Taxes are essential means of revenue generation for governments across the world. Direct taxes are levied on incomes and wealth of different entities and indirect taxes are levied on various economic transactions. While governments levy taxes and determine tax rules and rates, they also provide several tax relief provisions. Entities can take advantage of these provisions to reduce their tax burden by fulfilling the conditions specified in the provisions. Some entities however resort to unscrupulous means to reduce their tax burden and sometimes avoid taxes altogether.
This article looks at meaning of and differences between two ways in which taxpayers try to reduce their tax burden – tax evasion and tax avoidance.
Definitions and meanings
Tax evasion involves tax paying entities resorting to illegal means to reduce or altogether escape tax liability. In cases of tax evasion, entities do not pay or pay reduced taxes on transactions that ought to be subjected to tax as per relevant tax rules.
Tax evasion takes several forms, such as:
- Concealing source of income from revenue authorities
- Misreporting or under-reporting of incomes from revenue authorities
- Inflating or fudging expenses to reduce taxable income
- Withholding of information from revenue authorities in a way that results in a lower levy of tax
An example of tax evasion
Mr. A is a trader who deals in mobile phones. Say, as per jurisdictional law, traders are not permitted to undertake cash sales in excess of $1,000 per day. Mr. A however undertakes more than 50% of his sales in cash. This is done by Mr. A to avoid reporting of sales effected by him. In this way he evades both indirect taxes levied on sales of mobile phones and direct taxes by not reporting profits on sales made by him in cash. This tantamounts to tax evasion by Mr. A.
It is important that revenue authorities focus on cases of tax evasion as they can cause significant loss to the public exchequer. Tax evasion can be caught through robust taxation systems and through in-depth scrutiny and assessment by revenue authorities.
Tax avoidance is when tax payers adopt tax planning by taking advantage of benefits and reliefs provided by tax rules, to reduce their tax liability. Tax avoidance is a legal and bonafide way of reducing a tax payer’s tax liability.
To achieve tax avoidance, tax payers seek out beneficial rules which can apply to their business and transactions and look to structure their business activities so as to take advantage of these beneficial provisions and rules.
An example of tax avoidance
Jurisdictional tax laws that apply to Mr. A provide for deduction from taxable income of interest paid on housing loans by individuals. Mr. A plans his investments in a way so as to divert his stock investments to paying EMIs on a second house obtained by way of loan. In this way he is able to claim deduction from his taxable income based on jurisdictional rules and reduces his tax liability.
The key aspect of tax avoidance is that it is done within the framework of the law and its rules and provisions. Tax payers can seek help from tax professionals to help devise legal tax avoidance strategies.
Differences between tax evasion and tax avoidance:
The difference between tax evasion and tax avoidance has been detailed below:
- Tax evasion is the illegal reduction of tax liability by not abiding to tax provisions and rules.
- Tax avoidance involves taking advantage of beneficial tax provisions and rules through tax planning so as to reduce tax liability.
- Tax evasion is an illegal act.
- Tax avoidance is legal tax planning.
- Means to achieve tax evasion involves taking advantage of loopholes in tax laws or tax systems to evade taxes.
- Means to achieve tax avoidance involves taking advantage of beneficial tax provisions for tax relief
4. Intent of tax payers
- Tax payers resorting to tax evasion have malafide intent to escape taxes by adopting illegal means.
- Tax payers adopting tax avoidance have bonafide intent to reduce their tax burden by devising legal tax planning strategies.
5. Legal consequences for tax payers
- The legal consequences for tax payers for resorting to tax evasion are negative and can be severe. These can include monetary fines as well as criminal punishment. The consequences differ from jurisdiction to jurisdiction and also depend on the severity of tax evasion.
- Tax avoidance does not result in any negative legal consequences for tax payers. The only legal consequence that results is a reduction in their tax outflow.
6. Cost to public exchequer
- The cost to public exchequer can be high especially if instances of tax evasion are not detected. The cost cannot be predicted.
- The cost to public exchequer depends on the extent of tax relief claimed. In any case, revenue authorities can predict and plan for the cost as it is based on their own formulated tax relief provisions.
7. Outlook of revenue authorities
- Tax evasion is discouraged by revenue authorities.
- Tax avoidance strategies are supported and encouraged.
8. Need for monitoring by revenue authorities
- Avoiding cases of tax evasion requires efficient monitoring by revenue authorities which can be set up by implementing robust tax systems. Detecting instances of tax evasion also requires detailed scrutiny by revenue authorities.
- Tax avoidance requires limited monitoring by tax authorities.The scrutiny is only limited to ensure all conditions required to be fulfilled for taking advantage of beneficial rules are complied with.
- Examples of tax evasion includes under-reporting or non-reporting of income, over-stating or falsifying expenses etc.
- Examples of tax avoidance include claiming investment-based deductions, claiming tax holidays on eligible businesses etc.
Conclusion – tax evasion vs tax avoidance:
Both tax evasion and tax avoidance instances are seen across classes of tax payers. Tax evasion however is more severe and is what revenue authorities attempt to plug by strengthening taxing systems as well as subsequent scrutiny systems. While tax avoidance is supported, it is essential for revenue authorities to ensure that all required eligibility criteria are being met by tax payers else several tax payers can evade taxes under the garb of tax avoidance.