Tax credits can be granted for a wide variety of reasons, and can be extended to cover a broad spectrum of taxes. A tax credit can serve as a form of recognition of taxes that have already been paid, to provide a subsidy to the legal entity who is receiving the tax credit, or in order to serve as a method of encouragement to particular behaviors or to entice an investment.
Depending on the tax system under which the tax credits are granted, the tax credit may or may not be refundable, depending on whether or not the tax credit exceeds the respective tax. Different tax systems may be designed to grant a tax credit to businesses or to individuals, and these tax credits can vary according to the type of credit that is offered.
Under most tax systems, taxes that are paid indirectly, such as withholding taken out of income checks are considered tax credits, rather than being known as prepayments. The most common tax credits are payroll withholding of income tax (also known as PAYE), withholding of tax at the source of payment to non-residents, and input tax credits that are associated with a value added tax.
A tax credit is designed to provide financial compensation for a choice that has been made, or to subsidize particular course of action, such as a child tax credit, a tax credit to individuals who have completed an adoption, an earned income tax credit, a tax credit to foster retirement savings, or a variety of other tax credits.