Chapter 26 eg 2 course notes

(Current tax is profit - capital allowances) taxed at 30%. In year 1 that's 300,000 profit less 37,500 = 262,500 and that's taxed at 30% = 78,750 But, instead of capital allowances, the company is using a depreciation rate of 33.33% (1/3) to write off the asset over three years. Tax on that (profit less depreciation) is 30% of 270,000 = 81,000 We know that ultimately we should be allowed 90,000 to write off against profits. The taxman says "You can have 37,500 in the first year" but he's giving us too much if we wish to write the asset down equally over three years. He's allowing us 37,500 instead of just 30,000. So we're "underpaying" tax by the difference between capital allowances and depreciation ie 30% of that 7,500 difference = 2,250. That's where we get the deferred tax figure from and if you carry on like that over three years you'll see that that underpayment is clawed back in years 2 and 3 Is that better? You can look at it slightly differently by working out the net book value per the company (150 - 30) and compare that with the tax written down value (150 - 37,500) That difference between nbv and tax wdv is 7,500. Tax at 30% on that difference gives you the 2,250 deferred tax liability again

Much better, thanks Mike. There are so many rules I'm trying to wrap my head around.

No problem - you're welcome