Deferred Tax Asset (DTA)

A deferred tax asset (DTA) is an amount of income tax that a company expects to save in future periods because of items that have already passed through its accounts. It arises when the tax rules allow a deduction later than the accounting rules recognise the expense, when a company has unused tax losses it can carry forward, or when it holds unused tax credits. The DTA is shown on the balance sheet and represents tax the company has, in effect, paid in advance or will be able to avoid paying.

DTAs are governed by IAS 12 Income Taxes under IFRS and by ASC 740 under US GAAP. Their opposite is the deferred tax liability, which records tax that has been postponed rather than prepaid. The central question for any DTA is recoverability: the asset only has value if the company will earn enough taxable profit in future to use the deductions.

Imagine you buy a train season ticket in December that covers January to March. Your household budget for December already shows the money as gone, but you know you will not have to buy tickets for the next three months. In a sense you are holding a voucher for future savings.

A deferred tax asset is that kind of voucher for tax. The company's accounts have already counted a cost, but the tax office will only let the deduction be claimed later. When that later year comes, the company pays less tax than its profit would suggest. The voucher is only useful, though, if there is profit to set it against; a company that keeps losing money may never get to use it.

• Deductible temporary differences. An expense is recognised in the accounts before it is deductible for tax. Examples include warranty provisions, a bank's loan loss provision where tax relief comes only on write-off (the allowance is now measured on an expected credit loss basis in many countries), and an accrued expense such as bonuses deductible only when paid.
• Income taxed early. Some jurisdictions tax cash received in advance, while the accounts treat it as deferred revenue until it is earned.
• Unused tax losses. A loss-making company can often carry forward tax losses (net operating losses in the US) and offset them against future profits; in some regimes an unused capital loss can be carried forward against later gains.
• Unused tax credits. Credits for research, foreign tax paid or investment that cannot be used in the current year.
• Write-downs not yet deductible. An accounting impairment charge may not reduce the tax base of an asset until it is sold.

For each item the DTA is measured as the deductible difference multiplied by the tax rate expected to apply when it reverses:

Here the difference applies to an asset whose tax base exceeds its carrying amount, or equivalently to a liability whose carrying amount exceeds its tax base, and $t$ is the enacted (or, under IFRS, substantively enacted) tax rate. For tax losses the DTA is simply the losses carried forward multiplied by $t$.

A company records a $400,000 warranty provision this year, but tax law allows a deduction only when repairs are paid. The provision is a liability with a carrying amount of $400,000 and a tax base of zero. At a 25% tax rate the DTA is $400{,}000 \times 0.25 = 100{,}000$, or $100,000. The entry debits the DTA and credits deferred tax expense, so the income statement shows a tax charge consistent with the reported profit, and the asset unwinds as repairs are paid and deducted.

Both main frameworks test whether future profits will be available. IAS 12 allows a DTA only to the extent that it is probable that taxable profit will be available. ASC 740 starts by recognising the full DTA and then requires a valuation allowance if it is more likely than not that some portion will not be realised. Evidence includes the reversal of existing deferred tax liabilities, profit forecasts and tax-planning strategies. A history of recent losses is strong negative evidence. Writing down a large DTA can produce a sudden hit to net income, so analysts reading the tax note in the financial statements watch these judgements closely.

Changes in tax law also matter. When the US Tax Cuts and Jobs Act of 2017 cut the federal corporate rate from 35% to 21%, companies with large DTAs had to remeasure them at the lower rate, and several large banks reported multibillion-dollar charges in the fourth quarter of 2017. The same law made US losses arising after 2017 carry forward indefinitely but usable against only 80% of taxable income in a year.

Banks can build up large DTAs, especially after crises, from loan provisions and tax losses. Because a DTA cannot be sold to raise cash in a crisis and may be worthless if the bank keeps losing money, Basel III limits how much counts as regulatory capital. DTAs that depend on future profitability and arise from tax losses are deducted from Common Equity Tier 1 in full, while those arising from temporary differences are deducted above a threshold. Some countries, including Italy and Spain, have converted certain bank DTAs into tax credits guaranteed by the state so that they keep their capital value.

• IFRS Foundation
• Financial Accounting Standards Board