation amount from the profit of the company is equal to £4,400.
After this, the corporation tax will be calculated on this amount of accounting profit.
£4,400 * 20% (as at June 2016) = £880
If we assume the everything remains same in the subsequent years, the tax will be the same. The deduction of depreciation lowers the profit in the first year, so the tax is lowered.
However, this is not the case while computing the deferred taxes.
After this computation, the total cost of the tax paid in year two and year three will be higher as the depreciation will not be taken into account. However, it increased in the second and third years.
Benefits of Deferred tax
Some of the major benefits of deferred taxes include the balancing of the accounts records. It provides a complete guide on the taxes how to calculate them and which adjustments are needed to take into account.
Secondly, the deferred taxes help reduce the profits and the company can avoid the overestimation of the profits.
Thirdly, the deferred allows the companies to defer the payments in future. So, the payment is lower in the first year, but the higher payments have to be made in the next years.
Finally, we can say that balancing the accounts is crucial for calculating the accurate profit and the corporate tax. For this, the deferred payments become quite challenging. However, if you take into account the deductions and allowances correctly, you can calculate the deferred taxes rightly.
After reading this blog, you must not get worried about what is deferred tax as we have given you a comprehensive guide on the deferred taxes with a precise example.
Disclaimer: All the information provided in this article on What is Deferred Tax including all the text and the graphics is general in nature. It does not intend to disregard any of the professional advice.