Provision for Income Tax (Definition, Formula)

Provision for Income Tax Meaning

Provision for Income Tax is the tax that the company expects to pay in the current year and is calculated by making adjustments to the net income of the company by temporary and permanent differences which are then multiplied by the applicable tax rate.

Provision for Income Tax Calculation

Provision for Income tax will be calculated on the income earned by the individual or the company using the below-mentioned formula:

Provision for Income tax Formula = Income Earned Before Tax * Applicable Tax Rate

Calculation Example of Provision for Income Tax

The following is an example to understand the concept in a better manner.

You can download this Provision for Income Tax Excel Template here – Provision for Income Tax Excel Template

A ltd is the company which is manufacturing and selling the automobile products in the market reports following figures for the accounting year ending on December 31^st, 2018. Suppose the applicable income tax rate on the company for the year under consideration is 30%. Calculate the profit before tax using the given figured and the provision to be made for the income tax for the accounting year ending on December 31^st, 2018.

Solution

In order to calculate it, first of all, the profit before tax will be calculated from the details given.

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Statement of Calculation of Profit before taxes

=$170000+100000
=$70000

Thus from the above Statement of Calculation of Profit before taxes, $ 70,000 is the profit before tax of the company A ltd. for the accounting year ending on December 31^st, 2018.

Now, the calculation of the provision of the income tax will be as follows:

= $ 70,000 * 30%
Provision for Income tax = $ 21,000

Thus the provision of the income tax for the accounting year ending on December 31^st, 2018 for the company A ltd is $ 21,000.

Advantages

The various different advantages related to these are as follows –

It is the provision which is made by the company out of its profits of the current profits in order to meet its tax obligation which will arise in the future. However, there will be a certain time gap between the date of making of the provision for tax by the company and the date when it is actually paid. So the company can take the opportunity of the time gap and used the provision for tax as the source of short-term finance in the intermediate period. This does not any extra cost to the company as well as does not involve any of the legal formalities.
With the help of the provision for income tax, the company makes the provision for future liability well in advance. This will make all the stakeholders aware of the tax liability which will arise in the future to the company.

Disadvantages

The disadvantages related to these are as follows:

It is the source of finance for the company but only for the short term and cannot be used for financing the long term under the requirement of the company.
It is possible some of the times that the company creates the excess provision for the income tax which leads to the insufficient use of the funds of the company as that funds could have been utilized by the company in other productive areas.

Important Points Related to the Provision for Income Tax

The different important points related to these are as follows –

It is created by the company out of its profits of the current profits in order to meet its tax obligation which will arise in the future.
It is created considering the tax rate applicable to the company for that period.
It is made by the company by making adjustments to the difference of permanent as well as the temporary nature in the company’s net income for the period.
As there is a certain time gap between the date of making of the provision for tax by the company and the date when it is actually paid, so, it can be used by the company as the source of the short-term finance in the intermediate period.

Conclusion

Provision for Income Tax refers to the provision which is created by the company on the income earned by it during the period under consideration as per the rate of tax applicable to the company. This provision is made by the company by making adjustments to the difference of permanent as well as the temporary nature in the company’s net income for the period.

As there is a certain time gap between the date of making of the provision for tax by the company and the date when it is actually paid, so, the company can take the opportunity of the time gap and used the provision for tax as the source of the short-term finance in the intermediate period. However, it is the source of finance for the company but only for the short term and cannot be used for financing the long term under the requirement of the company. Also, it is possible some of the times that the company creates the excess provision for the income tax which may lead to the insufficient use of the funds of the company.