23 Nov 2009

Tax Credit vs Tax Deduction

by Darren

I think it is important to note at this point some key differences in tax related terminology This entry will focus on the distinction between a tax deduction and a tax credit. The core concept is that deductions reduce the amount of your income that is taxable. Tax credits reduce the actual amount of tax owed. A tax deduction represents an expense incurred by you the taxpayer. These amounts can be subtracted from your gross income when preparing your income tax returns. As a result, the tax deduction will lower overall taxable income and thus lower the amount of tax paid. In previous and upcoming entries we have/ will analyze all the types of deductions available to your business in multiple jurisdictions (Australia, China, Hong Kong, Japan, Singapore and the USA). A tax credit, on the other hand, is broken down into two different concepts: The recognition of tax payments already made. A benefit allowed to your business through the tax system which reduces your the amount of tax payable. Examples include:
  • Credits for foreign taxes paid
  • Disabled Access Credit - tax credit for making their businesses accessible to persons with disabilities (USA).
  • Fuel Tax Credits (Australia)
Example
    Net Business Income $150,000
    Office Rent $10,000
    Office Expenses $5,000
    Total Deductions $15,000
    Taxable Income $135,000
    Tax Payable 15% $20,250
    Foreign Tax Credit $15,000
    Net Tax Payable $5,250
So you can see that the deductions reduce the income which tax is charged upon, while the tax credit reduces the actual amount of tax paid to the government. We will look into the tax credits available in each country in the near future.

Next entry: General Deductions Under The Income Tax Ordinance
Previous entry: Australian Small Business Tax Deductions

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