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28.5 Tax Accounting: Deferred Tax Assets and Liabilities

Understanding Tax Accounting​

Tax accounting involves recognizing the tax effects of transactions in financial statements. This includes current taxes (taxes payable for the current year) and deferred taxes (tax effects of temporary differences between accounting and tax treatment).

Temporary Differences​

What Are Temporary Differences?​

Temporary differences arise when:

  • Income or expenses are recognized in different periods for accounting vs. tax
  • Depreciation methods differ between accounting and tax
  • Provisions are treated differently
  • Other timing differences exist

Key Point: Temporary differences reverse over time, creating deferred tax assets or liabilities.

Deferred Tax Assets​

When Deferred Tax Assets Arise​

Deferred Tax Assets arise when:

  • Tax deductions are recognized before accounting expenses
  • Accounting expenses exceed tax deductions
  • Tax losses create future tax benefits
  • Other situations where taxes paid exceed accounting tax expense

Example:

  • Accounting depreciation: €10,000
  • Tax depreciation: €15,000
  • Difference: €5,000 (tax deduction exceeds accounting expense)
  • Deferred tax asset: €5,000 × 24.94% = €1,247

Recognition of Deferred Tax Assets​

Recognition Criteria:

  • Must be probable that future taxable profit will be available
  • Can use deferred tax asset to reduce future taxes
  • Valuation allowance may be needed if recovery uncertain

Deferred Tax Liabilities​

When Deferred Tax Liabilities Arise​

Deferred Tax Liabilities arise when:

  • Accounting expenses are recognized before tax deductions
  • Tax deductions exceed accounting expenses
  • Income is recognized for accounting before tax
  • Other situations where accounting tax expense exceeds taxes paid

Example:

  • Accounting depreciation: €15,000
  • Tax depreciation: €10,000
  • Difference: €5,000 (accounting expense exceeds tax deduction)
  • Deferred tax liability: €5,000 × 24.94% = €1,247

Accounting for Deferred Taxes​

PCN Accounting​

Deferred Tax Asset:

  • Debit: Account 281 (Deferred Tax Assets)
  • Credit: Account 695 (Tax Expense) or Account 13 (Tax Provisions)

Deferred Tax Liability:

  • Debit: Account 695 (Tax Expense)
  • Credit: Account 17 (Deferred Tax Liabilities)

Common Temporary Differences​

1. Depreciation Differences​

Situation:

  • Accounting: Straight-line depreciation
  • Tax: Accelerated depreciation

Result:

  • Early years: Deferred tax liability (tax depreciation > accounting)
  • Later years: Deferred tax asset (accounting depreciation > tax)
  • Reverses over asset life

2. Provisions​

Situation:

  • Accounting: Provisions recognized immediately
  • Tax: Provisions not deductible until paid

Result:

  • Deferred tax asset created
  • Reverses when provision is paid

3. Revenue Recognition​

Situation:

  • Accounting: Revenue recognized when earned
  • Tax: Revenue recognized when received

Result:

  • Deferred tax liability if revenue recognized for accounting first
  • Reverses when revenue received for tax

Tax Expense Calculation​

Total Tax Expense​

Components:

  1. Current Tax Expense: Tax payable for current year
  2. Deferred Tax Expense: Change in deferred tax assets/liabilities

Formula:

  • Total Tax Expense = Current Tax + Deferred Tax Expense

Example:

  • Current tax: €50,000
  • Deferred tax expense: €2,000
  • Total tax expense: €52,000

Luxembourg Compliance Note​

Important Requirements:

  • Accurate calculation: Calculate deferred taxes accurately
  • Proper recognition: Recognize deferred taxes in financial statements
  • Valuation allowances: Consider need for valuation allowances
  • Disclosure: Disclose deferred taxes in financial statements
  • Professional advice: Consult accountant for complex situations

Common Issues:

  • Missing deferred taxes: Not recognizing deferred taxes
  • Calculation errors: Errors in deferred tax calculations
  • Valuation allowances: Not considering need for allowances
  • Reversal timing: Incorrect timing of reversals

Think It Through​

TechLux Solutions purchases equipment for €100,000. For accounting, they use straight-line depreciation (10% per year). For tax, they use accelerated depreciation (50% in first year). How will this create deferred taxes? What will happen over the asset's life?

Concepts in Practice​

Deferred Tax Example

TechLux Solutions equipment purchase:

Equipment: €100,000 Accounting Depreciation: 10% per year (€10,000) Tax Depreciation: 50% first year (€50,000), then 20% (€10,000)

Year 1:

  • Accounting expense: €10,000
  • Tax deduction: €50,000
  • Difference: €40,000 (tax > accounting)
  • Deferred tax liability: €40,000 × 24.94% = €9,976

Year 2:

  • Accounting expense: €10,000
  • Tax deduction: €10,000
  • Difference: €0
  • Deferred tax reversal: €9,976 (liability reduces)

Result: Deferred tax liability created in Year 1, reverses in Year 2.