What is a temporary difference in income tax?

Personal Tax

Qualifying year for state pension purposes

Why is this important?In order to get a full basic state pension, an individual must have paid sufficient national insurance contributions (NIC) for a minimum number of qualifying years in their working life. As NIC cannot be paid in the tax year before the individual reaches the age of 16, or in a

14 Jul 2020 13:03 | Produced by Tolley Read more

Employment Tax

Loans written off

Companies sometimes provide directors, employees or shareholders with low interest (or interest-free) loans either as part of the reward package or on special occasions to help the individual meet significant expenditure. The employment income implications of these loans are discussed in detail in

14 Jul 2020 12:11 | Produced by Tolley Read more

Corporation Tax

Qualifying charitable donations

Companies can obtain corporation tax relief for qualifying payments or certain transfers of assets to charity under the qualifying charitable donations regime. Definition of qualifying charitable donationThe definition of ‘qualifying charitable donations’ includes:•qualifying cash donations to

14 Jul 2020 13:03 | Produced by Tolley Read more

Temporary differences occur whenever there is a difference between the tax base and the carrying amount of assets and liabilities on the balance sheet.

Permanent differences are differences between the tax and financial reporting of revenue or expense items that will not be reversed in future.

Temporary Differences

The formation of deferred tax assets or liabilities from temporary differences can only occur if the differences will reverse themselves at some future date and to such an extent that the balance sheet items are expected to create future economic benefits for the company.

Temporary differences are divided into: (i) taxable temporary differences, and (ii) deductible temporary differences.

Taxable temporary differences are temporary differences that result in a taxable amount in future when determining the taxable profit as the relevant balance sheet item is recovered or settled.

Taxable temporary differences result in a deferred tax liability when the carrying amount of an asset exceeds its tax base, or when the tax base of liability exceeds its carrying amount.

Deductible temporary differences are temporary differences that result in a reduction or deduction of taxable income in future when the relevant balance sheet item is recovered or settled. They result in a deferred tax asset when the tax base of an asset exceeds its carrying amount, or the carrying amount of liability exceeds its tax base.

Permanent Differences

Since they are irreversible, permanent differences do not give rise to deferred tax assets or liabilities. Examples of the items which give rise to permanent differences include:

• income or expense items that are not allowed by tax legislation; and
• tax credits for some expenditures directly reduce taxes.

All permanent differences result in a difference between a company’s effective tax rate and statutory tax rate.

The following examples will help to highlight the implications of temporary differences and permanent differences.

• Dividends receivable: dividends receivable are usually not taxable, and therefore, the carrying amount will equal the tax base. This gives rise to a permanent difference and will not result in the recognition of any deferred tax asset or liability. Unlike a temporary difference, a permanent difference will never be reversed. Taxable income and accounting profit will permanently  be different from the amount of dividends receivable, even on future financial statements as an effect on the retained earnings reflected on the balance sheet.
• Research and development costs: any difference between the carrying amount and tax base is a temporary difference that will reverse in future.
• Accounts receivable: like the case of research and development costs, any difference between the carrying amount and tax base is a temporary difference that will reverse in future.
• Donations: if tax legislation does not allow deduction of donations for tax purposes, then no temporary difference will arise. Therefore, no deferred tax asset or liability will be recognized. This constitutes a permanent difference.
• Interest received in advance: any difference between the carrying amount and tax base is a temporary difference that will reverse in future.
• Rent received in advance: any difference between the carrying amount and tax base is a temporary difference that will reverse in future.
• Loan: if no temporary difference results from the loan or interest paid, no deferred ta item will be recognized.

Question 1

Which of the following statements is least likely accurate?

1. Permanent differences arise when there is a difference between the tax base and the carrying amount of assets and liabilities.
2. Temporary differences arise when there is a difference between the tax base and the carrying amount of assets and liabilities.
3. Permanent differences are differences between the tax and financial reporting of revenue or expense items which will not be reversed in future.

Solution

The correct answer is A.

Temporary differences, and not permanent differences, arise whenever there is a difference between the tax base and the carrying amount of assets and liabilities.

Question 2

Canadian Syrup Inc. received a government grant of $2,000 for buying a domestically manufactured machine. The governmental grant would result in:

1. A permanent tax difference.
2. A taxable temporary tax difference.
3. A deductible temporary tax difference.

Solution

The correct answer is A.

The grant would result in a permanent difference because the difference is not expected to reverse in the future.

What are examples of temporary differences?

What is temporary and permanent differences in tax?

How is temporary difference tax calculated?

What are the two kinds of temporary differences?