In Pakistan, the government incentivizes charitable giving by offering tax credits to individuals and companies who donate to approved organizations. This article explains how to calculate your tax credit and outlines the key terms involved.
What is a Tax Credit?
A tax credit directly reduces the amount of income tax you owe. Unlike a tax deduction, which lowers your taxable income, a tax credit provides a reduction in your tax liability.
Calculating Your Tax Credit:
The amount of tax credit you receive for charitable donations depends on several factors:
- Total Donations: This includes the sum of all your monetary donations and the fair market value of any property you donated during the tax year.
- Taxable Income: This is your total income minus allowable deductions before considering charitable donations.
- Tax Rate: This is the percentage of your taxable income you owe in taxes based on your income bracket.
The Formula:
The following formula determines your tax credit amount:
(A / B) x C
- A: Total tax assessed for the year before tax credits.
- B: Your taxable income for the year.
- C: The lesser of:
- Total Donations: The combined value of all your charitable contributions in the tax year.
- Donation Limit:
- Individuals and associations: 30% of taxable income.
- Companies: 20% of taxable income.
Important Note:
- There’s a further limitation if donating to an “associate” (related entity). In such cases, the donation limit is reduced to 15% for individuals and associations, and 10% for companies.
- Cash donations must be made through a crossed cheque drawn on a bank to qualify for the tax credit.
Understanding Key Terms:
- Fair Market Value: This is the estimated price a willing buyer would pay to a willing seller in an arm’s length transaction. It’s used to determine the value of donated property.
- Taxable Income: This is your total income minus allowable deductions before considering charitable donations.
Conclusion:
By understanding these calculations and definitions, you can effectively utilize tax credits for charitable donations. However, this article only covers the calculation aspect. In a separate article, we’ll explore the extensive list of organizations approved for receiving tax-deductible donations.
