Deferred Tax Assets: What They Are and How They Work

Deferred tax assets (DTA) are a useful way for businesses to manage their tax liabilities more efficiently, allowing them to reduce their taxable income in the future in the case of overpayment. 

This guide will detail exactly what they are, how they work, and how they can be a valuable concept in accounting and taxation.

What is a deferred tax asset (DTA)?

A deferred tax asset is an item on a business’s balance sheet that will reduce the amount of tax they have to pay in the future. They arise as a result of timing differences between accounting (profits as recorded in financial statements) and tax reporting (profits as reported to tax authorities). This gap in time can cause a company to either overpay or advance the payment of their taxes if they can’t yet be recognised on their income statement, so a DTA is created to act as an asset, reducing their tax liability in the future.

How do deferred tax assets work?

Deferred tax assets are a type of non-current liability that works to reduce a company’s future tax obligation due to differences between accounting methods and tax laws. 

When a business incurs an expense that isn’t immediately tax-deductible, but will be in a future period, it can record a DTA. This will then result in temporary tax benefits at the time, and a lower tax payment in the future when those deductions are eventually valid.

Examples of DTAs

There are a few instances in which businesses can benefit from deferred tax assets, including:

• Tax losses: When a business reports a financial loss, they’re able to carry forward these losses to offset taxable income in future years, reducing their future tax liabilities.
• Differences in depreciation accounting: Individual accounting depreciation methods may differ from legal tax depreciation rules, creating timing differences that lead to deferred tax assets.
• Expenses: Some expenses, like employee benefits or research and development costs, can be recognised in financial statements before they’re able to be deducted for tax purposes, resulting in a deferred tax asset.
• Product warranties: If a business provides warranties, they may estimate and record the costs upfront, despite tax deductions only happening when the warranty expenses are incurred. This gap creates a deferred tax asset.

Deferred tax assets vs deferred tax liabilities

Deferred tax assets are the opposite of deferred tax liabilities, the latter indicating a predicted increase in tax owed by a business, as opposed to the DTA’s prediction of owing less tax. Here’s a simple breakdown of the differences:

How to calculate deferred tax assets

You can calculate any deferred tax assets with a simple formula:

Deferred Tax Asset = Temporary Difference × Tax Rate.

For example, a company incurs $10,000 in expenses that are deductible next year. If the corporate tax rate is 30%, the DTA is $10,000 × 30%, so the company will record a $3,000 deferred tax asset to offset their future taxable income.

To find a temporary difference, look for instances where income or expenses are recorded in financial statements in a different period than in tax filings. This could be:

• Revenue is recognised before it is taxed
• Expenses deducted in accounting before they are deductible for tax
• Tax losses carried forward to future years

When can a business use a deferred tax asset?

If a business has prepaid its taxes, or there was a difference between the time they have paid their taxes and the tax authority crediting it, they can reflect a deferred tax asset on their balance sheet. This will offset their taxable income in future periods, however, there are some limitations to this under Australian tax law. 

Businesses must ensure they will have enough taxable income in the future to use the DTA, or it may need to be adjusted. Additionally, some DTAs (such as tax losses) can expire if not used within a certain period. Deferred tax assets are also only recognised when the depreciation of the asset is expected to offset any profit in the future.

Benefits of deferred tax assets

Deferred tax assets offer several benefits for businesses, including:

• Improving cash flow: By reducing future tax payments, DTAs free up cash that can be used better elsewhere.
• Stabilising financial planning: DTAs provide predictable tax reductions, helping companies forecast and manage their resources better.
• Adding flexibility: DTAs allow businesses to offset future tax liabilities, creating financial flexibility when it comes to managing tax obligations.
• Supporting business growth: Startups and growing businesses can use DTAs to reduce future tax burdens as they grow their profits.
• Enhancing business valuation: DTAs can make a business more attractive to investors or acquirers by lowering future tax obligations.
• Offering tax benefits for R&D: Companies investing in R&D can use DTAs to offset future taxable income, lowering their tax bills.

Risks of deferred tax assets

While there are many benefits to creating deferred tax assets, they don’t come without a couple of risks. These include:

• Uncertainty: If a business cannot generate sufficient taxable income, it may not be able to utilise any DTAs on their statement. This means they may have to write down this DTA, which could negatively affect their financial position.
• Tax law changes: Changes in tax rates or regulations may reduce the value of DTAs or eliminate certain benefits. For example, if the tax rate decreases, the value of the DTA will also decrease, so the future tax benefits will be smaller.
• Risk of expiration: In certain cases, tax losses carried forward will expire if they aren't used within a specific time frame, or if certain tests under Australian tax law aren't met, meaning businesses will lose the tax benefits.
• Added complexity: While DTAs can reduce future tax liabilities, companies also need to ensure they can benefit from it. This can result in an added level of complexity in financial reporting.

Accounting treatment of deferred tax assets

In financial statements, deferred tax assets are recorded as non-current assets when it’s likely they will be able to reduce future tax liabilities. Under the Australian Accounting Standards (AASB 112) and the International Accounting Standards (IAS 12), businesses must disclose the total value of already recognised DTAs, any unrecognised DTAs, and details of the temporary difference that led to them.

Following these standards is important for transparency, giving stakeholders a clear insight into a company’s tax situation. Deferred tax assets should also be reviewed regularly to ensure they are recoverable – if it turns out they are unlikely to be used, a company will have to write down the DTA. 

Manage tax assets with QuickBooks

Understanding and managing deferred tax assets can be an extremely helpful way to reduce future tax liabilities and improve financial planning for businesses. QuickBooks makes it simpler than ever to track your tax assets, helping you stay organised and compliant with your relevant tax reporting requirements. 

If you need guidance on a complex scenario, or just want more detailed, personalised advice, our ProAdvisor search can help you find an expert near you.

Deferred Tax Assets FAQs