1. The Core Objective of Tax Accounting (IAS 12 / ASC 740)
Financial reporting and tax reporting serve different purposes. Financial accounting (under IFRS or US GAAP) provides relevant and faithfully represented information to investors, focusing on the accrual concept. Tax reporting (under local statutory tax laws, like the US Internal Revenue Code or European tax decrees) generates revenue for governments, often focusing on a cash basis or specific economic policies.
Because of these differing objectives, a company’s financial accounting profit before tax (book income) rarely matches its taxable profit (tax income).
2. Permanent vs. Temporary Book-Tax Differences
- Permanent Differences: Transactions that enter into the calculation of accounting profit but never enter into the calculation of taxable profit, or vice versa. They do not create future tax consequences and never reverse. Examples include fines and penalties (expenses that are non-deductible for tax), municipal bond interest income (exempt from tax under US law), or non-deductible corporate entertainment expenses. Permanent differences alter a company’s Effective Tax Rate (ETR) but do not create deferred tax balances.Â
- Temporary Differences: Differences between the carrying amount of an asset or liability in the balance sheet and its tax base. These differences arise in one period and reverse in one or more subsequent periods. They generate deferred tax assets or liabilities.
Â