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Deferred tax explained

Keeping track of tax is key to compliance, but what should you do about tax that is due but not yet paid? That’s deferred tax. Your company may have a deferred tax asset or a deferred tax liability. Find out everything you need to know with our guide to deferred tax explained, right here.

What counts as a deferred tax liability?

Deferred tax liability is simply the name given to temporary differences between the tax noted on your balance and your actual tax paid or unpaid.

Deferred tax asset vs. deferred tax liability

Depending on the nature of your tax, it can be a deferred tax liability or a deferred tax asset, both of which will appear on your company’s balance sheet.

  • Deferred tax assets: An item on the balance sheet that shows overpayment or advanced payment of tax.

  • Deferred tax liability: An item on the balance sheet that shows unpaid tax.

While one counts as owed and one counts as paid, it’s possible to have one without the other, so it may be that your company books feature only deferred tax asset entries and no deferred tax liability entries, or the other way around.

How does a deferred tax liability occur?

A deferred tax liability occurs when a business’s income for a set period is different from what’s been recorded on their tax return. This can be because the tax doesn’t need to be paid yet, rather than a genuine failure to pay. Even if the tax is not yet due, the taxed item still needs to be added to the balance sheet, which is where the discrepancy occurs.

Deferred tax liability example

Deferred tax liability cases most commonly involve the depreciation of fixed assets.

For example, Company A decides to purchase new machinery and chooses a depreciation method that allows them to have higher deductions now and lower deductions in the future. Alternatively, they could have spread the depreciation of this new asset evenly across its whole life cycle. As the company has opted for a higher deduction – thus less tax – their income for this period will be higher than future tax periods. However, this is only temporary. In the future, the deductions will be lower. This temporary difference will still show on the balance sheet as a liability, even though it balances out over the life of the asset.

How does a deferred tax asset occur?

A deferred tax asset happens when a company overpays its tax or pays it in advance. By doing so, they ensure a tax break in the future and decrease their tax liabilities. Many larger companies must pay UK corporation tax based on forecasted profits for a certain period. If these do not prove accurate once that period has passed, a refund is due. HMRC can send the deferred tax payments to the company bank account or let you use it to pay off other taxes, such as VAT.

Generally speaking, no one should aim to purposefully overpay on tax, as it can be complicated to claim back tax unless you can prove your business will not be able to benefit from a tax cut in the future. For example, if your company has suffered from falling profits in one tax period (and would be due a tax return) but then successfully closes half a dozen contracts, HMRC may not grant you a refund on the basis that you are on the road to financial recovery.

Is deferred tax bad?

No, deferred tax is a widespread business occurrence, so you shouldn’t worry that HMRC will come knocking at your door if you find you have some on your balance sheet. It’s essential to report your figures accurately and make sure any liabilities are paid in the future and any assets refunded or put towards future tax.

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GoCardless (company registration number 07495895) is authorised by the Financial Conduct Authority under the Payment Services Regulations 2017, registration number 597190, for the provision of payment services. GoCardless SAS (23-25 Avenue Mac-Mahon, Paris, 75017, France), an affiliate of GoCardless Ltd (company registration number 834 422 180, R.C.S. PARIS), is authorised by the ACPR (French Prudential Supervision and Resolution Authority), Bank Code (CIB) 17118, for the provision of payment services.