Tax evasion vs tax avoidance

Tax evasion vs tax avoidance

Subject: Economy

Section: Fiscal Policy

Context: Tax evasion by companies

Concept:

Tax liability of an individual can be reduced by tax avoidance, tax planning and tax evasion. Whereas, tax planning and tax avoidance are legal means, tax evasion are completely illegal means.

The objective of Tax avoidance is to reduce tax liability by applying the script of law whereas Tax evasion is done to reduce tax liability by exercising unfair means. Tax planning is done to reduce the liability of tax by applying the provision and moral law.

The basic differences are as follows:

Tax Avoidance means an attempt to reduce tax liability through legal means, i.e. to regulate one’s financial affairs in such a way that one pays the minimum tax imposed by the law.

Tax avoidance is an activity of taking unfair advantage of the shortcomings in the tax rules by finding new ways to avoid the payment of taxes that are within the limits of the law. Tax avoidance can be done by adjusting the accounts in such a manner that there will be no violation of tax rules. Tax avoidance is lawful but in some cases it could come in the category of crime.

Common tax avoidance techniques include:

• Deducting a charitable donation
• Deducting Health Savings Account contributions
• Putting money into a 401(k)
• Using a student loan interest deduction

Transfer pricing itself is not a means of tax avoidance if transfer price matches what the seller entity would charge to an unrelated customer (called customer at arm’s length). However, since lowering or increasing the prices between parent-daughter entities doesn’t affect the whole organization, the companies artificially increase or decrease the transfer price to avoid corporate tax. This processing of using unusual transfer pricing to avoid tax is called Base Erosion and Profit Sharing (BEPS).

Tax evasion is the use of illegal methods of concealing income or information from the IRS or other tax authority to reduce or avoid tax burden. Tax evasion can result in fines, penalties and/or prison time.

Tax Evasion is a criminal activity for which the assessee is subject to punishment under the law. It involves acts like:

• Deliberate misrepresentation of material facts.
• Hiding relevant documents.
• Not maintaining complete records of all the transactions.
• Making false statements.