What is Tax Credit? (Don't sulk already!)

13 Jul 2022  Read 612 Views

What would you call a person who can simply wake up one day and leave for an impromptu vacation or impulsively buy an expensive car? You might call this person privileged and irresponsible and yet, envy him. One could be a billionaire and throw cash at things, but every individual checks, rechecks and sulks before making one payment, tax. It is the one liability that unites humankind with its undesirability, irrespective of the person’s station. In a struggle to find ways to reduce this burden somehow, tax credit is a crutch that can not be ignored. But what exactly is a tax credit? Let's find out!

Understanding tax credit

Tax credit is the sum that allows certain assessees to offset their taxes Rupee by Rupee, thereby reducing the overall local, state or federal tax liability. Simply put, this amount is subtracted from the total tax payable by the individual, thereby acting as an incentive. Another way to think of tax credit is as a rebate. For example, say you owe ₹4,000 as tax and have a tax credit of ₹1,000; your final tax liability would be ₹3,000.

The central or state government may provide these credits under particular circumstances surrounding an individual. This may promote specific behaviours deemed beneficial to the economy, environment or society. 

  • Tax credit for installing solar panels for domestic usage
  • Tax credit to offset child and dependent care, education and adoption costs. 

Let us try to categorise these for ease of their computation.

Types of tax credit

There are various tax credits available in India and all over the world. For starters, let’s focus on some of the most popular and common tax credits an assessee may come across under the Indian Income Tax law- 

1. Income Tax Credit

Do you know the feeling of waking up to an almost ready breakfast because you prepped it last night or your outfit is already laid out? A little sweat yesterday is a blessing for today. 

Similarly, suppose an individual is invariably charged higher taxes than is due. In that case, the excess amount is remitted as a tax credit and can be adjusted against future tax liabilities of the taxpayer, irrespective of his tax bracket.

2. Input Tax Credit

ITC is available to a host of businesses/ individuals such as service providers, e-commerce traders, suppliers, dealers or manufacturers on inputs purchased through the course of business, whether manufacturing or reselling. Businesses can reduce tax liabilities on outward supplies by claiming credit to the extent of GST on capital goods purchases and goods involved in manufacturing. These rates differ from state to state where goods are purchased and sold. 

For example, Mr A purchases worth of raw material and pays input GST of ₹2,000. Then Mr A sells the goods manufactured worth y. GST payable is ₹3,400. Here, Mr A is liable to pay a net GST of ₹1,400 after claiming an input tax credit of ₹2,000.

3. Child Tax Credit

While there are no specific laws regarding child tax credits in India, the government offers many benefits as exemptions and deductions to tax-paying families with children to incentivise education and improve literacy rates. 

4. Foreign Tax Credit

With the growth and globalisation of economic activities, international trade has become more common. For ease of tax computation of these cross-country transactions, especially avoidance of double taxation, India has entered into a Double Taxation Avoidance Agreement (DTAA) with more than 80 countries worldwide. As per this treaty, in the case of Resident Indians earning income from abroad, tax credits are allowed in the home country if the host country has deducted TDS on income.

5. Other Tax Credit

  • Tax credit to senior citizens in the above 65 age bracket
  • Tax credit to disabled individuals falling into a particular income bracket 
  • Tax credit of ₹2000 for taxpayers with a total income less than ₹5,00,000
  • Total tax credit to individuals with net taxable income less than ₹5,00,000.

Difference between tax credit and tax deductions

A layman only cares about minimising his tax liabilities as much as possible, but there are different ways to do so under the law through tax deductions and/or tax credit. They may appear the same at a glance but work differently. Let’s take a closer look to understand these terms better for the most effective tax computation. 

By now, you must have understood tax credit. It reduces the actual overall tax liability of the assessee, whereas tax deductions reduce the taxable income and rates. Simply put, tax credit can be claimed on the tax due only after all tax deductions are applied to the individual’s income to compute such tax due. 

These deductions are applied through standard deduction, which any taxpayer can claim, and/or by individual itemised deductions specific to an assessee according to their expenses, such as charitable donations, unreimbursed business expenses, medical expenses, etc. 

Say,

Annual income

₹3,00,000
Tax deduction ₹1,000
Tax liability ₹6,000

Here, after deduction the taxable income will be ₹2,99,000 (3,00,000-1000). Since the person falls under the under ₹5,00,000 income bracket, he can claim ₹2,000 tax credit, therefore the new tax liability will be ₹4,000  (6,000-2,000)

But which one is better? Though generally, tax credit is considered to give more benefits, applying these functions is very subjective. There is a limit to both tax credit and deductions. Thus, the assessee eligible for both must compare the reliefs derived from each incentive to arrive at the least tax liability. 

Bottom line

We all run away from taxes, but they are unavoidable. Instead of evading taxes, we must develop a healthy attitude to learn to compute them better, using all deductions and credit to our advantage. Simple habits like keeping ourselves updated with relevant provisions and amendments can help us better understand and manage our finances. That being said, do you qualify for claiming tax credit? Hurray for you if you do!

About the Author: Yashi Ojha | 5 Post(s)

Yashi is currently pursuing Chartered Global Management Accounting. Her creative, artsy heart but number-crunching mind has led her to financial content writing. She would prefer to be the observer & the listener in the room so she can soak in all the knowledge from the rest, but wouldn’t compromise on being the funniest.

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