Income Tax Expense Accounting Treatment

When a company estimates its income tax expense for the financial year, a provision for income tax is created. This ensures compliance with the matching principle, recognizing the tax expense for the period.

Provision for Income Tax in Accounting

Step 1: Journal Entry to Record the Provision for Income Tax

Income Tax Expense A/c           Dr. ₹2,50,000

To Provision for Income Tax A/c         ₹2,50,000

(Being provision made for income tax expense for the year)

Step 2: Explanation of Accounts

1. Income Tax Expense A/c:
   • This account is debited to recognize the estimated tax expense in the Profit and Loss Account.
2. Provision for Income Tax A/c:
   • This account is credited to create a liability for the estimated tax payable, which will appear in the Balance Sheet.

Step 3: Impact on Financial Statements

1. Profit and Loss Account:
   • Income Tax Expense of ₹2,50,000 will reduce the company’s net profit.
2. Balance Sheet:
   • Provision for Income Tax of ₹2,50,000 will be shown under Current Liabilities, as it represents an obligation payable in the near future.

Step 4: When Actual Payment is Made

Once the income tax is paid, the following entry is passed:

Provision for Income Tax A/c    Dr. ₹2,50,000

To Bank A/c                           ₹2,50,000

(Being payment of income tax for the year)

Additional Notes:

• If there is any difference between the provision and the actual tax liability assessed, the adjustment is made in the next financial year.
• Disclosure: The provision for income tax should be disclosed in the Notes to Accounts, along with the basis of estimation and any reconciliation with the tax return.

Q1. will Income Tax Expense of ₹2,50,000 be allowed as deduction?

No, the Income Tax Expense of ₹2,50,000 will not be allowed as a deduction while computing taxable income for the year. Here’s why:

Explanation:

1. Income Tax is Not a Deductible Expense:

1. • As per Section 40(a)(ii) of the Income Tax Act, 1961, income tax paid or payable (including provisions for income tax) is expressly disallowed as a deduction while calculating taxable income.
   • This is because income tax is considered an appropriation of profits, not an expense incurred for earning income.

2. Accounting vs. Tax Treatment:

1. • While Income Tax Expense is recognized in the books of accounts as per accounting standards (e.g., Ind AS 12 or AS 22), it cannot be deducted while calculating taxable income for the purpose of filing the income tax return.

What is Allowed as a Deduction?

1. Deferred Tax Expense/Income:

1. • If deferred tax arises due to temporary differences, it is accounted for in the books but does not affect the taxable income directly.

2. Other Taxes Paid:

1. • Taxes such as GST, customs duty, or other indirect taxes that are incurred in the course of business are allowed as deductions.

3. Surcharge or Interest on Income Tax:

1. • Surcharge, penalty, or interest on income tax (e.g., for late filing or non-payment) is also not deductible as it arises from non-compliance, not business operations.

Treatment in Financial Statements:

1. In the Profit and Loss Account:

1. • Income Tax Expense (₹2,50,000) will reduce the accounting profit.

2. For Tax Computation:

1. • While computing taxable income, the Income Tax Expense of ₹2,50,000 must be added back to the net profit as it is a disallowed item under the Income Tax Act.

Summary:

• The ₹2,50,000 Income Tax Expense is not deductible for tax purposes.
• For computing taxable income, you must add this back to the accounting profit.

Q2. where will it be shown?

The Income Tax Expense of ₹2,50,000 will be shown in the financial statements, but it will not be considered as a deductible expense in the computation of taxable income. Here’s how it will be presented in different parts of the financial statements:

1. Profit and Loss Account (P&L Statement)

• Income Tax Expense of ₹2,50,000 will be shown as a separate line item under the heading Tax Expenses in the P&L Statement.
  • It is part of the calculation of Net Profit after Tax (i.e., profit available to shareholders).
• Example Format:

Profit Before Tax (PBT)                 ₹X,XX,XXX  Less: Income Tax Expense               ₹2,50,000  Net Profit After Tax (PAT)              ₹X,XX,XXX

2. Balance Sheet

If the income tax is unpaid as of the balance sheet date, the provision for income tax will be shown under Liabilities.

• Provision for Income Tax (₹2,50,000) will be included in:
  • Current Liabilities section if it is due within 12 months.

Example Format in Balance Sheet:
Liabilities

• Current Liabilities:
  • Provision for Income Tax: ₹2,50,000

3. Cash Flow Statement

In the Cash Flow Statement, the income tax expense is adjusted based on whether it is paid or remains unpaid:

1. If paid:
   • Income tax paid is shown as an outflow under Operating Activities.
2. If unpaid:
   • It will not appear as a cash outflow until it is actually paid.

4. Notes to Accounts

Details of the income tax provision will be disclosed in the Notes to Accounts, including:

• The basis of computation of income tax expense.
• Breakup of current tax and deferred tax components, if applicable.

Summary:

• P&L Account: Shown as an expense under Tax Expenses.
• Balance Sheet: Shown as a liability under Provision for Income Tax (if unpaid).
• Cash Flow Statement: Tax paid is reflected as an outflow in Operating Activities.
• Notes to Accounts: Disclose the details of the provision.

While it is an accounting expense, it is not deductible under the Income Tax Act when computing taxable income. Instead, it serves as an appropriation of profits for tax reporting purposes.