How AS 22 and Ind AS 12 work, the step-by-step method, and a fully worked example under the section 115BAA regime
Every year, a company works out two profit figures. One is the accounting profit in the financial statements, prepared under the Companies Act, 2013 and the applicable accounting standards. The other is the taxable income computed under income-tax law. The two rarely match, and that is perfectly normal: accounting aims to show economic performance, while tax law follows its own rules on when income is taxed and when expenses are allowed.
Deferred tax is the accounting mechanism that bridges this gap. It ensures that the tax expense in the profit and loss statement relates sensibly to the profit reported, and that the balance sheet reflects future tax effects the company has already set in motion. Once the logic is clear, the calculation is very manageable. This guide walks through it step by step.
1. Which standard applies?
Indian companies follow one of two frameworks:
- AS 22, Accounting for Taxes on Income applies to companies following Indian GAAP (Companies (Accounting Standards) Rules, 2021).
- Ind AS 12, Income Taxes applies to companies covered by the Companies (Indian Accounting Standards) Rules, 2015, such as listed companies and companies above the net-worth thresholds, along with their holding, subsidiary and associate companies.
Both arrive at a deferred tax figure, but they look at the problem from different angles.
| Point | AS 22 | Ind AS 12 |
|---|---|---|
| Approach | Income statement approach | Balance sheet approach |
| What is compared | Accounting income vs taxable income for the year | Carrying amount of each asset/liability vs its tax base |
| Differences recognised | Timing differences | Temporary differences |
| DTA recognition – general | Reasonable certainty of sufficient future taxable income | Probable that taxable profit will be available |
| DTA on unabsorbed depreciation / carried-forward losses | Virtual certainty, supported by convincing evidence | Probable, with convincing other evidence where there is a history of recent losses |
| Items routed through OCI / equity | Generally not relevant | Deferred tax follows the item to OCI or equity |
| MAT credit | Recognised as an asset under the ICAI Guidance Note, not as DTA | Presented as a deferred tax asset |
2. The building blocks
Permanent differences
These never reverse, so they never create deferred tax. Examples include penalties disallowed under the Explanation to section 37(1), CSR expenditure disallowed for computing business income, and income that is fully exempt. They simply cause the effective tax rate to differ from the statutory rate.
Timing / temporary differences
These arise in one period and reverse in one or more later periods. Ind AS 12’s temporary differences are a wider concept: every timing difference is a temporary difference, but some temporary differences (for example, fair valuation of assets in a business combination) do not pass through profit or loss at all.
- Taxable temporary differences lead to higher tax in the future and give rise to a Deferred Tax Liability (DTL). Typical case: tax depreciation is faster than book depreciation, so the book value of the asset exceeds its tax WDV.
- Deductible temporary differences lead to lower tax in the future and give rise to a Deferred Tax Asset (DTA). Typical case: a provision for gratuity or leave encashment is expensed in the books but allowed for tax only on payment.
A simple rule of thumb (Ind AS 12): For an asset, if carrying amount > tax base → DTL; if carrying amount < tax base → DTA. For a liability, it works the other way round: if carrying amount > tax base → DTA.
3. Choosing the right tax rate
Deferred tax is measured at the rates expected to apply when the difference reverses, based on rates and laws that are enacted (or, under Ind AS 12, substantively enacted) by the balance sheet date. In practice, Indian companies use the full effective rate, including surcharge and health & education cess.
| Regime | Base rate | Effective rate* |
|---|---|---|
| Section 115BAA (existing domestic companies opting for concessional regime) | 22% | 25.168% |
| Section 115BAB (eligible new manufacturing companies) | 15% | 17.16% |
| Normal regime – turnover up to ₹400 crore in the relevant year | 25% | 26.00% – 29.12% |
| Normal regime – other companies | 30% | 31.20% – 34.944% |
*Including applicable surcharge and 4% cess. Under the normal regime the effective rate depends on the surcharge slab, so use the slab you expect to apply in the reversal years.
A few practical points on rates:
- If the company has opted for section 115BAA (or intends to opt in the reversal period), the deferred tax balance should be remeasured at the concessional rate. The resulting change goes to profit or loss (or OCI/equity, where the original item was recognised there).
