Income Tax Accounting for Indian Businesses: Complete Guide

Introduction: The Tax That Surprised Everyone

Ashok’s manufacturing company had a fantastic year—revenues up 40%, profits at ₹2 crores. His accountant confidently projected a tax liability of ₹50 lakhs at 25% rate.

Then the tax consultant reviewed the accounts: “Your book profit is ₹2 crores, but your taxable income is actually ₹2.8 crores because of depreciation differences and disallowed expenses. And you’ve not been paying advance tax correctly, so add interest under Section 234B and 234C.”

Final tax outflow: ₹82 lakhs. The ₹32 lakh surprise almost derailed their expansion plans.

This guide will help you understand how income tax interacts with your accounts—so there are no surprises.

Understanding Tax vs Book Profit

Why They Differ

Book Profit (Accounting Profit):

• Prepared under accounting standards (Ind AS/AS)
• Follows matching principle
• Reflects economic reality

Taxable Income:

• Computed under Income Tax Act, 1961
• Specific allowances and disallowances
• Follows tax policy objectives

Common Book-Tax Differences

1. Depreciation

Example:

• Machine cost: ₹10,00,000
• Book depreciation (Year 1): ₹1,50,000 (15% SLM)
• Tax depreciation (Year 1): ₹1,50,000 (15% WDV)
• Difference: Nil initially, but grows over time

2. Provisions Not Allowed Until Paid

3. Disallowed Expenses (Section 40)

Expenses not allowed as deduction:

• Interest/salary to partners beyond limits
• Income tax payment
• Wealth tax (when applicable)
• Payments without TDS deduction
• Cash payments above ₹10,000 (Section 40A(3))

4. Income Differences

Tax Rates for Different Entities (AY 2024-25)

Companies

Section 115BAA (New Tax Regime):

• 22% base rate
• Must forego certain deductions/exemptions
• No MAT applicable

Section 115BAB (New Manufacturing):

• For companies set up after October 1, 2019
• Manufacturing commenced before March 31, 2024
• 15% base rate

LLPs and Firms

Individuals/HUF (in Business)

Regular tax slabs apply, or can opt for presumptive taxation under:

• Section 44AD (6-8% of turnover for business)
• Section 44ADA (50% of receipts for professionals)

Deferred Tax Accounting

What is Deferred Tax?

Deferred tax arises from timing differences between book profit and taxable income. It ensures tax expense in financial statements reflects the tax attributable to the current period’s accounting profit.

Types of Timing Differences

1. Taxable Temporary Differences (Create Deferred Tax Liability)

• Book income recognized before tax income
• Tax deduction allowed before book expense

Example: Accelerated tax depreciation

• Year 1 Tax Depreciation: ₹40,000
• Year 1 Book Depreciation: ₹30,000
• Taxable temporary difference: ₹10,000
• Deferred Tax Liability: ₹10,000 × 25% = ₹2,500

2. Deductible Temporary Differences (Create Deferred Tax Asset)

• Tax income recognized before book income
• Book expense recognized before tax deduction

Example: Provision for bad debts

• Provision in books: ₹5,00,000
• Tax deduction: Nil (until write-off)
• Deductible temporary difference: ₹5,00,000
• Deferred Tax Asset: ₹5,00,000 × 25% = ₹1,25,000

Deferred Tax Calculation Example

XYZ Ltd - Year End Calculations:

Calculation at 25% tax rate:

Journal Entries

Creating Deferred Tax Asset:

Deferred Tax Asset A/c        Dr.    50,000
    To Deferred Tax Income (P&L)            50,000

Creating Deferred Tax Liability:

Deferred Tax Expense (P&L)    Dr.    XX
    To Deferred Tax Liability A/c             XX

Recognition Criteria

Deferred Tax Liability:

• Always recognize (with few exceptions)

Deferred Tax Asset:

• Recognize only if probable that taxable profit will be available
• Review at each balance sheet date
• Reduce if recovery is not probable

Minimum Alternate Tax (MAT)

What is MAT?

MAT ensures companies pay minimum tax even if they have zero or low taxable income due to exemptions and deductions. It’s computed on book profit with adjustments.

Current MAT Rate: 15% + surcharge + cess ≈ 17.47%

When MAT Applies

If tax computed normally < MAT on book profit, then MAT becomes the tax liability.

MAT Computation

Starting Point: Profit as per P&L

Add:

• Income tax expense
• Depreciation (as per books)
• Transfer to reserves (other than specified)
• Provision for doubtful debts
• Provision for losses of subsidiaries
• Deferred tax provision

Deduct:

• Depreciation (as per Schedule II)
• Withdrawal from reserves
• Amount withdrawn from provisions
• Income exempt under specified sections

MAT Credit

Concept: Difference between MAT paid and normal tax becomes MAT credit, which can be carried forward for 15 years.

