What do we understand by a tax credit?
Tax credit is a rebate that the government provides in special circumstances and subject to the taxpayer meeting certain specified criteria. Some examples are given below:
- In case of foreign income earned outside India where tax is paid abroad, tax credit can be claimed in India subject to Double Taxation Avoidance Agreement (DTAA) norms.
- Taxpayers having a total income of less than Rs5 lakh per annum can claim tax rebate of Rs2,000. The corresponding rebate for senior citizens above 65 is Rs20,000.
- The Income Tax Act also provides tax credit for people with special disabilities and those who are physically challenged to mitigate their circumstances.
Tax deductions on specified investments
The Income Tax Act offers tax deduction on specified investments with a larger social or national impact. For example, deductions under Section 80C for life insurance, ELSS, long-term fixed deposits, and provident funds. Contribution to health insurance of dependents is also eligible as deduction under Section 80D.
Tax deductions involve deducting the part of income eligible for exemption from tax before tax is calculated.
Let us recapitulate and highlight some key differences between tax deductions and tax credits:
- Tax credit is a direct rebate on the actual tax payable to the government. On the other hand, deductions like Section 80C, Section 80CCC and Section 80D reduce the taxable income of the assessee.
- When it comes to filing your tax returns, the tax deduction is your primary benefit and the tax credit is your secondary benefit. This means that once your total income is calculated, first the eligible deductions under Section 80C, Section 80CCC, Section 80D, etc. are applied. After applying these deductions, the total taxable income is calculated and the tax payable is determined based on the income slabs. The tax credit is applied on this final tax payable and reduces your tax liability accordingly.