The Valuation of Deferred Taxation: Evidence from the UK Partial Provision Approach

The UK provides a virtually unique environment in which to examine the information content of the partial provision approach to deferred tax accounting. In addition this issue is of particular interest to UK accounting standard setters in the light of trends towards international accounting standard harmonisation. Taking the total amount of deferred taxation to be equal to the partial balance sheet provision plus the potential portion appearing in the notes, this study tests the relationship between these various deferred tax components and market value. It also examines the economic rationale for the potential portion. The study is based on 1,512 company/years from the period 1989–1991. It finds that, while the full amount of deferred taxation is not valued by the market as a liability, there is evidence of the partial balance sheet provision being so valued. There is also evidence that the potential portion is positively related to market value, consistent with its proxying for information about future growth. This result is supported by the positive relation between the potential portion and measures of future capital spending, indicative of an underlying economic rationale for this deferred taxation component. From a regulatory perspective, the study concludes that the main benefit of the partial provision approach is that the balance sheet amount constitutes a reasonably reliable measure of the portion likely to crystallise as a liability, information that would be lost were only the full amount to be disclosed.