- Companies under section 115BAA are outside MAT. Any MAT credit still carried forward should be reassessed, since it cannot be utilised once the company switches regime.
- The Income-tax Act, 2025 has replaced the Income-tax Act, 1961 with effect from 1 April 2026 (tax year 2026-27 onwards). The deferred tax principle does not change: measure balances using the rates and provisions that will apply when the differences reverse. While carrying forward working papers, map the old section references to their new equivalents.
4. The calculation – step by step
- List every asset and liability in the balance sheet (Ind AS 12), or every item where accounting and tax treatment differ in timing (AS 22).
- Determine the tax base of each item, i.e. the amount attributable to it for tax purposes. For fixed assets, this is the tax WDV under the block-of-assets method.
- Compute the difference between the carrying amount and the tax base, and classify it as taxable or deductible.
- Strip out permanent differences and items covered by recognition exemptions (for example, goodwill on initial recognition under Ind AS 12).
- Multiply each difference by the applicable tax rate to get the DTL or DTA.
- Test DTAs for recoverability (reasonable/virtual certainty under AS 22; probability under Ind AS 12).
- Compare the closing net position with the opening net position. The movement is the deferred tax charge or credit for the year, routed to profit or loss, OCI or equity, depending on where the underlying item sits.
- Reconcile: current tax + deferred tax should explain the total tax expense against accounting profit, after allowing for permanent differences and rate changes.
5. Worked example
ABC Industries Pvt Ltd has opted for section 115BAA (effective tax rate 25.168%). Figures for FY 2025-26 are below. For simplicity, there are no permanent differences.
| Particulars | Books (₹) | Tax (₹) |
|---|---|---|
| Opening WDV of plant & machinery (1 Apr 2025) | 80,00,000 | 65,00,000 |
| Add: additions during the year | 50,00,000 | 50,00,000 |
| Less: depreciation for the year | (20,00,000) | (27,00,000) |
| Closing WDV (31 Mar 2026) | 1,10,00,000 | 88,00,000 |
Other information:
- Gratuity provision (unfunded) – opening ₹10,00,000; provision made ₹3,00,000; paid ₹1,00,000; closing ₹12,00,000. Allowed for tax only on payment (section 40A(7) of the 1961 Act).
- Profit before tax as per books: ₹2,00,00,000.
Step A: Deferred tax balances
| Item | Book value (₹) | Tax base (₹) | Difference (₹) | DTL / (DTA) @ 25.168% (₹) |
|---|---|---|---|---|
| Opening – PPE | 80,00,000 | 65,00,000 | 15,00,000 | 3,77,520 |
| Opening – gratuity | 10,00,000 | – | (10,00,000) | (2,51,680) |
| Opening net DTL | 1,25,840 | |||
| Closing – PPE | 1,10,00,000 | 88,00,000 | 22,00,000 | 5,53,696 |
| Closing – gratuity | 12,00,000 | – | (12,00,000) | (3,02,016) |
| Closing net DTL | 2,51,680 |
Gratuity is a liability with a tax base of nil (it will be fully deductible on payment), so its carrying amount exceeds the tax base and a DTA arises.
Step B: Deferred tax charge for the year
| Particulars | Amount (₹) |
|---|---|
| Closing net DTL | 2,51,680 |
| Less: opening net DTL | (1,25,840) |
| Deferred tax expense for FY 2025-26 | 1,25,840 |
Cross-check through the movement in differences: the depreciation gap widened by ₹7,00,000 (DTL up by ₹1,76,176), and the gratuity provision grew by ₹2,00,000 (DTA up by ₹50,336). Net increase in DTL = ₹1,25,840. ✓
Step C: Current tax
| Particulars | Amount (₹) |
|---|---|
| Profit before tax | 2,00,00,000 |
| Add: book depreciation | 20,00,000 |
| Less: tax depreciation | (27,00,000) |
| Add: gratuity provision disallowed (₹3,00,000 – ₹1,00,000 paid) | 2,00,000 |
| Taxable income | 1,95,00,000 |
| Current tax @ 25.168% | 49,07,760 |
Step D: Total tax expense and the reconciliation
| Particulars | Amount (₹) |
|---|---|
| Current tax | 49,07,760 |
| Deferred tax | 1,25,840 |
| Total tax expense | 50,33,600 |
| Profit before tax × 25.168% | 50,33,600 |
The total tax expense equals accounting profit multiplied by the tax rate. That is exactly what deferred tax is designed to achieve: the tax charge now matches the profit reported, even though the cash tax for the year is lower because of the higher tax depreciation.
