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A deferred tax liability is tax you’ll owe later on income your books already show today. It appears when the accounting rule and the tax rule spread the same cost over different years. The classic case is equipment: the CRA lets you deduct capital cost allowance (CCA) faster than a company usually writes the asset off in its financial statements, so tax gets paid later than the expense suggests.
Where does a deferred tax liability come from?
Your accounts say a $10,000 machine wears out over ten years, so they charge $1,000 a year. The tax return can’t use that number. The CRA says you can’t deduct the full cost of depreciable property in the year you buy it, and instead you claim CCA, a yearly deduction set by the asset’s class.
Class 8, the catch-all for business property that isn’t in another class, carries a 20% rate on the CRA’s classes of depreciable property page. Class 10, which covers motor vehicles and some computer equipment, carries 30%. Buildings bought after 1987 mostly sit in class 1 at 4%.
The two schedules disagree in the early years, then meet up. That gap, multiplied by a tax rate, is the number an accountant records as the liability.
What does a deferred tax liability example look like?
Here’s an example we worked by hand from the declining balance method. It’s a $10,000 class 8 asset at 20%, against straight line book depreciation of $1,000 a year. We used a flat 12% because it makes the arithmetic clear, and it isn’t a real combined rate for any province. We also applied the full rate in year one. The CRA pages we read didn’t cover first-year limits, so a real return may claim less in year one.
| Year | CCA on the return | Book depreciation | Cumulative gap | Liability at 12% |
|---|---|---|---|---|
| 1 | $2,000 | $1,000 | $1,000 | $120 |
| 2 | $1,600 | $1,000 | $1,600 | $192 |
| 3 | $1,280 | $1,000 | $1,880 | $226 |
| 4 | $1,024 | $1,000 | $1,904 | $229 |
| 5 | $819 | $1,000 | $1,723 | $207 |
| 6 | $655 | $1,000 | $1,379 | $165 |
See the turn? The liability peaks at the end of year four. In year five the CCA claim drops below the $1,000 of book depreciation for the first time, so the gap starts to close. It keeps shrinking as the CCA claims fall further behind. Over the machine’s life, the timing moves and the total deducted comes closer together, usually when the asset is sold or written off.
To check one row yourself: by the end of year three you’ve claimed $2,000 + $1,600 + $1,280 = $4,880 of CCA against $3,000 of book depreciation. The gap is $1,880, and 12% of that is $225.60, which the table rounds to $226.
Does the liability change what you pay the CRA?
No. It’s a bookkeeping entry, not a bill. The tax you pay each year is the tax on the return, worked out with CCA. The deferred tax figure sits on the balance sheet to show that a slice of today’s profit has tax attached that hasn’t been paid.
You’ll only see a payment effect when the timing gap reverses. In the years when book depreciation exceeds CCA, taxable income runs higher than book income, and the liability winds down.
Whether a company records one depends on the accounting rules behind its statements, which we didn’t check on an official page. If your statements are prepared by an accountant, ask which method they use and why.
What mistakes and limits should you know about?
People often treat the liability as a debt owed to the CRA. It isn’t. Others assume the tax year and the calendar year are the same. The CRA says to base the CCA claim on the fiscal period that ends in the tax year, so a company with a March year end has to be careful.
Selling the asset early breaks the schedule above, so redo the numbers if that’s your plan.
The same timing idea shows up outside companies. Capital gains and RRSPs push tax to a later year too, though nobody records a liability for them on a personal return. Try the capital gains tax calculator for a sale, and the corporate tax calculator if you want to see the rate a corporation might pay. Then the percentage calculator works out the liability for any gap and rate you choose.
The calculation has three steps. First, find the temporary difference: the CCA claimed so far minus the amount written off in the accounts over the same span. Second, pick the tax rate you expect to pay when the difference reverses. Third, multiply the two. The result is the balance recorded at the end of that period.
In the table above, the end of year four shows a $1,904 difference. At 12% the balance is $228.48, shown as $229. What reaches the accounts is the change from one period to the next. Going from $226 in year three to $229 in year four adds $3, while going from $229 to $207 in year five releases $22.
The base is a gap between two schedules, so a larger asset makes a larger liability. A $20,000 class 8 asset would double every figure in the table, because the arithmetic scales in a straight line.
What is the difference between a deferred tax liability and a deferred tax asset?
A deferred tax asset is the mirror image. A liability means tax will be higher later because deductions came early on the return. An asset means tax will be lower later, because an expense reached the accounts before the return allows a deduction for it. Both come from the same source: a temporary difference between the accounting treatment and the tax treatment of one item.
Think of it as direction. Deductions that run faster on the return than in the books create a liability. Deductions that run slower create an asset. In our example the CCA runs ahead of the book charge for the first four years, so the machine produces a liability.
Neither one is cash. Both sit on the balance sheet and move as the timing gap opens and closes. How a particular company presents them depends on the accounting rules it follows, which we have not checked.
Is a deferred tax liability a bad sign?
Not by itself. A growing business that keeps buying equipment will carry one almost permanently, because each new purchase starts a fresh gap before the old ones close. A small shop owner in Halifax who replaces a delivery van every few years would see exactly that. It’s worth a second look only when it’s large compared with the firm’s profit, and that’s a question for the person who prepares the statements.
The sources behind this page
CCA class rates and the rule against deducting full cost come from the Canada Revenue Agency’s pages on capital cost allowance and CCA classes. The example is our own arithmetic. The 12% rate is an assumption for illustration. We aren’t connected to the CRA or any government, and we haven’t reviewed the accounting rules behind deferred tax.
Frequently asked questions
What is a deferred tax liability in plain terms?
It's tax attached to profit your books show now but your tax return will only pay later, because deductions are timed differently.
Do I owe this amount to the CRA?
Not as a bill. It's an accounting entry that shows future tax. What you pay each year is set by the return.
What creates one most often?
Claiming CCA faster than the asset is depreciated in the financial statements.
Does it ever go away?
Yes. When book depreciation catches up with CCA, the gap closes and the liability reverses.
Which year's figures does CCA use?
The CRA says to base the claim on your fiscal period ending in the tax year, not the calendar year.
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