Key Points
- A permanent difference affects the current tax charge but never creates a deferred tax asset or liability.
- Common examples include non-deductible entertainment expenses, tax-exempt dividend income, and fines or penalties disallowed by local tax law.
- Permanent differences are the primary driver of the gap between the statutory tax rate and the effective tax rate; the reconciliation under IAS 12.81(c) must explain each material item.
- Misclassifying a temporary difference as permanent (or the reverse) misstates both deferred tax on the balance sheet and the tax charge in profit or loss.
What is Permanent Difference?
IAS 12 does not use the phrase "permanent difference" as a defined term. The standard builds its deferred tax model entirely around temporary differences (the gap between an asset's or liability's carrying amount and its tax base that will reverse in future periods). A permanent difference is what remains: an item that creates a gap between accounting profit and taxable profit but that will never reverse because no future taxable or deductible amount arises. Because no reversal occurs, IAS 12.15 does not generate a deferred tax asset or liability.
The practical effect shows up in two places. First, the current tax computation: permanent differences adjust accounting profit to arrive at taxable profit each period. Second, the effective tax rate reconciliation required by IAS 12.81(c): each material permanent difference must be disclosed, either as a separate line or grouped by nature. Regulators pay attention to this reconciliation because unexplained gaps between the statutory rate and the effective rate raise questions about the completeness of the tax provision.
Worked example: Bergström Skog AB
Client: Swedish forestry and paper company, FY2025, revenue €75M, IFRS reporter. Sweden's corporate income tax rate is 20.6%. Bergström's accounting profit before tax is €9,200,000.
Step 1 — Identify permanent differences
Bergström incurred €180,000 in client entertainment expenses during FY2025 and received €420,000 in dividend income from a Swedish subsidiary that qualifies for the participation exemption under Swedish tax law. Entertainment expenses are non-deductible under Swedish income tax legislation. Dividends from qualifying subsidiaries are tax-exempt.
Step 2 — Calculate taxable profit
Start with accounting profit of €9,200,000. Add back the non-deductible entertainment of €180,000. Subtract the exempt dividend income of €420,000. Taxable profit before any temporary difference adjustments: €8,960,000.
Step 3 — Calculate the current tax effect
Current tax on €8,960,000 at 20.6% = €1,845,760. For comparison, tax at the statutory rate on accounting profit would be €9,200,000 x 20.6% = €1,895,200. The net permanent difference of €240,000 (€420,000 exempt income less €180,000 non-deductible expense) reduces the current tax charge by €49,440.
Step 4 — Confirm no deferred tax arises
Neither the entertainment disallowance nor the dividend exemption will reverse in a future period. The entertainment was consumed in FY2025 and will never become deductible. The dividend exemption applies each year the subsidiary qualifies. No asset or liability carrying amount differs from its tax base as a result of these items. IAS 12.15 does not apply.
Conclusion: the two permanent differences are defensible because each rests on a specific statutory provision, neither generates a deferred tax balance, and both are separately disclosed in the effective tax rate reconciliation per IAS 12.81(c).
Why it matters in practice
Teams sometimes create deferred tax balances for items that are permanently non-deductible. A common example is goodwill arising in a business combination where the jurisdiction provides no tax deduction for goodwill amortisation. IAS 12.15 read together with IAS 12.21A prohibits recognition of a deferred tax liability on such goodwill at initial recognition, precisely because the difference is permanent. Recording a deferred tax liability on non-deductible goodwill overstates the liability and distorts the acquisition accounting.
The effective tax rate reconciliation under IAS 12.81(c) frequently lumps all permanent differences into a single "other" line. The FRC has flagged inadequate disaggregation of the tax rate reconciliation as a recurring finding in its thematic reviews of tax disclosures. Each material permanent difference (fines, exempt income, non-deductible expenses) should appear as a separate reconciling item so that a reader can understand why the effective rate deviates from the statutory rate.
Permanent difference vs. temporary difference
| Dimension | Permanent difference | Temporary difference |
|---|---|---|
| Reversal | Never reverses; the gap between accounting and tax treatment persists indefinitely | Reverses over time as the asset is recovered or the liability is settled |
| Deferred tax effect | None; no deferred tax asset or liability arises | Creates a deferred tax asset (deductible) or liability (taxable) under IAS 12.15 |
| Where it appears | Current tax computation and effective tax rate reconciliation (IAS 12.81(c)) | Deferred tax note, balance sheet, and tax rate reconciliation |
| Common examples | Non-deductible fines, tax-exempt dividends, non-deductible entertainment | Accelerated tax depreciation, fair value adjustments, provisions deductible only on payment |
| Audit risk | Misclassification as temporary overstates deferred tax balances | Misclassification as permanent understates deferred tax balances |
The distinction matters because it determines whether a balance sheet item carries a deferred tax consequence. On a first-year audit or when a client operates across multiple jurisdictions, the auditor tests each significant book-to-tax difference individually rather than accepting management's blanket split between permanent and temporary categories.
Related terms
Frequently asked questions
How do I tell a permanent difference from a temporary difference?
Ask whether the item will ever reverse. If an expense is non-deductible now and will remain non-deductible in all future periods (no carry-forward, no future deduction), the difference is permanent. If the tax treatment differs only in timing (an asset is depreciated faster for tax), IAS 12.15 creates a deferred tax liability or asset because reversal will occur.
Does a permanent difference affect deferred tax at all?
No. Permanent differences affect only current tax and the effective tax rate reconciliation. They do not create a deferred tax asset or liability under IAS 12 because there is no future taxable or deductible amount. If an item has been classified as permanent but a deferred tax balance exists for it, either the classification or the deferred tax balance is wrong.
What are the most common permanent differences in European jurisdictions?
Participation exemptions on qualifying dividend and capital gains income (applicable in the Netherlands, Sweden, Germany, and most EU member states), non-deductible fines and penalties, non-deductible client entertainment (fully or partially, depending on jurisdiction), and tax-exempt government grants where the grant income is not subject to corporate tax. IAS 12.81(c) requires disclosure of each material item.