Tax Credit and Deductible Allowances: How can you Pay Less in Taxes and Save More?

You may have been burdened by a load of taxes or paying a heavy amount of money in taxes for a long time.

We all have heard about the above-mentioned tax terms once. We may even get confused about their benefits, compliance, and application. Well, there is no rocket science involved in understanding these terms and using them afterward.  

We are going to discuss these terms each after each. Then, we will illustrate them with an example to make it easy for you to get to know and understand each tax term separately.

What is Tax Credit?

It is a kind of tax saving; it relieves your annual income for the tax year. Thus, it helps you reduce the burden of tax on your total annual income.  

Tax Credit is the credit given to tax, which means that when you extract all the taxes from your income and right after that when you fluctuate (increase and decrease) in the tax ratios, that is called ‘tax credit or relief.’ 

Multiple variants of the section have been detailed in the “income tax ordinance 2001” to discuss the tax credit. From them, the essential clauses are:

• Section 61
• 62
• 62A
• 63
• 64B
• 64C
• 65B
• 65C
• 65D
• And 65E 

How can you save your money by applying for a tax credit?

You need to invest in mutual fund schemes, investment plans, or pension schemes by complying with the tax credit.

If I invest in the organizations, do I become eligible for Tax Credits?

Yes, if you invest in the following organizations, you would become eligible for the tax credit. Moreover, from the following sectors, you can avail yourself of tax credit benefits. And can reduce the burden of taxes.

1. Charitable Donations (Section 61).

If you performed a charity under section 61, you would get the tax credit; in other words, you would get the tax relief. And an important point to remember is that the particular investment must not exceed 30% of your taxable income. 

You will get tax credits on the number of donations and donate charity in those organizations approved by the SECP. 

You shall be entitled to a tax credit in respect of any sum you paid, or any property given by you in the tax year as a donation to:

(a) any board of education or any university in Pakistan established by, or under, a Federal or a Provincial law;

(b) any educational institution, hospital or relief fund established or run in Pakistan by Federal Government or a Provincial Government or a Local Government; or

(c) any non-profit organization.

2. Tax Credit for Investments in Shares and Insurance (Section 62).

Suppose you invested in any company shares (listed in the PSX) and in the insurance policy so that you will get the tax credit. Suppose if you invested in shares and insurance simultaneously, you would be only entitled to a 20% tax credit on your taxable income.

You other than your company shall be entitled to a tax credit for a tax year either:

a) in respect of the cost of acquiring in the year new shares offered to the public by a public company listed on a stock exchange in Pakistan, provided that you are the original allottee of the shares or the shares are acquired from the Privatization Commission of Pakistan.

b) in respect of the cost of acquiring in the tax year, sukuks offered to the public by a public company listed and traded on the stock exchange in Pakistan, provided that you are the original allottee of the sukuks; or

c) in respect of any life insurance premium paid on a policy to a life insurance company registered by the Securities and Exchange Commission of Pakistan under the Insurance Ordinance, 2000, provided that you are deriving income chargeable to tax under the head “salary” or “income from a business.

            Credit will be given to the lesser of:

i. the total cost of acquiring the shares, sukuks, or the total contribution or premium paid by you.

ii. 20% of your taxable income for the year; or

iii. two million rupees.

The amount that could be less than among the above three mentioned amount clauses, the tax credit will be given to the lesser amount.

3. Tax Credit for Investment in Health Insurance (Section 62A).

The healthcare system is costly in Pakistan, and most people face problems while acquiring healthcare facilities. While keeping an eye on this, the government has put this idea under the bracket of the Income Tax Ordinance. So that people can facilitate their health insurance.  

If you purchased the health insurance policy, then you will get the tax credit.

You other than your company shall be entitled to a tax credit for a tax year regarding any health insurance premium or contribution paid to any insurance company, provided that you are deriving income chargeable to tax under the head “salary” or “income from the business.”

Credit will be given to the lesser of:

i. the total contribution or premium paid by the person

ii. 5% of your taxable income for the year; or

iii. one hundred and fifty thousand rupees.

The amount that could be less than among the above three mentioned amount clauses, the tax credit will be given to the lesser amount.

4. Contribution to an Approved Pension Fund (Section 63).

The government provided an opportunity to the private company employees to open up a voluntary pension scheme under the income tax in their companies to secure and safely live their future.

You are deriving income chargeable to tax under the head Salary or Income from Business. However, you shall be entitled to a tax credit for a tax year in respect of any contribution or premium paid in the year by you under a contract of annuity scheme approved by Securities and Exchange Commission of Pakistan of an insurance company duly registered under the Insurance Ordinance.

The amount of tax examined to you for the tax year, before allowance of any tax credit under this part;

Your taxable income for the tax year;

Credit will be given to the lesser of:

(i) the total contribution or premium referred to in sub-section (1) paid by you in the year; or

(ii) 20% of your taxable income for the relevant tax year; Provided that your joining of the pension fund at the age of forty-one years or above, during the first ten years shall be allowed an additional contribution of 2% per annum for each year of an age exceeding forty years.

