What Is A Tax Credit?

The commonly used term, 'tax credit', can refer to two different concepts

. One, which is just the recognition of a partially made payment towards the taxes due. The second is a benefit paid by the state, to workers, through the tax system which actually increases the net income, not reduce it.

About Taxes Already Paid

In Canada, Australia, the United Kingdom and the United States, a tax credit is their recognition of a partial payment that has already been made of taxes due. A similar concept is also present in the French tax system. This normally happens when the 'standard' taxes have been deducted (Like out of your paycheck, 'Withholding tax'), but you are still subject to more taxation and a different, often higher, rate.

In the UK, tax credit actually refers to taxes that are treated as deducted at the source, but haven't actually been paid. The "R&D tax credit" (Research and Development) is a payable tax relief scheme that refers to the cash surrendered loss on eligible research and development work. The credit is worth up to 24.5% of the spending, and was introduced in 2000, with an extension made so it's available to large companies in 2002. It's still unclear, though, whether this has lead to an increase in research and development in the UK. Experts don't expect to see clear results for at least 10 years.

What About the Other Tax Credit?

A tax credit is also a coupon that a company uses to lower the actual amount of state income taxes it owes, and has to pay. Kind of like using a coupon at the grocery store or in a restaurant. Let's say Company Alpha owes $1,000 in taxes towards the state. The more credits it has, the less it has to pay so the larger it's bottom line is.

Tax credits aren't always useful. Let's say Company Beta has a huge warehouse, but it's used solely for storage and distribution. It has a lot of business dealings going on there, and pays taxes, but it doesn't actually sell anything on the premises. Without that sale, it doesn't generate taxable income, and shouldn't have any state income tax liability. Why would Company Beta need a compute to reduce taxes that it doesn't even owe?

In some situations, tax credits can be very useful but clearly, in others, a tax credit would do a company no good at all!

by: Inessa Khaykin

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