IAS 12 Income Taxes: Current Tax, Deferred Tax and Temporary Differences

IAS 12 Income Taxes: Current Tax, Deferred Tax and Temporary Differences

By Sai Manikanta Pedamallu (ACCA, CMA US, CSCA US, CGMA, ACMA, Dip IFRS, M.Com, MBA, MA)

Lead Instructor, Global Fin X | www.globalfinx.in/manikanta

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IAS 12 exists because accounting profit and taxable profit are two different numbers, calculated under two different rule sets, for two entirely different purposes. Accounting profit answers a question posed by investors: how did this business perform? Taxable profit answers a question posed by the state: how much should this business pay? There is no reason those two answers should coincide, and in practice they almost never do.

The standard's job is to reconcile the timing gap between them. Where a difference is genuinely permanent, IAS 12 does nothing at all. Where a difference will reverse in a future period, IAS 12 requires the entity to recognise the future tax consequence now, in the period the underlying transaction occurred, rather than waiting until the cash tax effect actually arrives.

This post covers the foundational architecture: current tax, the tax base concept, and how temporary differences arise and are classified. Post 63 covers the recognition and measurement of deferred tax assets and liabilities with full worked examples, and Post 64 covers the specifically Indian MAT credit question.

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Current Tax: The Straightforward Half

Current tax is the amount of income taxes payable (or recoverable) in respect of the taxable profit (or tax loss) for a period.

The recognition rules are simple. Current tax for the current and prior periods is recognised as a liability to the extent it remains unpaid, and as an asset to the extent the amounts already paid exceed the amount due. A tax loss that can be carried back to recover current tax of a previous period is recognised as an asset in the period the loss arises, since the benefit is realisable and measurable at that point.

Current tax is measured using the tax rates and tax laws that have been enacted, or substantively enacted, by the end of the reporting period. This "substantively enacted" concept matters in practice: in India, the relevant point is generally when the Finance Act receives Presidential assent, not when the Budget is presented or when a Bill is introduced.

Where current tax relates to items recognised outside profit or loss, the tax follows the item. Tax on a revaluation surplus recognised in OCI is itself recognised in OCI. Tax on an equity transaction is recognised directly in equity. This "follow the item" principle runs throughout IAS 12 and is one of the most consistently mishandled aspects of the standard in practice.

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The Tax Base: The Concept Everything Depends On

Deferred tax cannot be calculated without first determining the tax base of each asset and liability, and this is where most conceptual confusion originates.

The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to the entity when it recovers the carrying amount of that asset. If those economic benefits will not be taxable at all, the tax base of the asset simply equals its carrying amount, and no temporary difference arises.

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. For revenue received in advance, the tax base of the resulting liability is its carrying amount less any amount of the revenue that will not be taxable in future periods.

Working Through the Definitions

A machine costing Rs. 100 lakh, with accounting depreciation of Rs. 20 lakh and tax depreciation of Rs. 35 lakh in the first year. Carrying amount: Rs. 80 lakh. Tax base: Rs. 65 lakh (the amount still available as a future tax deduction). The carrying amount exceeds the tax base by Rs. 15 lakh, and that difference will reverse over the asset's remaining life as the tax depreciation falls below the accounting depreciation.

A warranty provision of Rs. 10 lakh, deductible for tax only when the warranty claims are actually paid. Carrying amount of the liability: Rs. 10 lakh. Tax base: Rs. 10 lakh less the Rs. 10 lakh future deduction, giving a tax base of nil. The liability's carrying amount exceeds its tax base by Rs. 10 lakh.

Interest receivable of Rs. 5 lakh, taxable only when the cash is received. Carrying amount of the asset: Rs. 5 lakh. Tax base: nil, since no future tax deduction is available against the taxable economic benefit. Carrying amount exceeds tax base by Rs. 5 lakh.

A trade receivable of Rs. 50 lakh, where the related revenue has already been taxed. Carrying amount: Rs. 50 lakh. Tax base: Rs. 50 lakh, since recovering the receivable produces no further taxable amount. No temporary difference.

That last example is worth noting specifically because it illustrates something students frequently get wrong: not every asset generates a temporary difference. Many, perhaps most, of the items on a balance sheet have a tax base equal to their carrying amount and require no deferred tax at all.

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Temporary Differences: Two Directions

A temporary difference is the difference between the carrying amount of an asset or liability in the statement of financial position and its tax base. Temporary differences reverse in one or more future periods, which is precisely what makes them temporary and therefore worth accounting for.

Taxable Temporary Differences

A taxable temporary difference is one that will result in taxable amounts in determining taxable profit in future periods, when the carrying amount of the asset is recovered or the liability is settled. These give rise to deferred tax liabilities.

