Temporary difference

Every asset and liability has a carrying amount in the accounts and a tax base, which is the amount the tax authority recognises for it. Where the two differ and the gap will eventually close, that is a temporary difference, and it is the entire source of deferred tax under IAS 12.

There are two directions and the rule is worth memorising as a sentence rather than a table. A tax deduction taken before the book expense, accelerated tax depreciation being the standard case, makes taxable profit lower now and higher later, and builds a deferred tax liability. A book expense recognised before the tax deduction, a warranty or restructuring provision being the standard case, makes taxable profit higher now and lower later, and builds a deferred tax asset.

The consequence for reported rates is the part interviewers test. Because the total amount taxed over the life of the item is unchanged, a temporary difference moves the cash tax rate and leaves the effective tax rate alone. That is exactly what separates it from a permanent difference, which does the reverse.

One honest caveat. Each individual difference reverses, but a company that keeps investing keeps creating new ones, so the aggregate deferred tax liability can grow for years without unwinding. Whether that makes it debt like is a genuine disagreement among practitioners, and the defensible middle position is to treat only the portion expected to reverse inside the forecast horizon as a claim.