In the wake of the Panama
papers revelations, the distinction between tax planning, tax avoidance,
aggressive tax avoidance and tax evasion seems to have been lost between the
lines. The basic difference is that avoidance is legal and evasion is not. But
it’s not quite as simple as that.
There are many legitimate ways
in which tax can be saved and that are actively promoted by governments.
Tax-free investments, for example, donations to charity, or paying into a
pension scheme. Through tax planning, a taxpayer exercises an option clearly
allowed by law and does not exploit unintended loopholes. This respects both
the “letter” and the “spirit” of the law.
Tax avoidance seeks to
minimise a tax bill in a way that respects the letter of the law, but not
necessarily the spirit of the law. To do so it takes advantage of unintended
loopholes in tax legislation. This can, however, be taken too far and lead to
prosecutions to recoup the taxes that have been avoided.
The loopholes that are
exploited by tax avoidance may be in your home country’s tax law alone, but can
also seek to exploit gaps that exist between domestic tax law and the law of
other countries. In an increasingly globalised world businesses and individuals
operate across many countries, all with slightly different tax rules. This
makes it easier to structure their tax affairs to reduce taxable profits or hide their wealth
altogether.
In response to the Panama papers, US President Barack Obama warnedthat “tax avoidance is a big global problem” and
called for international reform. This speaks to how the loopholes that tax
avoidance exploits may be targeted and laws changed.
In general, the more complex and the
more “aggressive” avoidance becomes, the more likely it is to be investigated
by tax authorities. Anti-avoidance legislation can be introduced to close legal
loopholes and legislation can be changed. In the UK, the traditional approach
to counter tax avoidance has been to introduce legislation to prevent
individual tax-planning schemes exploiting loopholes in the law, once the
schemes have come to light. In January 2015 a general anti-abuse rule was introducedto deter taxpayers from entering into certain types of
abusive arrangements (a tax arrangement which has the main purpose of obtaining
a tax advantage), and to deter would-be promoters from promoting such
arrangements.
These rules will deter the use of some
schemes, but they do not catch all instances of tax avoidance. Ultimately,
whether through a tax audit or court hearings, the decision on whether an
arrangement amounts to tax avoidance will be based on a close examination of
the specific circumstances of each case.
A recent case in the UK courts involved a tax planning scheme used
by high street betting shop Ladbrokes that took advantage of an element of the
tax code that dealt with the way loans between a company and another party are
taxed. Under the scheme, two group companies entered into specially designed
arrangements whereby an artificial fall in the value of shares in one company,
in turn, created a loss in the other company for tax purposes. In reality, the
group suffered no economic loss overall. In the first-tier tribunal, the court
ruled that it was tax avoidance. Commenting on the outcome of the case, HMRC’s
director general of business tax Jim Harra said: “Avoidance just doesn’t pay –
we win around 80% of cases taxpayers choose to litigate and many more concede
before litigation.”
Another recent case involved a tax avoidance scheme where the investors
attempted to benefit from £29m in tax relief by claiming to have spent £122m on
research, when in fact only £7m reached the genuine research company. It was
also deemed to be a case of tax avoidance, and the court agreed that there were
elements in the scheme’s documents and fees paid that were a “sham”.
In both cases, the courts ruled that claiming
this level of tax was illegal. But there is no hard and fast rule to determine
when a tax avoidance arrangement is too “aggressive”. Each tax jurisdiction
will have its own definitions, rules, interpretation and legal precedents on
what constitutes avoidance and at what point it is challenged by tax
authorities.
Where the tax benefits or returns are
out of proportion with any real economic activity, expense or investment risk,
however, this is when tax authorities tend to question matters. So too where a
scheme involves arrangements which seem very complex, artificial or contrived;
offshore companies or trusts are involved for no sound commercial reason; or a
tax haven country is involved.
The thickness of a prison wall
Denis Healey, former UK chancellor of
the exchequer, famously quipped: “The difference between tax avoidance and tax evasion is the thickness
of a prison wall.”
Put simply, tax evasion is when a person
or company purposefully tries to mislead the tax authorities by misrepresenting
or concealing facts in an effort to escape their lawful tax liability. This can
be done by omitting to disclose relevant facts about your taxable assets, for
example hiding income or profits you earn in a tax year or purposely
overstating your taxable deductions.
Tax havens are often used to
facilitate tax evasion. Their secrecy laws prevent overseas tax authorities
from accessing information on the money that’s held in these offshore
jurisdictions. It is only through data leaks, such as the Panama papers, that
authorities are tipped off about the people using these havens and can then
investigate them.
For example, following a data
leak of HSBC’s Swiss subsidiary in 2009, Arlette Ricci, the heir to the Nina
Ricci perfume and fashion business, was found guilty by a Paris court of tax
evasion in 2015. She hid millions of euros from the French tax authorities by
using an offshore HSBC account.
UK tax authorities have also
investigated and challenged more than 1,000 account holders from HSBC’s Swiss
subsidiary, and collected £135m from them in unpaid tax,
interest and fines. The expectation is that once the information included in
the Panama Papers is investigated by tax authorities, this will also unveil a
world of undeclared income and unpaid taxes through the illegal method of
evasion – and that prosecutions will follow.
So, while there are
differences between tax avoidance and tax evasion, both can be prosecuted and
can result in additional tax and fines have to be paid.
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