What is the definition of 'deferred tax'?

The definition of 'deferred tax' refers specifically to situations where a tax obligation arises from differences between accounting income and taxable income. When income is recognized in the financial statements but is not immediately subject to taxation under the tax laws, a deferred tax liability is created. This mechanism ensures that tax is accounted for in the right period according to the matching principle, reflecting that while the income has been reported, the corresponding tax has not yet been paid.

In essence, deferred tax liabilities arise when the taxable income is lower than the accounting income due to either temporary differences or timing differences in revenue recognition. As a result, the business will ultimately settle this tax obligation in the future when the income is taxed.

In contrast, the other options revolve around different aspects of tax accounting. Recognizing a tax obligation when expenses are paid pertains more to current or accrued taxes rather than deferred taxes. The idea of an asset that reduces taxable income is not applicable in the context of deferred taxes, as deferred tax typically relates to liabilities rather than assets. Lastly, the notion of taxes paid upfront before being accrued does not capture the nature of deferred tax accounting, which is focused on timing differences in income recognition rather than cash flows directly associated with tax payments.

Understanding deferred tax is critical