Step E: Journal entry
| Entry | Dr (₹) | Cr (₹) |
|---|---|---|
| Deferred tax expense (P&L) | 1,25,840 | |
| To Deferred Tax Liability (net) | 1,25,840 |
6. Common sources of deferred tax in Indian companies
| Item | Usually | Why |
|---|---|---|
| Depreciation on PPE / intangibles | DTL | Tax WDV under block method falls faster than book WDV under Schedule II |
| Gratuity, leave encashment, bonus provisions | DTA | Deductible only on actual payment (sections 40A(7) and 43B of the 1961 Act) |
| Payments to MSMEs outstanding beyond the time limit | DTA | Disallowed under section 43B(h) until actually paid |
| Expected credit loss / provision for doubtful debts | DTA | Allowed only when the debt is actually written off (subject to conditions) |
| TDS-related disallowances | DTA | Disallowed under section 40(a)(i)/(ia) and allowed in the year the TDS is paid |
| Unabsorbed depreciation and business losses | DTA | Recognise only if the recoverability test is met |
| Right-of-use asset and lease liability (Ind AS 116) | Both | Tax follows actual rent paid; recognise DTL and DTA separately on each |
| Fair value gains on investments (Ind AS 109) | DTL | Taxed only on transfer; measure at the capital gains rate if that is how the gain will be taxed |
| Remeasurement of defined benefit plans | DTA/DTL in OCI | Deferred tax follows the item to OCI |
7. Points that need extra care
- Rate matching. Use the rate at which the item will actually be taxed. A fair value gain on equity shares that will be taxed as long-term capital gains should not be measured at the business income rate.
- Initial recognition exemption (Ind AS 12). No deferred tax on goodwill on initial recognition, or on an asset/liability from a transaction that is not a business combination and affects neither accounting nor taxable profit. Note that, since the 2023 amendment, this exemption does not apply where equal taxable and deductible differences arise, as with leases and decommissioning obligations.
- Tax holiday periods (AS 22). No deferred tax on timing differences that reverse within the tax holiday period. Recognise deferred tax only on differences that reverse after it ends (first-in-first-out basis).
- Group accounts (Ind AS). Consider deferred tax on undistributed profits of subsidiaries and associates, unless the parent controls the timing of reversal and reversal is not probable. Also consider deferred tax on unrealised intra-group profits, measured at the buyer’s tax rate.
- Review DTAs every year. Recoverability can change. A DTA written down earlier can be reinstated when the recognition criteria are met again.
- Offsetting and presentation. Offset DTA and DTL only where there is a legally enforceable right to set off and they relate to the same taxation authority. Deferred tax is always non-current and is never discounted.
8. A quick year-end checklist
- Confirm the tax regime (115BAA/115BAB/normal) and the effective rate for reversal years.
- Reconcile tax WDV with the tax audit report (Form 3CD) depreciation schedule.
- List all provisions, disallowances and allowances that are timing-based.
- Identify permanent differences separately for the effective tax rate reconciliation.
- Test DTA recoverability and document the evidence (projections, order book, history).
- Route deferred tax on OCI and equity items correctly.
- Prepare the tax expense reconciliation (Ind AS) or deferred tax note (AS 22).
- Map section references to the Income-tax Act, 2025 for years from FY 2026-27.
In summary
Deferred tax can look intimidating in a set of financial statements, but the logic underneath is straightforward: identify the differences that will reverse, apply the right rate, and account for the movement. With a well-maintained working paper that ties book values to tax bases, the calculation becomes a routine part of the year-end close, and it gives management and auditors a clearer picture of the company’s true tax position.
This article is for general information and does not constitute professional advice. The treatment in a specific case depends on the facts and the applicable accounting framework; please consult your Chartered Accountant before acting on it.