What is a deferred tax liability?
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A DTL means that a company owes a tax liability, which it does not have to pay immediately. Instead, it has to pay the liability at some point in the future.
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What is Deferred Tax Liability?
By Bajaj Broking Team
March 07, 2025
6 mins read
Taxes
Synopsis:
Often while analysing a company’s financials, you can see an item called “Deferred Tax Liability,” which is a tax liability that a company owes but is not payable until a future date. Read more..It typically arises due to differences between tax laws and accounting rules in terms of how to recognise certain income and expenses. As such liabilities are payable at a later date, they can affect a company’s future financials. Read less
Deferred tax liability is a common item that you can find in the financial statements of companies. It means a tax liability that a firm owes but is not payable until a future date.
Let us say that you are analysing the balance sheet of ABC Ltd. and you notice that it has a deferred tax liability of ₹ 10 lakh. In simple words, it means that ABC Ltd. owes ₹ 10 lakh as taxes but it is payable only on a future date. Hence, it is recorded as a liability. Having learnt what deferred tax liability is, let us delve deeper into this topic.
Causes of Deferred Tax Liabilities
Such liabilities are the result of the differences between how certain income and expenses are treated for accounting and tax purposes. Some of the common reasons for deferred tax liabilities are explained below:
Differences in depreciation methods: Let us explain this with an example. Suppose a company uses a straight-line method for depreciation, which results in the same amount of depreciation every year. However, for tax purposes, it uses the accelerated depreciation method, which results in higher depreciation in the initial years of an asset’s life. Therefore, for tax purposes, the company records a higher depreciation expense than it records for accounting purposes. Consequently, it has a lower profit before tax for tax purposes than for accounting purposes. So, it pays a lower tax to authorities in the current year. To adjust for it, it should record a deferred tax liability.
Differences in revenue recognition: Companies often record revenue when it is accrued. In other words, they record certain revenue when they ought to receive it, even if they have actually not received it in cash. But, tax laws can say that a certain revenue should be recognized only when a company actually receives it in cash. In such a case, a company’s accounting income is higher (because it has already recorded revenue) than its income as per tax laws. Hence, it has to record a deferred tax liability.
Impact of Deferred Tax Liability on Financial Statements
A deferred tax liability can have a profound impact on a company’s financials, depending upon its size and when it is falling due. Hence, you should be careful of such liabilities when analysing a company’s financial statements.
Deferred tax liabilities are shown on the liability side of a balance sheet, as they represent an amount that a company owes to tax authorities, which is payable on a future date. Typically, it is a long-term obligation, usually payable after a year. Hence, deferred tax liability is often classified as a long-term liability. However, if it is falling due within 12 months, it can also be classified as a current liability.
While such liabilities are usually not payable in the current financial year, they certainly are payable sometime in the future. Hence, if you notice a significant amount under deferred tax liabilities on a company’s balance sheet, you should check when the amount is payable because it will affect the company’s cash flows in the future.
You need to analyse whether the company will have sufficient cash flows in the future to pay its deferred tax liabilities. If you think a company may struggle to pay such liabilities, then you should definitely raise a concern.
Hence, whether you have just opened a trading account or are an experienced stock market investor, you ought to understand the concept of deferred tax liability really well.
Deferred Tax Asset (DTA) vs. Deferred Tax Liability (DTL)
Both deferred tax liability and deferred tax asset are created due to timing differences between how tax laws and accounting regulations recognize certain income and expenses. While these concepts are related, they are also different from each other, as explained in the following table.
Criteria | Deferred Tax Liability (DTL) | Deferred Tax Asset (DTA) |
When it is recognised | When a company owes tax, which is payable on a future date, it records a DTL. | When a company pays tax in the current financial period, which is actually payable on a future date, it records a DTA. |
Differences in profit between an income and a tax statement | When a firm’s profit in its income statement is higher than that in its tax statement, a DTL is created. | When a company’s profit in its income statement is lower than its profit in its tax statement, a DTA is created. |
Where it is shown | A DTL is typically shown under non-current liabilities on a firm’s balance sheet. | A DTA is shown under non-current assets on a company’s balance sheet. |
How to Manage Deferred Tax Liabilities
It is extremely important for companies to manage their deferred tax liabilities (DTL). If DTLs are not managed well, a company may not have sufficient cash to pay them when they fall due. Here are the steps that a firm can follow to manage such liabilities well:
Know the root cause of DTLs: A firm needs to understand the source of its DTLs to effectively manage them. Typically, such liabilities arise because of differences in how certain income and expenses are treated by accounting rules and tax laws. Often, DTLs are caused by differences in how tax laws and accounting regulations treat depreciation and certain revenues.
