Tax Avoidance vs Tax Evasion

Posted by

Vivek Dodd

on 16 Feb 2022

The difference between tax avoidance and tax evasion essentially comes down to legality. Avoiding tax is legal, but it is easy for the former to become the latter.

Tax Avoidance vs Tax Evasion

Crossing that line can lead to hefty fines and prosecution. We have gathered examples from recent and historic high-profile cases to help you unpick the fine line between tax avoidance and tax evasion.

Tax evasion is back in the news...

In October 2021, a cache of over 11m files of confidential offshore records shared by the International Consortium of Investigative Journalists had exposed the secret financial dealings of 130 billionaires, 300 public officials and 30 world leaders in the biggest leak in history.

The Pandora Papers leak showed how these individuals bought real estate, cars, and even artworks by Banksy and Picasso via a complex web of offshore shell companies and incognito bank accounts.

Enabled by banks, law firms and accounting practices, they evaded taxes in their home countries and, in some cases, misappropriated wealth through embezzlement. The implicated parties included politicians receiving donations via offshore corporate structures, dealers transferring ownership of Cambodian antiquities to bypass UK inheritance tax, as well as celebrities concealing their earnings to evade income tax.

Following the leak, at least eight countries announced investigations into implicated individuals' financial and wealth assets. In response, the FATF insisted that countries do more to strengthen transparency by establishing beneficial ownership registers.

What is tax avoidance?

Tax avoidance is when a person or company legally exploits the tax system to reduce tax liabilities, such as establishing an offshore company in a tax haven.

Done properly, tax avoidance is actually encouraged by the Government. Simply put, it means paying as little tax as possible while still staying on the right side of the law - and who doesn't want that, right?

Some examples of legitimate tax avoidance include putting your money into an Individual Savings Account (ISA) to avoid paying income tax on the interest earned by your cash savings, investing money into a pension scheme, or claiming capital allowances on things used for business purposes.

What is tax evasion?

Tax evasion is when a person or company escapes paying taxes illegally. This is typically done by concealing the true state of their financial affairs to tax authorities.

Common examples of tax evasion include:

  • Not reporting or under-reporting income to the tax authorities
  • Keeping business off the books by dealing in cash or other devices with no receipts
  • Hiding money, shares, or other assets in an offshore bank account
  • Misreporting personal expenses as tax-deductible business expenses
  • Using company property for personal use without a valid business reason

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How do tax evasion and tax avoidance differ?

There is a fine line between avoidance and evasion. Many tax avoidance schemes devised by accountants and marketed towards the wealthy have been heavily criticised, leading to HM Revenue & Customs (HMRC) shutting them down, arguing that they amount to tax evasion.

Jimmy Carr, Gary Barlow, Starbucks, Google and Amazon are just a few names you may have seen in the media connected with tax avoidance and evasion schemes.

In the case of Jimmy Carr, he received public scrutiny when news surfaced that he was involved in the K2 Scheme, a tax avoidance arrangement which meant that the rich paid less than 1% tax, ultimately costing the tax man £168m.

Similarly, pop star Gary Barlow and many other celebrities invested in a scheme known as Icebreaker, which purported to find finance for creative projects within the music industry and offer a return for investors, but in fact, generated losses. Barlow, along with two of his Take That bandmates, Mark Owen and Howard Donald, and the band's former manager, Jonathan Wild, have repaid more than £20m to HMRC after pouring £66 million into the scheme.

They were penalised because HMRC deemed this an "aggressive" tax avoidance scheme. If you go up against HMRC and lose, you could be ordered by the courts to repay the tax, the interest and any penalties it deems fit.

UK approach to tax evasion

The UK Government has been working to change the common perception of tax evasion as being a petty crime. The Criminal Finances Act 2017 that took effect on 30 September 2017, created a new corporate criminal offence of failing to prevent the facilitation of tax evasion by associated persons.

The government has introduced hundreds of measures. In recent years, the HMRC has hired hundreds of new officers to act against aggressive tax avoidance schemes and reduce the tax gap, i.e. the difference between the tax that should be paid and what is actually collected.

Now companies need to be more alert than ever. In an article titled 'If your suppliers cheat us we'll fine you, says taxman', The Times newspaper reported that companies could be prosecuted and face unlimited fines if they fail to spot tax evasion by their suppliers. HMRC wants to see enhanced due diligence in supply chains and provision of labour. It has hired officers to step up raids and demand inspections of business records.

You can read more about the legislation to criminalise failure to prevent tax evasion in the government guidance document tackling tax evasion.

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