Example:

• Normal tax liability: ₹20,00,000
• MAT liability: ₹25,00,000
• Tax paid: ₹25,00,000 (MAT)
• MAT credit: ₹5,00,000

Next Year:

• Normal tax liability: ₹35,00,000
• MAT liability: ₹30,00,000
• Tax before credit: ₹35,00,000
• Less: MAT credit utilized: ₹5,00,000
• Tax payable: ₹30,00,000

MAT Credit Accounting

When MAT credit created:

MAT Credit Entitlement A/c    Dr.    5,00,000
    To Deferred Tax Asset (MAT Credit)        5,00,000

When MAT credit utilized:

Provision for Tax A/c         Dr.    5,00,000
    To MAT Credit Entitlement A/c             5,00,000

Advance Tax

Requirements

Companies must pay advance tax in installments:

Interest for Default

Section 234B (Default in advance tax):

• If advance tax paid < 90% of assessed tax
• Interest: 1% per month from April to date of assessment

Section 234C (Deferment of instalments):

• If any instalment falls short
• Interest: 1% per month for 3 months

Advance Tax Accounting

When paid:

Advance Tax A/c               Dr.    15,00,000
    To Bank A/c                              15,00,000

Year-end provision:

Profit & Loss A/c (Tax Expense) Dr.  50,00,000
    To Provision for Tax A/c                 50,00,000

Advance tax adjustment:

Provision for Tax A/c         Dr.    45,00,000
    To Advance Tax A/c                       45,00,000
(Balance provision: ₹5,00,000 = Tax payable)

Tax Provision and Payment

Year-End Tax Provision

Steps:

1. Compute taxable income
2. Apply applicable tax rate
3. Add surcharge and cess
4. Consider MAT if applicable
5. Adjust for advance tax paid
6. Adjust for TDS credits
7. Compute net payable/refund

Example: Complete Tax Computation

ABC Pvt Ltd - AY 2024-25

Presentation in Financial Statements

Income Statement

Profit Before Tax                    1,00,00,000
Less: Tax Expense
  - Current Tax            29,07,190
  - Deferred Tax           (2,50,000)
  Total Tax Expense                   26,57,190
Profit After Tax                       73,42,810

Balance Sheet

Assets:

• Advance Tax (net of provision): Current Asset
• Deferred Tax Asset: Non-current Asset
• MAT Credit Entitlement: Non-current Asset

Liabilities:

• Provision for Tax (net of advance tax): Current Liability
• Deferred Tax Liability: Non-current Liability

Tax Loss Accounting

Carry Forward of Losses

Deferred Tax on Losses

Recognition:

• Recognize DTA for carry-forward losses only if taxable profit is probable
• Re-assess at each balance sheet date

Example: Company has ₹50 lakh carry-forward loss. Future profits expected.

Deferred Tax Asset (Loss)     Dr.    12,50,000
    To Deferred Tax Income                   12,50,000
(DTA on ₹50 lakh loss @ 25%)

When loss utilized:

Deferred Tax Expense          Dr.    12,50,000
    To Deferred Tax Asset (Loss)             12,50,000

Common Tax Accounting Mistakes

Mistake 1: Ignoring Advance Tax

Problem: Not paying advance tax leads to interest liability under Section 234B and 234C.

Solution: Quarterly estimation and payment

Mistake 2: Wrong Provision

Problem: Provisioning at book profit instead of taxable income.

Solution: Compute taxable income properly for provision

Mistake 3: Missing Deferred Tax

Problem: Not recognizing deferred tax creates misstated financial statements.

Solution: Identify all timing differences and compute DTA/DTL

Mistake 4: Ignoring MAT

Problem: Not checking if MAT applies leads to tax surprises.

Solution: Always compute both regular tax and MAT

Mistake 5: Not Tracking MAT Credit

Problem: Forgetting to utilize MAT credit in future years.

Solution: Maintain MAT credit register; claim when eligible

Tax Planning Considerations

Legitimate Tax Planning

1. Optimize depreciation – Choose appropriate rate; consider Section 32 additional depreciation
2. Time income and expenses – Within legal limits
3. Utilize exemptions – SEZ benefits, Section 80-IA, etc.
4. Plan capital structure – Interest is deductible, dividend is not
5. Consider new tax regime – Compare with old regime

Documentation Requirements

1. Tax audit report – If applicable
2. Transfer pricing documentation – For related party transactions
3. Supporting schedules – For all adjustments
4. Depreciation register – Book and tax depreciation comparison
5. Advance tax workings – Quarterly estimates

Key Takeaways

1. Book profit ≠ taxable income – Understand the differences
2. Deferred tax bridges the gap – Between book and tax timing
3. Advance tax is mandatory – Plan and pay quarterly
4. MAT ensures minimum tax – Even with exemptions
5. MAT credit is valuable – Track and utilize within 15 years
6. Tax provision needs care – Both current and deferred components
7. Document everything – For audit and assessment

Disclaimer

This article is for educational purposes only and does not constitute tax advice. Tax laws change frequently, and rates mentioned are as per current knowledge. Consult a qualified Chartered Accountant or tax professional for specific tax planning and compliance.

Tax Accounting Checklist

Quarterly:

• Estimate taxable income
• Calculate advance tax
• Pay by due dates
• Update tax provision

Annually:

• Compute final taxable income
• Calculate current tax
• Identify all timing differences
• Compute deferred tax
• Check MAT applicability
• Verify MAT credit availability
• Prepare tax provision
• File tax return by due date

Tax accounting might seem complex, but getting it right ensures no surprises, maintains compliance, and reflects true financial position—skills every business needs.