Whether you’re rich or poor, an individual or a business, nobody enjoys paying tax. Of course the taxation system serves a purpose that many of us don’t fully appreciate but seeing part of your hard earned money disappear from sight isn’t something that sits well with most people and businesses. As a result some people will go to great lengths to reduce their tax bills and in some cases try to avoid paying tax altogether. In this article we will be looking at the often confusing subject or tax evasion vs tax avoidance. Including how to spot the difference between tax evasion vs tax avoidance.
What Is Tax Avoidance?
In simple terms tax avoidance is legally arranging your tax affairs to ensure only the minimum amount of tax is paid. Tax avoidance works within the letter of the law and takes many different forms. Some of the most simple forms that many people have access to include :
- Holding assets such as shares in your spouses name to make use of their capital gains allowance
- Selling off assets before the end of the tax year to make use of unused allowances when those allowances cannot be carried forward
- Holding cash savings in an ISA so that any interest generated in free from taxation
What Is Tax Evasion
Tax evasion on the other hand is the criminal act of paying less tax than is legally due usually by deliberately understating income or overstating expenses. Again this can be done on a small all large scale by individuals, businesses and other entities. The key takeaway is that tax evasion is a criminal activity and can carry heavy penalties and even criminal charges. At this point it is important to note that despite these definitions it is not a simple equation of tax evasion vs tax avoidance = bad vs good as you will discover below.
Tax Evasion Vs Tax Avoidance – How To Spot The Difference
Spotting the difference between tax evasion vs tax avoidance isn’t always black and white because some avoidance measures really push the limits of what’s acceptable so far that they end up in tax evasion territory. It is always best to speak to an accountant who will help you determine which side of the fence your actions would fall on in this tax evasion vs tax avoidance debate.
To help you decide whether or not to partake in an activity it’s better to think of 3 categories rather than just 2. Those 3 categories would be:
- Light Tax Avoidance/Planning – Activities in this category would include holding assets in an ISA to legally avoid tax. Transferring assets to a spouse or civil partner to utilise their allowances. Selling shares at the end of a tax year to realise a gain with the intent to repurchase the asset at a later date.
- Heavy Tax Avoidance – Offshore corporations and specifically designed tax avoidance schemes would usually fall into this category.
- Tax Evasion – Understating/concealing income or overstating/fabricating expenses would be classed as tax evasion.
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Tax Avoidance Schemes
As some laws can be subject to interpretation it has become more common that third parties will design specific tax avoidance schemes aimed at individuals or businesses that want to pay less tax. Although these schemes do their best to stay within the letter of the law they are usually manipulating the law in a way that was not intended to be possible. If you are taking part in a tax avoidance scheme you are expected to disclose the details of the scheme to HMRC. If you do not disclose the use of a scheme and are later found to be taking part then you will be subject to harsher penalties.
HMRC define a tax avoidance scheme in the following way:
“Tax avoidance involves bending the rules of the tax system to gain a tax advantage that parliament never intended. It often involves contrived, artificial transactions that serve little or no purpose other than to produce this advantage. It involves operating within the letter, but not the spirit, of the law.”
Scheme Examples
HMRC maintain a list of known tax avoidance schemes on their website that they are currently investigating. If you disclose that you are part of one of these schemes then you will be investigated by HMRC. Even if your scheme is not listed on the HMRC website, HMRC will expect you to disclose the details to them and in some cases they will actually ask you to pay the full tax and national insurance saving generated by the scheme upfront whilst the investigation takes place which is known as an accelerated payment notice. If you do not agree to pay the tax owed then HMRC will likely take legal action against you to recover the tax owing. In court HMRC typically win 9 out of 10 cases regarding tax avoidance. After all of this, HMRC will continue to treat you as a high risk tax payer which means that all of your tax affairs will be scrutinised in future. In HMRC’s own words “most tax avoidance schemes simply do not work, and those who use them may end up having to pay much more than the tax they tried to avoid, including penalties”
Two schemes highlighted on the HMRC website as currently under investigation are:
- Avoiding Income Tax on Pay (Spotlight 11) – “HMRC are aware that people who have used employee benefit trusts (or similar) to avoid paying tax on employment income. These people are being targeted with products designed to shelter funds in current schemes from the effect of tax legislation”
- Gift Aid With No Real Gift (Spotlight 9) – “An avoidance scheme exploiting the gift aid provisions has recently been disclosed to HMRC. The scheme seeks to exploit the rules, which enables a charity to claim a repayment of tax at the basic rate on a qualifying donation by an individual. In the correct circumstances, the individual may claim relief for the donation on the difference between the higher and basic rates of tax”
Spotting A Tax Avoidance Scheme
There are some key warning signs that you can look out for if you believe you have entered into a tax avoidance scheme or have been approached by a tax avoidance scheme:
- It sounds too good to be true – where the reward far outweighs the cost this is often an indicator of a tax avoidance scheme
- Pay in the form of loans – If you are encouraged to take payment in the form of a loan that doesn’t need repaying this is also an indicator of a tax avoidance scheme
- Huge Benefits – Scheme providers often promote huge benefits with little or no risk to your money. This is another indicator
- Round in circles – Where the aim is to move your money round in a circle with it ending up back where it started this can also be an indicator of a tax avoidance scheme
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Adam Hill
Practice based accountant with over 10 years experience, specialising in SME's, Freelancers and Personal Tax. "I take pride in proactively recognising tax planning opportunities on behalf of clients to help them operate more efficiently."
