One of the major concerns of the taxpayers, all around the world, is how to reduce their tax liability, without circumventing the law. There are two legitimate ways of reducing an assessee’s tax liability, which is tax deduction and tax credit. Most of the people often juxtapose the two tax concepts for one another, but there are subtle differences between them. A tax deduction lowers the taxable income of the taxpayer, on the other hand, tax credit diminishes the overall tax burden of the assessee. So, take a read of the article presented to you, which clarifies the differences and also discusses, which one of them is better.
Content: Tax Deduction Vs Tax Credit
|Basis for Comparison||Tax Deduction||Tax Credit|
|Meaning||A tax deduction, connotes an eligible expense, that curtails the taxable income of the assessee.||A tax credit is a tax incentive, in which the tax payer is able to subtract the amount of tax, in special circumstances.|
|Reduction in||Taxable income||Tax obligation|
|Adjustment||It is adjusted before the application of tax rate.||It is adjusted after the tax due is ascertained.|
|Tax saving||Reduces tax by marginal rate.||Reduces tax due rupee for rupee.|
|Occurence||Due to various expenses incurred by the assessee.||Due to tax already deposited with the taxation authorities or due to certain circumstances.|
|Amount||Depends on the deduction claimed.||Depends on the nature and purpose of credit.|
Definition of Tax Deduction
Tax deduction implies the curtailment of taxable income, as a result of making an investment in certain schemes or funds, which are eligible to attract deduction. The reduction in taxable income can also be due to a number of events that take place, during financial year.
It is a qualifying expense, which has the ability to decrease the gross total income, either by a specified amount or a percentage, as approved by taxation authorities. The amount of deduction allowed by the government can be subtracted from the gross total income of the assessee to arrive at the total taxable income. Further, the amount of deduction differs, on the basis of the deduction claimed by the assessee.
An assessee can claim deductions on various expenses like medical expenses, the donation to charitable institutions, and so on. One can also avail tax deduction if he/she has made an investment in insurance plans, savings schemes or funds permitted by the government.
Definition of Tax Credit
In simple terms, tax credit refers to the amount which can be offset against the overall tax obligation. It is the sum, which the assessee is able to subtract from the taxes payable to the taxation authorities. It is a tax incentive, which is used by the government to encourage the payment of taxes. The major advantage of a tax credit is that it directly minimises the tax liability. Various types of tax credit available in India are:
- Income Tax Credit: When an individual is charged tax which is higher than his/her actual liabilities, resulting from various factors, then the surplus amount is available as a tax credit to the assessee, that can be carried forward and adjusted against future tax obligations.
- Input Tax Credit: Tax credit available to registered dealers or manufacturers for the inputs they purchase for the purpose of reselling.
- Foreign Tax Credit: To ignore cascading effect, the foreign tax credit is available to the Indians. According to the Double Taxation Avoidance Agreement (DTAA), if an assessee is an Indian resident, but gets income from the source outside the country and charged taxes in both the countries then tax credit is available to the Indian resident, if the hosting country has charged TDS on the income.
Key Differences Between Tax Deduction and Tax Credit
The points given below are noteworthy, so far as the difference between tax deduction and tax credit is concerned:
- A tax deduction is defined as an eligible expense; that curtails the taxable income of the assessee. On the other hand, the tax credit can be understood as a tax incentive, in which the taxpayer is able to subtract the amount of tax, in special circumstances.
- While tax deduction reduces the taxable income of the assessee, a tax credit reduces the overall tax liability of the assessee.
- The adjustment for deductions is made before the application of tax rate on the income that is able to be taxed. Conversely, the amount of the tax credit is adjusted after the tax due is ascertained.
- Tax deduction saves the tax payer’s income by a small amount, as it reduces tax by marginal rate. As against this, tax credit saves the tax payer’s income by a larger sum, as it reduces tax liability rupee for the rupee.
- A tax deduction is available to the assessee if he/she has incurred some specified expenses. On the contrary, tax credit arises if tax already deposited with the taxation authorities or due to certain circumstances.
- The amount of tax deduction depends on the deduction claimed, but the amount of tax credit depends on the nature and purpose of the tax credit.
Both tax deduction and tax credit help in lessening the overall tax burden on the tax payer and also saves tax. However, the tax credit is more favourable than a tax deduction, as the former lowers tax liability rupee for rupee whereas the latter only lessens the tax liability by nominal rate.