(iii) Provided further that the total contribution allowed to you shall not exceed 50% of the total taxable income of the preceding year. Provided also that the additional contribution of 2% per annum for each year of an age exceeding forty years shall be allowed and subject to the condition that the total contribution allowed to such person shall not exceed 30% of the total taxable income of the preceding year.

How to Obtain the Tax Credit Opportunity?

To claim your tax credit amount, you need to do the following:

1. If you are a salaried individual, you need to inform your HR or Finance Department about your investments by submitting the account statement to adjust your tax credit amount from the monthly income tax deductions.
2. If you are a self-employed individual, you need to adjust your tax payable by showing investment in your wealth statement at the time of Income-tax return filing.

For knowing about the remaining sections and If you want to explore further regarding the other sections, you can click on this link to educate yourself more.  

What is Deductible Allowance?

Deductible allowances are deducted from the gross salary so that the taxes can be applied to the net salary, and you can get some relief and bear the low burden of taxes on your salary. 

Deductible allowances are such deductions from salary income to arrive at the taxable salary. When you calculate your salaried income, you add every sort of allowance and set the value of any benefit you get.

Multiple variants of the section have been detailed in the “income tax ordinance 2001” to discuss the deductible allowances. From them, the essential clauses are:

• Section 60
• 60A
• 60B
• 60C
• 60D 

From the following sectors, you can deduct your allowances. And can reduce the burden of taxes.

1. Zakat (Section 60):

Not every type of Zakat can be deducted under the deductible allowances; only the typical Zakat will be deducted. And under the Zakat and Ushr Ordinance, 1980, these zakats will go into the government treasury. The majority of the Zakat, which is deducted by your bank account, national saving certificate, and other sources, Zakat will go into the Ushr Ordinance, 1980. This is how you can deduct the Zakat; it has no limit. 

You shall be entitled to a deductible allowance for the amount of any Zakat paid by you in a tax year under the Zakat and Ushr Ordinance, 1980.

Sub-section (1) does not apply to any Zakat taken into account under subsection (2) of section 40.

Any allowance or part of an allowance under this section for a tax year that cannot be deducted under section 9 for the year shall not be refunded, carried forward to a subsequent tax year, or carried back to a preceding tax year. 

1. Workers’ Welfare Fund (Section 60A):

You shall be entitled to a deductible allowance for the amount of any Workers’ Welfare Fund paid by you in the tax year under the Workers’ Welfare Fund Ordinance, 1971.

• Workers’ Participation Fund (Section 60B):

You shall be entitled to a deductible allowance for the amount of any Workers’ Participation Fund paid by you in a tax year under the provisions of the Companies Profit (Workers’ Participation) Act, 1968.

• Deductible Allowance for Profit on Debt (Section 60C):

You shall be entitled to a deductible allowance for the amount of any profit or share in rent and share in appreciation (increase) for the value of house paid by you in a tax year on loan by a scheduled bank or non-banking finance institution regulated by the Securities and Exchange Commission of Pakistan or advanced by Government or the Local Government, Provincial Government or a statutory body or a public company listed on a registered stock exchange in Pakistan where you utilizes the loan for the construction of a new house or the acquisition of a house.

The amount of your allowance allowed for a tax year shall not exceed 50% of taxable income or “two” million rupees, whichever is lower.

Any allowance or part of an allowance under this section for a tax year that cannot be deducted for the year shall not be carried forward to a subsequent tax year.

•  Deductible Allowance for Education Expenses (Section 60D):

You shall be entitled to a deductible allowance in respect of the tuition fee paid by you in a tax year, provided that the taxable income is less than one and a half million rupees. 

The amount of your deductible allowance allowed under sub-section (1) for a tax year shall not exceed the lesser of:

(i) 5% of the total tuition fee paid by you referred to in sub-section (1) in the year;

(ii) 25% of your taxable income for the year;

(iii) an amount computed by multiplying sixty thousand with the number of your children.

Any allowance or part of an allowance under this section for a tax year that cannot be deducted for the year shall not be carried forward to a subsequent tax year. 

Allowance under this section shall be allowed against the tax liability of either of the parents making payment of the fee on furnishing national tax number (NTN) or name of the educational institution. 

Allowance under this section shall not be taken into account for tax deduction computation under section 149.

*Donations under Clause 61*

Donations to institutions under clause 61, part I of the 2nd schedule.

a) Amount paid as a donation to the institutions mentioned in clause 61 Part 1 of the 2nd schedule of the Income Tax Ordinance, 2001, are straightly deducted from the total income (treated like deductible allowances).

b) The amount donated shall not exceed 30% of the taxable income in the case of you as an individual, AOP and 20% in the company’s case.

c) The condition of payment through the banking channel is not applicable for donations to be permissible deductions.

Concluding Remarks:

The significant difference between a tax credit and deductible allowances is that “when you calculate all the tax ratios on your annual income, and when you increase or decrease the tax amount on that tax calculation, that is how your tax credited or you got relief from heavy tax margins.”

Whereas “deductible allowance deducted from your overall annual income after that tax applies on the remaining amount, this is how you got taxed less.” 

In both cases, you get benefits whether you credit the tax and deduct the deductible allowances from your annual income.