Meaning of debit and credit
The Minister of Finance of Euroland announces the introduction of a 20% research and development (R&D) tax credit for all Euroland-based companies. Under the scheme, a company will receive a 20 cent reduction in its annual corporate income tax liability for every euro it spends on ‘qualifying' R&D in the year.
Required
(a) Show in outline the journal entries a (profitable) company makes to record:
(i) its income tax liability for the year, without the R&D tax credit;
(ii) the impact of the R&D tax credit on its income tax liability.
(b) A manager asks you: ‘How can a tax credit reduce our company's tax liability? Credits represent increases in equities - therefore a tax credit should mean an increase in the tax we owe. Does the government use the terms "debit" and "credit" in the opposite sense to the way we use them?' Explain the reason for the term ‘tax credit' in this context.