Difference between refundable and non-refundable tax credits

To read more chapters, click below:

Chapter 1: Who is required to file an income tax return?

Chapter 2: Taxes for New Canadians: Step-by-Step Guide to Filing Your Tax Return

Chapter 4: Non-refundable tax credits  

For a lot of people in Canada one of the biggest incentives for filing taxes is to get a refund. Usually, people don’t know what are tax credits and cannot take advantage of them. But in this chapter, we’ll discuss what are tax credits and the main difference between refundable and non-refundable tax credits.

Tax credits are potential reductions that you might be eligible to request upon the completion and submission of your income tax declaration. These credits could be linked to your earnings, investments, educational pursuits, involvements, incurred expenses, or your occupational endeavors.

Key points to remember –

• Tax credits possess the ability to diminish the sum of income tax you're obligated to remit and potentially result in government disbursements to you.
• Refundable tax credits entail amounts granted irrespective of your income tax liability.
• On the other hand, non-refundable tax credits have the capacity to decrease your payable income tax, yet they cannot lower it beyond zero.

What is a tax credit?

In terms of Canadian taxes, a tax credit is a reduction in the amount of income tax that an individual or business owes to the government. Tax credits are designed to incentivize certain behaviors, activities, or circumstances by providing financial relief to taxpayers. They are subtracted directly from the amount of tax owed, which can result in a lower overall tax liability or even a tax refund if the credit amount exceeds the tax owed.

There are two main types of tax credits in Canada – refundable and non-refundable. We’ll discuss about each of these in the following sections.

Tax credits serve to decrease your tax liability, and in certain cases, they might even lead to you becoming eligible for additional funds. For instance, let's consider the scenario where your total income tax obligation for the 2023 tax period amounts to $3,000, and your applicable tax credits sum up to $500. By deducting these credits from the overall income tax, you arrive at your tax assessment for the year –

$3,000 - $500 = $2,500

The outcome of this could either be a tax refund or a reduced tax bill, contingent on the extent of income tax payments you have already made for that year, which might be through deductions from your paychecks or self-made installments.

How do tax credits work?

Tax credits serve as encouragements provided by the Canadian federal, provincial, and territorial governments, effectively decreasing your tax liability. Distinguishing them from tax deductions, which lower taxable income, tax credits operate by directly diminishing the tax amount owed.

Assuming eligibility, there exists no constraint on the quantity of tax credits at your disposal. While tax credits can enhance your probability of securing a tax refund from the government, they do not ensure it.

Every individual is obligated to contribute a portion of their earned income to the government, with the exact proportion contingent upon their location (varied provinces and territories have distinct income tax rates) and their income level. Subsequently, you have the opportunity to utilize specific circumstances that could reduce your taxable earnings or the income tax quantum you're liable for, and potentially yield additional funds. Within this set of circumstances, one category encompasses tax credits.

When you undertake the task of filing your taxes, essentially completing a comprehensive form, you are informing the government not only about your earnings but also about how many of these circumstances that lead to tax reduction you are eligible for.

Refundable tax credits

In Canada, refundable tax credits are tax benefits that can potentially result in a tax refund even if the credit amount exceeds the taxpayer's total tax liability. This means that if you qualify for these credits and the calculated amount is more than the tax you owe, you could receive the excess credit as a refund from the government. The different refundable tax credits in Canada include the following –

1. The Canada Workers Benefit provides a potential sum of $1,428 to eligible individuals with low income and up to $2,461 to eligible families with low income. (The maximum amount varies in Alberta, Quebec, and Nunavut.)
2. Within the framework of the Canada Workers Benefit, the CWB disability supplement extends an additional sum of up to $737 to individuals with disabilities and their families. (The maximum amount varies in Quebec and Nunavut.)
3. For qualifying teachers and early childhood educators, the Eligible Educator School Supply Tax Credit offers a reimbursement of up to $250 in tax funds for eligible teaching supplies, given that the $1,000 expenditure cap is met.
4. Under the Canada training credit, 50% of eligible education and training expenses can be refunded. The credit has a lifetime ceiling of $5,000. To determine your specific limit for this tax year, refer to your most recent notice of assessment or reassessment.

Non-refundable tax credits

Non-refundable tax credits in Canada are tax benefits that can lower the amount of income tax you owe, but they cannot result in a tax refund beyond reducing your tax liability to zero. If your total non-refundable tax credits exceed your tax payable, the excess credits cannot be refunded to you; they simply reduce your tax owing to zero.

Given below are some examples of non-refundable tax credits in Canada –

1. Basic Personal Amount

This credit reduces the amount of income that is subject to taxation. In other words, you can earn a certain amount of income each year without paying federal income tax on it. The exact amount of the Basic Personal Amount can vary year to year.

2. Medical Expenses Credit

This credit allows you to claim a portion of eligible medical expenses that you paid for yourself, your spouse or common-law partner, and certain dependents.

3. Charitable Donations Credit

If you've made donations to registered charities, you can claim a credit based on the total amount of donations made throughout the year.

4. Tuition and Education Credits

These credits apply to eligible tuition fees and education amounts paid for post-secondary education. While the federal education and textbook credits have been discontinued, some provinces still offer them.

5. Child Care Expenses Credit

If you paid for child care services so you or your spouse could work, go to school, or conduct research, you can claim a credit for eligible child care expenses.

6. Pension Income Credit

This credit applies to eligible pension income, which can include income from superannuation, registered pension plans, and annuities.

These non-refundable tax credits can significantly reduce your tax liability, but remember that they won't result in a tax refund on their own if they exceed the tax you owe.

In Canada, tax credits play a crucial role in shaping the tax landscape for individuals and families. These credits, whether refundable or non-refundable, are incentives provided by the government to encourage specific behaviors, alleviate financial burdens, and support various segments of the population. Refundable tax credits can potentially lead to tax refunds for those with lower incomes, while non-refundable tax credits can help reduce tax liabilities for a wide range of expenses, from medical costs to charitable donations. Understanding and leveraging these tax credits can significantly impact one's overall tax liability and financial well-being, making it essential for individuals to explore and utilize the available opportunities to their advantage.