Permanent Differences

Permanent differences are the differences between accounting and tax treatment of transactions that do not reverse. Because they are not included in the calculation of taxable income, they result in the difference between the corporate tax rate and the effective tax rate.

As the name suggests, permanent differences are the transactions that cause the difference between pretax accounting income and pretax accounting income subject to tax and this difference persists. They result from non-taxable incomes and non-deductible expenses. Non-taxable income is the income that is exempt i.e. which has zero tax and non-deductible expenses are expenses which can't be subtracted from taxable revenue. For tax purposes, non-deductible expenses are irrelevant as if they weren't incurred.

Permanent differences depend on the tax law and the jurisdiction. Some examples of non-taxable income include:

  • Interest earned on municipal bonds.
  • Capital gain on disposal of equity stake in other companies (exempt in Singapore).
  • Gain on foreign exchange on capital transaction.

Examples of non-deductible expenses:

  • Fines paid in relation to violation of any federal or state law, let’s say related to environment protection or regulatory action.
  • Expenses for which no proper invoices or supporting documents are available.
  • Expenses paid out in cash when they are required to be paid through banking channel.
  • Personal expenses.


Let’s consider a company that earned $40 million income before tax. It includes $2 million income on account of interest earned on municipal bonds and $0.5 million fines on account of breaches of environmental laws. The interest income is exempt which means that it won’t be taxed, and the fine is non-deductible which means it can’t be subtracted from revenues. These two items will cause a $1.5 million net difference between pretax accounting income and pretax accounting income for tax purposes.

The following table shows the reconciliation between pretax accounting income and accounting income for tax purposes and the effective tax rate:

Permanent differences Calculation USD in million
Pretax accounting income EBT 40.00
Less: exempt income (municipal bond interest) EI (2.00)
Add: non-deductible expenses (fines) NDE 0.50
Accounting income for tax purposes EBTT=EBT-EI+NDE 38.50
Corporate tax rate R 40%
Accrual income tax expense T = R × EBTT 15.40
Effective tax rate E = T/EBT 38.50%

Permanent differences vs temporary differences

Permanent differences differ from temporary differences in that , and temporary differences are differences that cause taxable income to be higher/lower than accrual accounting income in one period and lower/higher by an equal amount in the future period. Temporary differences are tricky. They arise when tax and accounting rules require them to be recognized at different times. Due to this timing differences, they are recognized in accordance with accounting principles in one period but recognized for tax calculation periods. This violates the accrual basis and matching concept of accounting and deferred tax assets or liabilities must be recognition to correctly reflect their impact on net income.

Written by Obaidullah Jan, ACA, CFA and last modified on