A deferred tax liability (DTL) is an amount of income tax that a company has postponed and expects to pay in future periods. It arises when the tax rules let the company report less taxable profit now than its accounting profit, because income is taxed later or deductions come earlier than in the accounts. The tax has not been avoided, only delayed, so the company records the future payment as one of its liabilities on the balance sheet.
DTLs are accounted for under IAS 12 Income Taxes and US ASC 740, the same standards that cover the deferred tax asset. Where a DTA raises the question of whether future relief will ever be usable, a DTL is generally certain to reverse, though the timing can stretch over many years. Capital-intensive businesses such as utilities, airlines, telecoms and leasing companies often carry large DTLs.
Deferred tax liability in plain terms
Think of a shop owner who is allowed by the tax office to delay paying this year's tax bill on part of her profit until later years. Her bank account looks healthy today because the money has not left yet, but she knows the bill will come.
A careful owner would keep a note saying "tax still to pay" so she does not mistake the money for spare cash. A deferred tax liability is that note. It usually appears because tax rules give generous deductions early, for example on new machines, while the company's own accounts spread the same cost evenly over the years the machine is used. The gap closes over time, and the postponed tax is paid.
Common causes
- Accelerated tax depreciation. Tax law allows faster write-offs of equipment, through bonus or capital allowances, than the straight-line depreciation used in the accounts. This is the most common source of DTLs.
- Revaluation to fair value. Property or investments written up in the accounts, often using inputs from the fair value hierarchy, are taxed only when sold, so a DTL builds up on the unrealised gain, often at the capital gains tax rate.
- Income recognised before it is taxed. Accrued revenue or instalment sales may be taxed only when cash is received.
- Acquired intangibles. When one company buys another, an intangible asset such as a customer list is recorded at fair value with no matching tax base, creating a DTL.
- Development costs. Costs capitalised and amortised in the accounts may be deducted immediately for tax.
Formula and example
For an asset, the DTL equals the excess of its carrying amount over its tax base, multiplied by the tax rate expected to apply on reversal:
Here is the enacted or substantively enacted rate. A company buys a machine for $1,000,000 with a five-year life. The accounts depreciate it straight-line by $200,000 a year, so after year one its carrying amount is $800,000. Tax law allows 40% in the first year, so the tax base is $600,000. The taxable temporary difference is , and at a 25% tax rate the DTL is , or $50,000. In later years the tax deductions fall below the accounting charge, the difference shrinks to zero, and the DTL is paid off through higher current tax.
Exceptions and presentation
IAS 12 and ASC 740 do not record a DTL in every case. The main exceptions cover the initial recognition of goodwill, which is excluded because recording a liability would simply increase goodwill again, and undistributed profits of subsidiaries where the parent controls the timing of any dividend and does not expect to distribute them; any withholding tax on such dividends is then not provided for. Deferred tax is not discounted to present value under either framework, even when reversal is decades away. A company may offset DTAs and DTLs on the balance sheet only where they relate to the same tax authority and it has a legal right to set them off.
Deferred tax liabilities in analysis
A growing DTL means the company is paying less cash tax than its income statement charge, which supports operating cash flow. For a business that keeps investing, new accelerated deductions can offset reversals for years, so the DTL may never fall in practice; some analysts therefore treat part of it as closer to equity than to debt. Rating agencies and lenders differ on this, which affects leverage ratios. Changes in the tax rate remeasure the balance and flow through net income: when the US cut the federal rate from 35% to 21% at the end of 2017 (effective 2018), companies with large DTLs reported one-off gains. Readers of financial statements can find the breakdown of deferred tax balances by source in the income tax note.