Definition of Income Tax Accounting
Income tax accounting refers to the branch of accounting which involves the determination of tax liability on income. Accounting which is undertaken to determine tax liability differs from the accounting used to report income, assets, and liabilities on the balance sheet. Income tax accounting involves determining current taxes, deferred tax, tax liability, and tax paid. income tax accounting applies to all categories whether it is business, individual, company, or other business forms.
Explanation
It is based on the premise that all income and expenses which are liable for taxation should be accounted for unlike financial accounting which involves that business transaction as well which doesn’t have tax consequences. Further income tax accounting procedure varies for individuals based on their income slab, corporations based on their legal form, etc.
Income tax expenses are determined based on financial statements usually differ from income tax expenses computed as per the relevant income tax act relevant to the business entity and separate two-way calculation result in different tax liability reported for financial reporting and value recognized for the actual tax purpose.
Objectives of Income Tax Accounting
There are multiple objectives behind income tax accounting and businesses need to follow that to attain its objectives. Objectives of income tax accounting are enumerated below:
- It helps in determining the appropriate capital structure for the business. a mix of debt and equity constitute the capital structure for the business and both have different tax complications on the business which ultimately impact the business decision.
- It helps business and individual to determine their actual tax liability and ensure the payment is made on time to avoid tax penalties and at the same time avoid early payments as there is a time cost attached to money.
- It enables various entities as well as individuals to claim eligible deductions to perform better tax management.
- It enables businesses to maximize their profit by understanding how tax liability is generated for business transactions undertaken and how it can be optimized in the best possible way to rationalize the tax liability. for instance, in many countries companies are charged a single tax and can avail input tax credit for raw materials used in the production of such goods if the vendor from whom such raw materials are procured is also covered under the same single tax regime. Thus income tax accounting helps businesses minimize their tax liability which subsequently leads to profit maximization.
Example of Income Tax Accounting
Let’s understand the same with the help of an example:
ABC International earned Net income of $120000 in the year 2019-20. Among the expenses incurred includes non-cash expenses of $2000 related to the depreciation on Machinery. A depreciation schedule is provided below:
| Particulars | Depreciation Rate as Per Income Tax Act | Depreciation Rate as Per Companies Act |
| Machinery (Written Down Value: $20000) | 5% | 10% |
| Depreciation Amount | $1000 | $2000 |
Based on the above it can be observed that taxable income as per income tax accounting will amount to $121000 ($120000+$2000-$1000) compared to $120000 as per financial reporting. Such temporary difference results in the creation of deferred tax assets/liabilities which are reported in the balance sheet and adjusted over the years by the business.
Record Income Tax in Accounting
Income tax recorded in financial accounts is based on book income whereas actual tax liability is based on the taxable income assessed in terms of income tax accounting rules which may or may not be the same resulting in temporary differences as well as permanent differences. Further income tax recorded forms part of income statement expenses and any deferred tax asset/liability arising out of temporary differences form part of the balance sheet.
How Income Tax Accounting differs under IFRS and US GAAP
Key Differences are as follows:
|
Basis |
Income Tax Accounting under US GAAP |
Income Tax Accounting under IFRS |
| Deferred Tax Asset recognized or not | It is recognized in full initially and reduced if tax assets are not realizable. | It is recognized only if taxable profits in the future will be sufficient to recover tax assets. |
| Classification of Deferred Tax Asset | It is classified as Current or Non-current based on the underlying asset or liability classification. | It is always classified as Non Current after netting it. |
| Revaluation permitted | Doesn’t permit the same. | Allowed and Deferred Tax assets created forms part of Equity. |
Advantages
Some of the advantages are given below:
- It helps in understanding the actual tax liability of the business and its post-tax profitability.
- It helps in understanding the differences that arise in accounting income and taxable income.
- Income tax expenses are also expenses that impact net income and income tax accounting helps in a better understanding of the same.
- It helps businesses to make timely payment of its tax liability and avoid any penalties related to non-compliance with tax payments.
- Trend analysis of income tax expenses over the period helps in understanding the tax expenses structure and enable better tax management.
Disadvantages
Some of the disadvantages are given below:
- It increases administration cost as entities that are governed by companies act need to separately keep two different sets of books of accounts one for financial reporting, other for income tax purpose leading to additional compliance cost.
- It is complex as it involves following the tax laws of relevant jurisdiction which varies from country to country. Also comparing income tax accounting based on IFRS and us GAAP or other accounting guidelines poses a challenge for common investors due to different treatment.
Conclusion
It is an important part of analyzing financial statements and stakeholders as well as analysts closely follow to understand the tax liability of the business which enables them to understand and appreciate its pre and post-tax profits in a more systemized manner. However, income tax accounting rules vary within different jurisdictions as well as under different accounting standards leading to variation in tax liability. Despite the challenges, income tax accounting is an important aspect of accounting and business need to ensure its compliance on time.
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