The standard sources:

Accelerated tax depreciation, where tax depreciation exceeds accounting depreciation in early years (the machine example above).

Accrued revenue recognised for accounting purposes but taxable only on cash collection (the interest receivable example).

Expenditure capitalised for accounting but deducted in full for tax in the year incurred.

Upward revaluation of assets that is ignored for tax purposes, where the tax base remains at historical cost while the carrying amount steps up.

Elimination of unrealised profits on intragroup transactions in consolidated financial statements.

Fair value uplifts on identifiable assets recognised in a business combination, where the tax base carries over at the acquiree's historical value (as covered in Post 46).

Deductible Temporary Differences

A deductible temporary difference is one that will result in amounts deductible in determining taxable profit in future periods. These give rise to deferred tax assets, subject to the recognition test covered in Post 63.

The standard sources:

Provisions (warranty, restructuring, employee benefits) recognised for accounting but deductible for tax only when the cash is actually paid.

Expenses recognised for accounting but disallowed for tax in the current year, becoming deductible in a later year.

Impairment losses on assets, where the tax base remains at the pre-impairment amount until disposal.

Unrealised losses on debt instruments measured at fair value, where the tax base remains at original cost.

Unused tax losses and unused tax credits carried forward.

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Worked Example: Building the Deferred Tax Position

An Indian company at 31 March 2026 has the following position. The applicable tax rate is 25.17% (Section 115BAA concessional regime: 22% base plus 10% surcharge plus 4% cess).

Net taxable temporary differences: Rs. 180 + Rs. 12 = Rs. 192 lakh

Net deductible temporary differences: Rs. 35 + Rs. 96 + Rs. 60 = Rs. 191 lakh

Deferred tax liability: Rs. 192 lakh x 25.17% = Rs. 48.33 lakh

Deferred tax asset: Rs. 191 lakh x 25.17% = Rs. 48.07 lakh (subject to the probability test for the DTA)

Where deferred tax assets and liabilities relate to income taxes levied by the same taxation authority on the same taxable entity, and the entity has a legally enforceable right to set off current tax assets against current tax liabilities, the deferred tax amounts are offset and presented net on the balance sheet. In this case, a net deferred tax liability of Rs. 0.26 lakh would be presented, though the gross amounts and their composition must still be disclosed.

Note the deliberate detail in the provision items: both the warranty provision and the gratuity provision generate deductible temporary differences because Indian tax law permits deduction only on actual payment, while Ind AS requires recognition when the obligation arises. This is one of the largest and most consistent sources of deferred tax assets on Indian corporate balance sheets.

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The Initial Recognition Exemption and Its 2021 Narrowing

IAS 12 contains a specific exemption preventing deferred tax recognition on the initial recognition of an asset or liability in a transaction that is not a business combination and that, at the time of the transaction, affects neither accounting profit nor taxable profit.

The logic was originally that recognising deferred tax in these circumstances would require grossing up the asset or liability itself, producing financial statements that were less transparent rather than more.

In May 2021, the IASB narrowed this exemption significantly. It no longer applies to transactions that, on initial recognition, give rise to equal taxable and deductible temporary differences.

This change was aimed squarely at two specific transaction types that had produced inconsistent practice across jurisdictions:

Leases under IFRS 16. On initial recognition, a lessee recognises a right-of-use asset and a lease liability of broadly equal amount. In many tax jurisdictions, including India, the tax deduction follows the lease rental payments rather than the accounting depreciation and interest, meaning the ROU asset has a nil tax base and the lease liability has a nil tax base, generating equal and offsetting taxable and deductible temporary differences. Under the narrowed exemption, deferred tax must now be recognised on both.

Decommissioning and restoration obligations. Similarly, where a decommissioning provision is recognised with a corresponding addition to the cost of the related asset, equal and offsetting temporary differences arise, and deferred tax is now required on both sides.

The practical effect for Indian companies with significant lease portfolios, particularly in aviation, retail, and IT services (as covered in Post 32), is that the Ind AS 116 balance sheet expansion carries a corresponding deferred tax gross-up that was not required before this amendment.

Two exemptions from deferred tax liability recognition remain intact: the initial recognition of goodwill, and taxable temporary differences on investments in subsidiaries, branches, associates and joint arrangements where the parent can control the timing of the reversal and it is probable the difference will not reverse in the foreseeable future.

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Measurement: Rates and the Manner of Recovery

Deferred tax assets and liabilities are measured at the tax rates expected to apply to the period when the asset is realised or the liability is settled, based on rates enacted or substantively enacted by the reporting date.

