Deferred Tax (DTA and DTL)
The tax consequence of a difference between a figure in the accounts and the same figure on the tax return. A deferred tax liability is tax that will be paid later on profit the accounts have already shown, most often because tax depreciation runs ahead of book depreciation. A deferred tax asset is tax that will be saved later, most often on losses carried forward. Neither is cash; both explain why the tax charge and the tax paid differ.
Behind the balance sheet · 10 of 12Next: Non-Controlling Interest (NCI)
Where deferred tax (dta and dtl) sits in the three statements
- Tax charge (current + deferred): £25: £20 + £5
- Deferred tax liability: +£5
- Add back deferred tax: +£5
What moving it does
A company with £100 of profit before tax at 25% owns a £100 machine. The accounts depreciate it over five years, £20 a year; the tax authority allows £40 in year one. Year one.
| Statement | Line | Effect |
|---|---|---|
| Income statement | Tax charge | £25. The accounts tax the £100 of book profit at 25% regardless of what the return says, so that profit and tax stay matched. |
| Balance sheet | Cash | Tax paid is £20, not £25. Taxable profit is £80, because the return deducted £40 of depreciation where the accounts deducted £20, and 25% of £80 is £20. |
| Balance sheet | Deferred tax liability | +£5: the tax not paid this year on £20 of profit the accounts have shown and the return has not. It reverses in years two to five as the tax deductions fall below the book charge. |
| Cash flow statement | Add back deferred tax | +£5. Net income carries a £25 charge; cash carried £20; the £5 difference is the non-cash part. |
| Cash flow statement | Cash from operations | £5 higher than net income plus depreciation alone would give. |
| Income statement | Net income | £75. Unchanged by any of this; the deferral is a cash and balance-sheet matter. |
The close. Assets are £5 higher than they would have been (cash), and liabilities are £5 higher (the deferred tax liability). Balanced. Across five years the company deducts £100 on both the return and the accounts and pays the same £25 a year on average; the liability builds to £5 and then unwinds. Replace the machine every year and the liability never unwinds, which is why it is not debt.
What the footnote discloses
In the note
- The deferred tax balance by source: accelerated capital allowances, intangibles from acquisitions, provisions, share schemes, losses, and their movement through profit and through other comprehensive income.
- Unrecognised deferred tax assets, mainly losses, with the reason: no convincing evidence of future taxable profit, or an expiry date.
- The rate reconciliation from the statutory rate to the effective rate, which is where permanent differences (non-deductible costs, tax-free income, incentives) show up.
- Tax losses carried forward by jurisdiction and their expiry, and any deferred tax on unremitted earnings of overseas subsidiaries.
What an analyst does with it
- Model cash taxes in the DCF: current tax, plus the reversal of timing differences you can see coming from the note, rather than the effective rate on book profit.
- Value recognised losses on their own: taxable profit forecast times the rate, discounted, capped at the loss and its expiry, and compare with the balance-sheet figure. Add the unrecognised losses as an upside a bidder with profits could use.
- Leave deferred tax liabilities from depreciation out of net debt unless the asset base is shrinking; leave deferred tax liabilities on acquired intangibles out too, since they are an accounting mirror of an asset nobody paid cash for.
- Read the rate reconciliation before comparing effective tax rates across peers: a low rate from a one-off release is not a low rate.
The interview question it becomes
- “Tax depreciation runs ahead of book depreciation. What is the effect on the three statements?”
- The tax charge in the income statement is unchanged, because it is based on book profit. Cash tax paid is lower, because taxable profit is lower. The difference is recorded as a deferred tax liability on the balance sheet and added back in operating cash flow as a non-cash charge. Net income is the same; cash is higher by the deferred amount; the liability holds the difference until the timing reverses.
- The follow-up: “Does the deferred tax liability go in net debt?”
- The catch is adding it mechanically because it is called a liability. For a business that keeps investing, the timing differences renew as fast as they reverse and the liability is never paid, so it is not debt. The strong answer distinguishes that case from a liability that will actually crystallise (a run-off asset base, or a planned disposal where the tax becomes due) and from a deferred tax asset on losses, which is a real future cash saving that can be valued separately and is worth more to a profitable bidder than to the company itself.
Why Deferred Tax (DTA and DTL) matters in interviews
Deferred tax is where the accounts and the tax return disagree and the balance sheet keeps score. It explains why a profitable company’s cash tax bill bears no resemblance to its tax charge, why a company with years of losses can suddenly report a large profit by recognising an asset, and why a bidder’s model needs cash taxes rather than book taxes. Interviewers ask because most candidates can recite the definition and few can walk one through the statements.
How it works in practice
A deferred tax liability arises when the tax return has deducted something the accounts have not yet charged, so profit is taxed later than it is reported. The usual source is depreciation: tax law often allows a faster write-off than the accounting useful life. The company pays less cash tax now, records the full book tax charge anyway, and the difference sits as a liability until the timing reverses.
A deferred tax asset is the mirror: something the accounts have charged that the tax return will deduct later, or a loss the tax return will let the company use against future profit. Provisions, share-based payments deducted on exercise rather than at grant, and losses carried forward are the common sources. An asset is recognised only where future taxable profit is probable, which is a judgement, and the note says how much was not recognised.
The income statement tax charge is current tax (what the return says is due) plus the movement in deferred tax. The cash flow statement pays only current tax, so the deferred element is added back like any non-cash charge. Over the life of the difference the two tax figures converge; in any one year they can be far apart.
In an acquisition, the target’s assets are written up to fair value in the accounts but not on the tax return, so a deferred tax liability is created on the write-up and goodwill is larger by that amount. This is why the goodwill on a deal is not simply price less book equity.
What candidates get wrong
- Treating a deferred tax liability from accelerated depreciation as debt. On a growing or stable capex base the timing differences are replaced as fast as they reverse, so the liability rolls forward indefinitely and no cash is ever due.
- Treating a deferred tax asset on losses as cash. It is worth something only if there is taxable profit to use it against, within any expiry limit, and the note’s unrecognised amount says how confident management is.
- Using the book tax charge in a DCF. Free cash flow is after cash taxes; the deferred tax movement is added back in operating cash flow for that reason.
- Forgetting that a change in the statutory rate re-measures every deferred balance at once, producing a large one-off charge or credit with no cash behind it.
Deferred Tax (DTA and DTL): frequently asked questions
What is a deferred tax liability?
Tax that will be paid in a future period on profit the accounts have already reported. It arises when the tax return deducts something earlier than the accounts charge it, most often depreciation, so the company pays less tax now and more later. The balance sheet records the later tax as a liability so that the tax charge in the income statement matches the profit it relates to.
What is a deferred tax asset?
Tax that will be saved in a future period. It arises when the accounts charge something the tax return will deduct later, or when the company has losses it can carry forward against future taxable profit. It is recognised only to the extent that future profit to use it against is probable.
Is deferred tax debt in the enterprise value bridge?
Usually not. A liability from accelerated depreciation on a business that keeps investing is replaced as it reverses and is never paid, so most practitioners leave it out. A deferred tax asset on losses is worth the present value of the tax it will save and is sometimes valued separately as an addition to equity value. Either way, say what you did and why.
Go deeper
This term comes up constantly in accounting interviews and on the desk.
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