Taxation Part 1 Notes

Taxation – Part 1

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Definition

Current income tax is the amount payable to the government within a year.

Deferred income tax is A liability that results from income that has already been earned for accounting purposes but not for tax purposes.

In other words

Income tax is a compulsory contribution to state revenue, levied by the government business profits.

Current income tax is the amount of tax payable in respect to the taxable profit for a period. If there has been a taxable loss then current income tax is the amount recoverable

Deferred tax is the estimated future tax consequences of transactions and events recognised in the financial statements of the current and previous periods.

Why is it important?

Taxable profits are nearly always different from accounting profits. Some differences are permanent; for example, fines, political donations and entertainment are normally disallowed for tax purposes. These items do not give rise to deferred tax. Some differences are temporary timing differences; for example interest received and paid is normally taxed on a cash basis, whereas it is accounted for on an accruals basis.

• Timing differences arise when the actual tax consequences of a particular transaction (tax payable or recoverable) arise in a different period than the period in which the transaction itself is included in the financial statements.

• The tax effects of transactions should be reported in the same accounting period as the transactions themselves.

• As a result there is a need to account for deferred tax.

Lecture Notes

Accounting profit and taxable profit

Before we move, the difference between accounting profits and taxable profits needs to be clear

• The accounting profit (or the reported profit), which is the figure of profit before tax, reported to the shareholders in the published accounts

• The taxable profit, which is the figure of profit on which the taxation authorities base their tax calculations.

The difference between accounting profit and taxable profit is caused by:

1. Permanent differences

2. Temporary differences.

Permanent differences

Permanent differences are:

• One-off differences between accounting and taxable profits caused by certain items not being taxable/ allowable

• Differences which only impact on the tax computation of one period

• Differences which have no deferred tax consequences whatever.

An example of a permanent difference could be client entertaining expenses or fines.

Temporary differences

Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base (the amount attributed to that asset or liability for tax purposes).

Examples of temporary differences include:

• certain types of income and expenditure that are taxed on a cash, rather than on an accruals basis, e.g. certain provisions

• the difference between the depreciation charged on a noncurrent asset that qualifies for tax allowances and the actual allowances (tax depreciation) given (the most common practical example of a temporary difference).

Accounting for Current Income Tax

Current tax appears in the financial statements

• as an expense in income statement (because it reduces profits)

• as a liability in the balance sheet

If a business made a taxable loss, there will be tax recoverable on the loss, this recoverable tax is treated as:

• tax income in the income statement

• an asset in the balance sheet

Deferred Taxation

A deferred tax liability occurs when taxable profits is smaller than the accounting profits on the income statements. This is a result of the accounting difference of certain income and expense accounts. This is only a temporary difference. for example depreciation methods.

A deferred tax asset is the opposite of a deferred tax liability. Deferred tax assets are reductions in future taxes payable, because the company has already paid the taxes on accounting profits to be recognized in the future (like a prepaid tax).

Calculation Deferred tax liability/ Deferred tax asset

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