What is deferred tax, and how is it calculated?
Deferred tax reflects in today’s financial statements how timing differences between accounting profit and taxable income will affect future tax payments. It is not a tax payment but a matching mechanism.
Deferred tax is the recognition in today’s financial statements of tax amounts that will be payable or deductible in future periods because of temporary differences between the carrying amount of assets and liabilities under financial reporting standards and their tax base. Under TFRS it is governed by TMS 12 Income Taxes (the equivalent of IAS 12).
Deferred tax is not a payment; it does not change what is paid to the tax office today. Its purpose is to match the accounting effect and the tax effect of a transaction to the same period.
Why does it arise?
In Turkey the statutory books are kept under tax law, so the amounts that count for tax are already in the books. Deferred tax arises when the statements are adjusted to TFRS or BOBİ FRS: the adjustments change accounting profit but not taxable income. I explain how the adjustments are made in converting statutory books to TFRS.
Temporary and permanent differences
| Type | Definition | Example | Deferred tax? |
|---|---|---|---|
| Temporary difference | Accounting and tax recognise the same amount in different periods | Severance provision, different depreciation periods | Yes |
| Permanent difference | An amount is recognised in one and never in the other | Certain non-deductible expenses, exempt income | No |
Temporary differences come in two kinds:
- Deductible temporary differences reduce taxable income in future and give rise to a deferred tax asset. An example is a severance provision expensed today under TFRS but deductible for tax only when paid.
- Taxable temporary differences increase taxable income in future and give rise to a deferred tax liability. An example is an asset depreciated faster for tax than under TFRS.
Unused tax losses can also give rise to a deferred tax asset, to the extent they can be offset against future taxable profit.
A hypothetical example
A company recognises a severance provision of TRY 1,000,000 under TFRS. For tax, the amount is deductible only when paid. Assume a corporate tax rate of 25% for this example:
- Deductible temporary difference: TRY 1,000,000
- Deferred tax asset: 1,000,000 × 25% = TRY 250,000
The provision expense reduces profit by TRY 1,000,000 and the deferred tax income increases it by TRY 250,000, so the tax charge becomes consistent with accounting profit. When the severance is paid, it is deducted for tax and the deferred tax asset reverses.
Points to watch in the calculation
- Rate: use the rate expected to apply when the difference reverses, enacted or substantively enacted at the reporting date. Rate changes require existing deferred tax balances to be remeasured.
- Recoverability of assets: a deferred tax asset is recognised if sufficient future taxable profit is expected against which the differences can be deducted.
- Offsetting: under certain conditions, assets and liabilities can be presented net.
- Items recognised in equity: deferred tax on transactions recognised directly in equity is also recognised in equity.
What it means for management
Deferred tax looks technical, but it tells management two things: why the company’s effective tax rate differs from the statutory rate, and which future tax burdens or benefits to expect. I explain how differences between accounting profit and taxable income look from the tax side in Why does accounting profit differ from taxable profit?
For the wider framework, see the financial reporting and tax from a CFO’s perspective pages.
Frequently asked questions
Is deferred tax recorded in the statutory books?
No. Deferred tax appears in statements prepared under TFRS or BOBİ FRS; it is not posted to the statutory books kept under tax law.
Is a deferred tax asset cash?
No. It represents a right that may reduce future tax payments; it turns into a cash effect only when sufficient taxable profit arises.