Short answer: Deferred tax is tax that a company will pay in a later year, or has already settled early, because its accounts and its tax computation recognise income and costs on different timelines. It appears as either a deferred tax asset or a deferred tax liability, depending on which way the timing gap runs.
Last reviewed: 8 November 2026
At a glance
| Term | What it means | Typical trigger |
|---|---|---|
| Deferred tax asset | Tax paid early, or a reduction in a future year’s tax | A gross loss carried forward to offset the next year’s profit |
| Deferred tax liability | Tax that accrues now but is paid in a later year | Tax depreciation higher than depreciation in the accounts |
| Temporary difference | A timing gap that reverses in a later year | Creates deferred tax |
| Permanent difference | A gap that never reverses | Penalties or tax-exempt income; creates no deferred tax |
Why do the accounts and the tax computation differ?
A company prepares two sets of numbers from the same business. Its income statement, the report that shows profit after costs, follows accounting recognition rules. Its tax computation, which sets the tax payable to the government, follows tax rules. Because the two rulebooks decide on timing differently, the figures can temporarily diverge.
Deferred tax exists to account for that temporary divergence. It covers tax that will be paid later, or that has already been settled early, because of these timing gaps between book income (profit as shown in the accounts) and taxable income (the profit the tax rules use).
What is a deferred tax asset?
A deferred tax asset arises when a company pays tax in advance or reduces a future year’s tax. The most common example is a gross loss. If a company makes a loss in one year, that loss can be carried forward to offset the next year’s profit, which lowers the tax due in that later year.
The catch is that this benefit only helps if the company earns enough profit later to use it. A carried-forward loss that is never offset against profit produces no tax saving. The asset therefore depends on future earnings, not just on the loss that created it.
What is a deferred tax liability?
A deferred tax liability arises when tax accrues in the current year but the company must pay it in a later year. It is recognised in the year the tax accrues, not in the year the cash is paid. This means the accounts show the obligation now, even though the payment comes later.
Depreciation, the gradual charge for the wear of an asset such as a machine, is the usual source. Tax rules and accounting rules often spread depreciation differently, and that difference creates the liability.
How does depreciation create a deferred tax liability?
When tax depreciation is higher than depreciation in the company’s accounts, current tax falls. The difference then reverses in later years, when tax depreciation becomes lower than book depreciation, and the extra tax comes due. That future payment is the deferred tax liability.
Consider this hypothetical example, with every figure invented for illustration. A company has a profit before depreciation of ₹20 lakh in Year 1. Its book depreciation is ₹2 lakh, so book profit is ₹18 lakh. Its tax depreciation is ₹4 lakh, so taxable profit is ₹16 lakh. The tax rate, also invented, is 25%.
- Current tax: 25% of ₹16 lakh = ₹4 lakh
- Tax reflected on book profit: 25% of ₹18 lakh = ₹4.5 lakh
- Difference: ₹4.5 lakh minus ₹4 lakh = ₹0.5 lakh, which is the deferred tax liability recognised in Year 1
Current tax is lower than the tax on book profit, and the ₹50,000 gap is the amount the company will pay in a later year as the depreciation difference reverses.
Which differences create deferred tax?
Only temporary, or timing, differences create deferred tax. Depreciation timing and carried-forward losses are both temporary, because they reverse over time. A permanent difference, such as a penalty or income that is tax-exempt, never reverses. Such items affect the tax charge in the year they arise, but they do not create deferred tax.
This distinction matters when you read a company’s notes. Two items can both make the tax charge look unusual, yet only one of them will be reflected as a deferred balance.
What should a reader watch for?
Deferred tax is an estimate of future tax effects, so its value depends on assumptions about when temporary differences will reverse. A large deferred tax asset is only as useful as the future profit needed to absorb it. A large deferred tax liability signals that tax payments are expected to rise later, not that the company owes more today.
Read the balances together with the rest of the accounts. Check the size of the carried-forward losses, the depreciation methods, and whether the tax figures change from year to year.
Frequently asked questions
Is deferred tax the same as unpaid tax?
Not exactly. Deferred tax covers tax that will be paid later, or that has already been settled early, because of timing gaps between book income and taxable income. Some of it is a future payment and some is a future reduction.
Can a penalty create deferred tax?
No. A penalty is a permanent difference, so it does not reverse and does not create deferred tax. Only temporary, or timing, differences do.
Does a deferred tax asset always mean a tax saving?
No. A deferred tax asset, such as one from a carried-forward gross loss, reduces tax only when the company has future profit to offset. Without that profit, the saving does not arrive.
Sources and last check
Facts in this article were checked against the sources below on 8 November 2026. Rules and figures can change; check the primary source before acting.
- groww.in (broker education)
- kotakneo.com (broker education)
- upstox.com (broker education)
- dhan.co (broker education)
This article is general information, not investment advice. MyFinanceBandhu is not a SEBI-registered investment adviser.