Deferred Tax on Ind AS 116 Leases — Why ROU Asset and Lease Liability Create Two Separate Temporary Differences
When a student first meets Ind AS 116 in CA Final Financial Reporting, the right-of-use (ROU) asset and lease liability feel like two sides of the same coin. You record them together on Day 1, often at the same amount. So a very natural question is: do they cancel each other out for deferred tax purposes?
The short answer is no — and understanding why is what separates a student who merely knows the journal entries from one who truly understands Ind AS 12.
---
Quick Refresher: What Is a Temporary Difference?
Under Ind AS 12, a temporary difference arises when the carrying amount of an asset or liability in the balance sheet differs from its tax base.
- If the carrying amount of an asset > its tax base → Taxable temporary difference → Deferred Tax Liability (DTL)
- If the carrying amount of a liability > its tax base → Deductible temporary difference → Deferred Tax Asset (DTA)
The critical word is separate. Ind AS 12 evaluates each asset and each liability independently. It does not net them against each other unless very specific offsetting criteria are met.
---
The ROU Asset: What Happens on the Tax Side?
Under Indian income-tax law, lease rentals paid by a lessee are typically deductible as revenue expenditure in the year of payment. There is no concept of a right-of-use asset or lease liability on the tax balance sheet (verify this position in the latest ICAI study material / announcement, as tax treatment can evolve).
So the tax base of the ROU asset is zero — the tax authority simply does not recognise it.
Result:
- Carrying amount of ROU asset (say ₹10,00,000) > Tax base (₹0)
- This is a taxable temporary difference
- → Deferred Tax Liability arises on the ROU asset
Think of it this way: the entity is getting accounting depreciation on the ROU asset, but no matching deduction in tax. So taxable income will be lower in the future when the ROU asset is fully written off and lease payments continue to be deducted for tax. The DTL captures that future burden.
---
The Lease Liability: What Happens on the Tax Side?
Again, since income tax does not recognise the Ind AS 116 liability, the tax base of the lease liability is also zero.
Now apply the Ind AS 12 logic for a liability:
- Carrying amount of lease liability (say ₹10,00,000) > Tax base (₹0)
- This is a deductible temporary difference
- → Deferred Tax Asset arises on the lease liability
The logic: the entity has already recorded a liability, meaning it owes future payments. When those payments are actually made, they will be deducted for tax. So the entity has future tax deductions waiting — that is a DTA.
---
Why They Do NOT Cancel Out — The Initial Recognition Exemption
Here is where students get tripped up. You might think: DTL on ROU asset and DTA on lease liability — same amount on Day 1 — they cancel! Move on.
But Ind AS 12 contains an initial recognition exemption: you do not recognise deferred tax on a temporary difference that arises when an asset or liability is initially recognised in a transaction that:
- Is not a business combination, AND
- At the time of the transaction, affects neither accounting profit nor taxable profit
Historically, this exemption was applied to both the ROU asset and the lease liability, meaning no DT was recognised on either — they were treated symmetrically and offset.
However, the IASB amended IAS 12 (the global equivalent of Ind AS 12) in May 2023, specifically to address leases. The amendment clarifies that the exemption does NOT apply to the ROU asset and lease liability arising from a single lease transaction, because recognising deferred tax on one without the other would be inconsistent. Instead, both DTA and DTL are recognised — and they are presented separately unless offset criteria are met.
> ⚠️ Important for CA Final students: Verify the exact position adopted by ICAI for Indian Ind AS 12 in the latest study material / announcement, since ICAI notifications govern what applies in your examination.
---
Walking Through the Logic Step by Step
Let us say a company signs a 5-year lease. On Day 1:
| Item | Carrying Amount | Tax Base | Temporary Difference | DT Impact | |---|---|---|---|---| | ROU Asset | ₹10,00,000 | ₹0 | ₹10,00,000 (taxable) | DTL | | Lease Liability | ₹10,00,000 | ₹0 | ₹10,00,000 (deductible) | DTA |
At Day 1, the net DTA/DTL is zero — but both are recognised separately. Why does this matter?
- Over the lease term, the ROU asset depreciates on a straight-line basis.
- The lease liability unwinds using the effective interest method — front-loaded interest, back-loaded principal reduction.
- These two move at different speeds over time.
By Year 3, the ROU asset's carrying amount and the lease liability's carrying amount will no longer match. The net deferred tax position will shift — sometimes to a net DTL, sometimes to a net DTA — depending on the pattern of depreciation vs. liability reduction.
If you had never recognised them separately, you would miss this evolving mismatch entirely.
---
Key Takeaways for Your Exam
- Two separate temporary differences arise from one lease transaction — one on ROU asset (DTL), one on lease liability (DTA).
- Tax base of both is typically zero under Indian income-tax law (verify in latest ICAI material).
- The initial recognition exemption under Ind AS 12 does NOT apply to leases — recognise both DTA and DTL.
- They start equal but diverge over time due to different accounting patterns.
- Always evaluate each asset and liability independently — that is the Ind AS 12 discipline.
---
FAQs
Q1. If DTA and DTL on a lease are equal on Day 1, does it make any difference to record them? Yes, absolutely. They diverge as the lease progresses because ROU asset depreciation (straight-line) and lease liability reduction (effective interest) follow different patterns. Recording them separately lets you capture the correct net deferred tax in every subsequent period.
Q2. Can a company offset the lease DTA and DTL in the balance sheet? Only if Ind AS 12 offset criteria are satisfied — same tax authority, legally enforceable right to set off, and both relate to the same taxable entity. Even then, they are calculated separately first; only presentation changes.
Q3. What if a lease qualifies for the short-term or low-value exemption under Ind AS 116? If the company elects not to apply Ind AS 116 (short-term or low-value), no ROU asset or lease liability is recognised in the books. So no temporary difference arises — the lease rentals are simply expensed, which often matches the tax treatment.
---
This is exactly the kind of conceptual depth that CA Final examiners reward. To practise applying these ideas to real-case scenarios — where a lease interacts with impairment, modification, or business combinations — head over to caparveensharma.com and explore the CA Final Financial Reporting course. And if you want to ensure you cover every topic like this one systematically before your exam, use the free day-by-day study planner — it maps your available days to the entire syllabus so nothing slips through the cracks.