Keep track of changes in tax laws and rates: When tax laws and rates change, it can result in deferred tax liabilities or assets. Hence, companies should monitor such changes. It is a good idea to take help of a chartered accountant or a tax expert on such matters to do away with any ambiguity.
Plan for future payment of DTLs: DTLs are tax liabilities that are payable in the future. Hence, companies should create cash reserves which can be used for such payments when required. By maintaining sufficient cash reserves to pay DTLs, companies will be able to avoid cash flow problems.
Common Examples of Deferred Tax Liabilities
Deferred tax liabilities are often caused by differences between how tax and accounting rules treat depreciation. Let us say that a company has an asset worth ₹ 20 lakh with a 10-year life-span and zero salvage value. Suppose that it follows the straight-line depreciation method. Hence, it will record a depreciation expense of ₹ 2 lakh per year for 10 years.
Suppose tax laws require it to follow the accelerated depreciation method at the rate of 15% depreciation every year. Hence, it will record ₹ 3 lakh depreciation (15% * ₹ 20 lakh) this year as per tax laws. As per tax laws, it records ₹ 1 lakh higher than what it records in its accounting books. Therefore, its profit in its tax books will be lower than in its accounting books. So, to adjust for it, it should record a deferred tax liability.
DTLs are also created due to differences in the way a certain income is treated by accounting and tax laws. Suppose a company records a gain in its books of accounts when it ought to receive it; however, the company will receive the gain only in the next year.
Suppose the tax laws require it to record the gain only on its actual receipt. So, it will record the gain in its tax books only next year. Hence, its accounting profit will be higher than its profit as per tax laws in the current financial year. So, it should record a DTL this year.
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This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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Frequently Asked Questions
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How does a deferred tax liability arise?
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It arises due to differences between how tax laws and accounting rules recognize certain income and expenses.
What are the common examples of deferred tax liabilities (DTLs)?
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Typically, DTLs are created due to differences between how tax and accounting rules treat depreciation expense, revenue recognition, and provisions for warranties or bad debts. Such differences cause a delay in tax payments, resulting in deferred tax liabilities.
How does deferred tax liability affect a company's financial statements?
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A DTL shows that a company will have to pay a tax obligation at some point in the future. Hence, it can affect its cash flow when it is actually paid. Depending upon the size of such a liability, it can have a huge impact on a company’s financials.
What is the difference between deferred tax liability and deferred tax asset?
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A deferred tax asset shows that some of the tax paid by a company in the current year actually belongs to a future year. However, a deferred tax liability shows that a company has to pay a tax liability on a future date.
How can companies manage deferred tax liabilities effectively?
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Companies can manage their deferred tax liabilities by understanding the root cause of such liabilities, monitoring changes in tax rates and laws, and planning for future payment of such liabilities.
Are deferred tax liabilities considered bad for a company?
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Such liabilities are not necessarily bad for a company. That said, a firm has to pay its deferred tax liability on a future date. Hence, it needs to have sufficient cash flow to pay it. Otherwise, it can result in a problem.
Can deferred tax liabilities impact cash flow?
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Yes, such liabilities can impact a firm’s cash flows when they are actually paid in the future. That said, a company can also maintain a cash reserve in the current financial year to pay its DTL on a future date.
How are deferred tax liabilities accounted for in financial statements?
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Such liabilities are shown under long-term liabilities on a company’s balance sheet if they are payable after 12 months. However, if they are payable within a year, they are shown under current liabilities.
What are the tax implications of deferred tax liabilities?
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DTL shows that a company owes tax that is payable in the future. Such liabilities arise when a firm’s accounting income is higher than its taxable income.
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