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How does deferred taxation work?
Thanks Charya Peiris for explaining this concept.
Does it mean the deferred taxation is always an assets item or could it be a liability as well in some situation?
- Basis for the deferred taxation is the differences arisig between the accounting depreciation and tax depreciation (a.k.a capital allowances ).
- Accounting depreciation is based on the accounting standards and the company policy which could vary from one company to another.
- Tax depreciation is the rate set by the tax regulator for taxation purpose which is a deductible expense when arriving at the taxable profit.
-When computing the annual tax expense, the accounting depreciation is added back and the tax depreciation is deducted from the accounting profit to arrive at the taxable profit.
- Since, there is a difference between the two bases, the temporary differences arising from the assets and liabilities on the bases used is considered as derdeferred tax.
- When there is a taxable temporary difference arising from assets and liabilities a deferred tax liability arise and when there is a deductible temporary difference arising from assets and liabilities a deferred tax asset arise. These are accounted in accordance with the applicable financial reporting/accounting standards relevant to a particular country.