Stephen J. Dann
UK Tax Advisor

Tax Avoidance and Evasion

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The distinction between tax evasion and tax avoidance is one that is often misunderstood, not least by tax authorities, who are quick to label any attempt to reduce a tax liability as "evasion". However, there is a real and important difference between the two practices, which is important in determining whether any activity that results in the reduction of a tax liability is evasion or avoidance. The difference lies in the fact that tax evasion relies on illegal means to reduce a tax liability. Tax avoidance - otherwise referred to as tax mitigation - relies on legal means.

Though it may be disputed by tax authorities, and is certainly disliked by them, it is the right of every taxpayer to arrange his or her affairs in any legitimate manner that reduces the payment of tax. In its very simplest sense this means that a taxpayer is, for example, in calculating liability to income tax, entitled to reduce taxable income by those deductions provided under law. In other circumstances it may mean, for example, that a taxpayer faced with a choice of funding an investment through debt or equity, chooses to fund using debt as this will result in a lower rate of tax.

In both these examples, there would be a reduction in the amount of tax payable as a result of the actions taken by the taxpayer. There has, therefore, been avoidance of tax, but, as the actions taken are legal, no evasion of tax.

The examples can be contrasted with some of the more blatant types of tax evasion. In its simplest form tax evasion equates to a deliberate under-reporting of income. Thus, enterprises engaged in sales for cash may fail to report such sales in their Returns, reporting only the credit sales for which a record exists. More elaborate schemes may involve the creation of false invoices to generate tax deductions for fictitious expenses, the creation of false accounting records or the artificial diversion of income from a taxable entity to a non-taxable entity.

How then can a taxpayer determine when an attempt to reduce a tax liability is moving from white to black? Some general guidelines for distinguishing between legitimate tax avoidance and illegal tax evasion might be as follows:

* Tax avoidance is supported by a credible basis in tax law.

* Tax avoidance does not rely on the suppression of information or on less than full disclosure to the tax authorities.

* In tax avoidance the tax position reported is consistent with the facts and circumstances.

* In tax avoidance there is a legitimate document trail which reflects the facts and circumstances.

A tax planning scheme which does not meet all of these criteria should be approached with caution, as it may be considered tax evasion.

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