Current vs. deferred tax – accounting principles, recognition
Physical and documentary inventory-taking needs to be performed and closing transactions need to be accounted for before the 2021 financial statement can be compiled. The final accounting entries are the recognition of tax payable and deferred tax, which we will look at today.
In our article, we will introduce you to the basic information on payable and deferred tax, the principles of accounting and reporting (in compliance with Decree No. 500/2002 Coll., for entrepreneurs – hereinafter referred to as the “Decree”) and remind you of the novelty from the year before last concerning the retroactive application of tax loss.
The corporate income tax payable is based on the profit/loss for the taxable period, which in most cases is also the accounting period. This profit/loss is adjusted in compliance with Act
586/1992 Coll., on Income Taxes, by individual entries that are assessed in terms of tax deductibility through individual lines of the tax return (entries increasing/decreasing the tax base). The result may be either a tax loss or, after deduction of income tax advances paid, a resulting tax liability (underpayment) or overpayment. If only a preliminary tax calculation is available when the financial statement is being compiled (i.e. the tax return itself is prepared and submitted to the tax authorities after the date of the financial statement), the company reports an income tax provision in the financial statement.
Income tax payable (resulting from the filed tax return) is debited to account 591 – Income tax payable and credited to account 341 – Income tax. The balance of account 341 in the accounts itself represents the overpayment or underpayment of tax, i.e. the total tax liability minus any advance tax paid. This account, same as other balance sheet accounts, should be subject to inventory-taking as of the balance sheet date. Income tax overpayment is recognised in the balance sheet in assets through entry C.II.2.4.3. State – tax receivable, tax underpayment under liabilities in entry C.II.8.5. State – tax liabilities and subsidies.
The income tax provision is debited to account 591 – Income tax payable and credited to account 453 – Provision for income tax. If advances paid exceed the calculated provision, an estimate of the overpayment (advances paid minus provision) is reported under assets and C.II.2.4.3. State – tax receivables. If the provision for income tax is higher than the advances paid, the provision reduced by the advances paid is shown under liabilities through entry B.2. Income tax provision. In the subsequent period, the tax payable is then cleared and the provision for income tax is reversed.
The Company does not account for tax loss, but it is one of the entries included in the calculation of deferred tax.
Deferred tax arises from temporary differences between the accounting and tax treatment of accounting events. The most typical examples are the calculation of deferred tax on the difference between the tax and accounting amortised cost of fixed assets, from provisions that will be tax provisions in the future (e.g. for untaken leave) and unused tax losses. The calculation of deferred tax may result in either a deferred tax liability or a deferred tax asset.
The basic procedures for accounting for deferred tax are regulated by the Decree (article 59) and Czech Accounting Standard No. 003 – Deferred Tax. The deferred tax liability represents the amount of income tax that the entity will be required to pay in future periods in respect of these temporary differences. In contrast, the deferred tax asset represents the amount of income tax, by which income tax is likely to be reduced in the future. A deferred tax asset is accounted for only if it is probable that the tax base against which the temporary differences can be applied is recoverable, i.e. that the asset will be recovered from the tax payable. If this condition is not met, it is not advisable to account for the deferred tax asset as this would be contrary to one of the fundamental principles of accounting, namely the prudence principle.
We account for deferred tax through account 481 – Deferred tax asset and liability and account 592 – Deferred income tax. If we account for deferred tax for the first time (its calculation is based on temporary differences of previous years), we account for this first deferred tax through the balance sheet account Other profit/loss of previous years, so we do not charge it to the profit/loss of the current accounting period (i.e. through account 592). In this context, we recommend reading Interpretation I-9 Deferred Tax – Initial Recognition, of the National Accounting Standards Board, available at www.nur.cz.
A deferred tax asset is recognised in assets under non-current receivables, specifically C.II.1.4. Deferred tax receivable. A deferred tax liability is recognised under non-current liabilities C.I.8. Deferred tax liability.
Retroactive application of tax loss
The pandemic associated with COVID-19 has brought many changes to our lives. In the context of the coronavirus, the Government adopted measures to respond to the coronavirus situation, which were intended to help at least partially to bridge the negative impact of the situation.
One of the changes approved in 2020 was an amendment to the Income Tax Act, which brought a significant innovation consisting in the option of claiming tax loss not only in subsequent periods, as was previously the case, but also newly introduced the concept allowing the claiming of tax losses retroactively in the two immediately preceding tax periods.
In the event that a tax loss is calculated for 2021, it can be claimed immediately through a supplementary tax return for 2020 and/or 2019 if a tax liability was reported for these periods. The option of claiming is limited for both periods by tax loss up to a maximum value of EUR 30m. The immediate saving may thus reach up to CZK 5.7m.
The exercise of this option will affect not only the value of the tax payable itself, but also the related calculation of deferred tax, as it will change (reduce) the value of the tax loss for possible future use.
What to say to conclude….
Current tax and deferred tax are two different concepts, but they have a lot in common and they must therefore always be understood in context (working together). If you are currently dealing with this issue and would like to check your procedures or need help with the calculation itself, please contact us. We are happy to support you, and not only in this area.
Author: Jitka Pešičková, Ivana Kůtová