Critically, deferred tax balances are never discounted, regardless of how far into the future the reversal is expected. This is a deliberate simplification: reliably scheduling the detailed timing of every reversal would be impracticable, and permitting discounting without such scheduling would produce inconsistent and uncomparable numbers.

The measurement must also reflect the manner in which the entity expects to recover or settle the carrying amount. An asset expected to be recovered through use may attract a different tax treatment (and therefore a different rate) from one expected to be recovered through sale, particularly in jurisdictions with distinct capital gains regimes.

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The Indian Rate Complexity

India presents an unusually complicated measurement question because a single company faces multiple possible rate tracks, and the choice between them is a management decision with direct deferred tax consequences.

For domestic companies under the Income-tax Act framework, the available tracks are: 30% default, 25% where turnover in the previous year did not exceed Rs. 400 crore, 22% under the Section 115BAA concessional regime (giving an effective rate of approximately 25.17% after the flat 10% surcharge and 4% health and education cess), and 15% under Section 115BAB for qualifying new manufacturing companies (effective rate approximately 17.16%), though the Section 115BAB route required manufacturing to commence by 31 March 2024 and that deadline has passed without extension.

Foreign companies pay 35%, reduced from 40% by the Finance Act 2024, with a lower surcharge of 2% or 5%.

The deferred tax consequence: a company that has opted into Section 115BAA, an irrevocable election, measures all its deferred tax balances at the 115BAA effective rate, since that is the rate expected to apply when the temporary differences reverse. A company that has not yet opted in but intends to do so faces a genuine judgment question about which rate reflects the expected manner of settlement, and the answer directly changes the reported deferred tax balance and the resulting tax expense.

MAT and Its Interaction

Minimum Alternate Tax applies at 15% of book profits to companies that have not opted into the 115BAA or 115BAB regimes, and at 9% for companies operating in International Financial Services Centres earning solely in convertible foreign exchange.

Companies exercising the 115BAA option are excluded from MAT entirely. Pursuant to the Finance Act 2026, such companies are now permitted to utilise accumulated MAT credit, subject to a cap of 25% of the normal tax liability for the relevant tax year, with any unutilised credit carried forward for 15 years. This is a meaningful change from the earlier position, where transitioning to 115BAA effectively meant forfeiting accumulated MAT credit.

MAT credit and its treatment as a deferred tax asset is a genuinely distinctive Indian question, and it receives full treatment in Post 64.

The Income-tax Act, 2025

The Income-tax Act, 2025 received Presidential assent on 21 August 2025 and commences on 1 April 2026, making tax year 2026-27 the first under the new Act. The Act renumbers and restructures provisions substantially without, in most respects, changing the underlying rate architecture described above. For deferred tax purposes, the practical implication is largely one of cross-referencing: the substantive rates and the temporary difference analysis are unchanged, but section references in accounting policies, tax notes, and audit documentation require updating.

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Pillar Two: The Temporary Exception

In May 2023, the IASB issued amendments introducing a mandatory temporary exception to the requirement to recognise and disclose deferred tax assets and liabilities arising from the OECD's Pillar Two model rules on global minimum taxation.

Entities within scope do not recognise deferred tax on Pillar Two income taxes. Where Pillar Two legislation has been enacted or substantively enacted but is not yet in effect, entities must disclose information enabling users to understand the potential exposure. Current tax expense relating to Pillar Two income taxes must be separately disclosed.

For large Indian multinational groups within the Pillar Two scope, this exception removes what would otherwise have been a substantial modelling burden, though the disclosure requirements remain.

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Recognition Outside Profit or Loss

The "follow the item" principle deserves restating as a discrete rule because it generates recurring errors.

Deferred tax is recognised in profit or loss, except to the extent it arises from a transaction or event recognised outside profit or loss. Where the underlying item was recognised in other comprehensive income, the related deferred tax goes to OCI. Where it was recognised directly in equity, the deferred tax goes to equity.

Practical applications: deferred tax on a revaluation surplus under IAS 16 goes to OCI. Deferred tax on remeasurements of a defined benefit obligation under IAS 19 (Post 57) goes to OCI. Deferred tax on the equity component of a compound financial instrument (Post 24) goes to equity. Deferred tax on share-based payments, where the expected future tax deduction exceeds the cumulative accounting expense, has the excess recognised in equity (Post 61).

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Ind AS 12 vs IAS 12

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What Big 4 Auditors Focus On

Completeness of the temporary difference schedule. Auditors test whether the entity has identified every asset and liability whose carrying amount differs from its tax base, rather than working only from a familiar list of recurring items. Newly recognised items, particularly right-of-use assets and lease liabilities following the 2021 amendment, and business combination fair value uplifts, are common omissions.

Tax rate applied and its consistency with the entity's regime election. Auditors verify that the rate used to measure deferred tax reflects the regime the entity has actually elected or realistically expects to be subject to when the differences reverse, not a default statutory rate applied out of habit.

Follow-the-item allocation. Auditors specifically test whether deferred tax relating to items recognised in OCI or equity has been allocated there rather than routed through profit or loss, since misallocation distorts both the effective tax rate reconciliation and OCI.

Lease deferred tax post-amendment. Given the 2021 narrowing of the initial recognition exemption, auditors test whether entities with material lease portfolios have recognised deferred tax on both the right-of-use asset and the lease liability, rather than continuing to apply the pre-amendment exemption.

Substantive enactment date. Auditors confirm that rate changes have been reflected from the correct date, based on when the relevant legislation was substantively enacted rather than when it was announced or when it takes effect.

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Dip IFRS Exam Angle

IAS 12 is among the most heavily and consistently examined standards in Dip IFRS, and the tax base calculation is the foundation everything else builds on.

Most tested areas:

Calculating the tax base of a given asset or liability from a scenario description, and identifying whether the resulting temporary difference is taxable or deductible.

Building a complete deferred tax schedule from a list of balance sheet items with their carrying amounts and tax treatments.

Applying the follow-the-item principle: correctly routing deferred tax to profit or loss, OCI, or equity depending on where the underlying item was recognised.

Recognising that deferred tax is never discounted, regardless of the expected timing of reversal.

Common traps:

Assuming every asset generates a temporary difference. Many have a tax base equal to their carrying amount.

Discounting deferred tax balances. IAS 12 prohibits this absolutely.

Recognising deferred tax on the initial recognition of goodwill. This exemption remains in place.

Routing deferred tax on a revaluation surplus through profit or loss rather than OCI.

Continuing to apply the initial recognition exemption to leases and decommissioning provisions after the 2021 amendment narrowed it.

Confusing a permanent difference (a genuinely non-deductible expense, such as certain penalties) with a temporary difference. Permanent differences generate no deferred tax at all; they affect only the effective tax rate reconciliation.

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FAQ

Why is deferred tax never discounted when so many other IFRS liabilities are?

Because reliably scheduling the detailed timing of every temporary difference reversal would be impracticable for most entities, and permitting discounting without that scheduling would produce inconsistent, incomparable results. The IASB chose comparability over theoretical precision.

What is the difference between a temporary difference and a timing difference?

Timing difference is the older income-statement-based concept, focusing on when items are recognised in profit versus in the tax computation. Temporary difference is the balance-sheet-based concept IAS 12 actually uses, comparing carrying amount to tax base. The balance sheet approach captures differences the income statement approach would miss, including revaluation surpluses and business combination fair value adjustments.

If an expense is permanently disallowed for tax, does it generate deferred tax?

No. A permanent difference never reverses, so there is no future tax consequence to recognise. It affects the effective tax rate but generates no deferred tax asset or liability.

How does a change in tax rate affect existing deferred tax balances?

All deferred tax assets and liabilities are remeasured at the new rate in the period the change is enacted or substantively enacted, with the effect recognised in profit or loss, except where the underlying item was recognised in OCI or equity, in which case the remeasurement follows the item.

Does an Indian company that has not yet elected Section 115BAA measure deferred tax at 25% or 22%?

At the rate expected to apply when the temporary differences reverse. If management has decided to elect 115BAA and the election is realistically expected before the reversals occur, measuring at the 115BAA effective rate is appropriate, with the judgment and its basis disclosed. This is a genuine estimation judgment, not a free choice.

Why does the tax base of a trade receivable equal its carrying amount when the receivable will produce cash?

Because the related revenue has already been included in taxable profit. Recovering the receivable produces no further taxable amount, so no future tax consequence arises and no temporary difference exists.

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Enroll with Global Fin X

IAS 12 rewards candidates who can calculate a tax base reliably and classify the resulting difference correctly, because everything downstream depends on getting those two steps right. Post 63 builds on this foundation with full deferred tax asset and liability recognition and measurement, and Post 64 addresses the specifically Indian MAT credit question. Our programme covers the complete IAS 12 series with detailed lectures, worked examples using current Indian tax rates, exam-style MCQs, and a dedicated LMS for working professionals.

Enroll Now: Dip IFRS Programme

Faculty profile: www.globalfinx.in/manikanta

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This is Post 62 of the Global Fin X IFRS Series. Previous: IFRS 2: ESOPs in Indian Startups and Listed Companies. Next: Post 63: IAS 12 Deferred Tax Assets, Liabilities, Recognition and Worked Examples.