Tax avoidance and tax evasion



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Tax avoidance and tax evasion



Tax avoidance and tax evasion

Translation

Tax avoidance and tax evasion

Tax avoidance is the legal utilization of the tax regime to one's own advantage, in order to reduce the amount of tax that is payable by means that are within the law. By contrast tax evasion is the general term for efforts to not pay taxes by "illegal" means. The term tax mitigation is a synonym for "tax avoidance". Its original use was by tax advisors as an alternative to the pejorative term of tax avoidance. Latterly the term has also been used in the tax regulations of some jurisdictions to distinguish tax avoidance foreseen by the lawmakers from tax avoidance which exploits loopholes in the law.

Some of those attempting not to pay tax believe that they have discovered interpretations of the law that show that they are not subject to being taxed: these individuals and groups are sometimes called tax protesters. An unsuccessful tax protestor has been attempting openly to "evade" tax, while a successful one "avoids" tax. Tax resistance is the declared refusal to pay a tax for conscientious reasons (because the resister does not want to support the government or some of its activities). Tax resistors typically do not take the position that the tax laws are themselves illegal or do not apply to them (as tax protesters do) and they are more concerned with not paying for particular government policies that they oppose.

Tax avoidance

Tax avoidance is the legal utilization of the tax regime to one's own advantage, in order to reduce the amount of tax that is payable by means that are within the law. The United States Supreme court has stated that "The legal right of an individual to decrease the amount of what would otherwise be his taxes or altogether avoid them, by means which the law permits, cannot be doubted." See Gregory v. Helvering. Examples of tax avoidance include:

Country of residence

One way a person or company may lower their taxes due is by changing one's tax residence to a tax haven, such as Monaco or Switzerland, or by becoming a perpetual traveler; however, some countries, such as the U.S., tax their citizens, permanent residents, and companies on all their worldwide income. In these cases, taxation cannot be avoided by simply transferring assets or moving abroad.

The United States is unlike almost all other countries in that its citizens, and legal permanent residents, are subject to U.S. tax on their worldwide income even if they reside temporarily or permanently outside the United States. U.S. citizens therefore cannot avoid U.S. taxes simply by emigrating. According to "Forbes" magazine some nationals choose to give up their United States citizenship rather than be subject to the U.S. tax system; [cite web|url=http://web.archive.org/web/20060227051231/http://www.frissell.com/taxpat/FORBES1.HTM|title=The new refugees. (Americans who give up citizenship to save on taxes)|publisher=Forbes|date=1994-11-21|accessdate = 2006-12-23] however, U.S. citizens who reside (or spend long periods of time) outside the U.S. may be able to exclude some salaried income earned overseas (but not other types of income) from U.S. tax. The 2007 limit on the amount that can be excluded was US$85,700.

Double taxation

Most countries impose taxes on income earned or gains realized within that country regardless of the country of residence of the person or firm. Most countries have entered into bilateral double taxation treaties with many other countries to avoid taxing nonresidents twice -- once where the income is earned and again in the country of residence (and perhaps, for US citizens, taxed yet again in the country of citizenship) -- however, there are relatively few double-taxation treaties with countries regarded as tax havens. [There are certain well-known exceptions to this: Cyprus has a heavily exploited double taxation relief treaty with Russia; another frequently used treaty is the double taxation relief treaty between Mauritius and India. There are also a number of other less well known and less frequently utilized treaties, such as the one between the British Virgin Islands and Switzerland.] To avoid tax, it is usually not enough to simply move one's assets to a tax haven. One must also personally move to a tax haven (and, for U.S. nationals, renounce one's citizenship) to avoid tax.

Legal entities

Without changing country of residence (or, if a U.S. citizen, giving up one's citizenship), personal taxation may be legally avoided by creation of a separate legal entity to which one's property is donated. The separate legal entity is often a company, trust, or foundation. Assets are transferred to the new company or trust so that gains may be realized, or income earned, within this legal entity rather than earned by the original owner. Usually one is only personally taxed on property and earnings that one actually owns; thus, by donating assets to a separate legal entity, personal taxation can be avoided, although corporate taxes may still be applicable. If the legal entity is ever liquidated and the assets transferred back to an individual, then capital gains taxes would apply on all profits.

The company/trust/foundation may also be able to avoid corporate taxation if incorporated in an offshore jurisdiction (see offshore company, offshore trust or private foundation). Although income tax would still be due on any salary or dividend drawn from the legal entity. In order for a settlor (creator of a trust) to avoid tax there may be restrictions on the type, purpose and beneficiaries of the trust. For example, the settlor of the trust may not be allowed to be a trustee or even a beneficiary and may thus lose control of the assets transferred and/or may be unable to benefit from them.

Tax evasion

By contrast tax evasion is the general term for efforts by individuals, firms, trusts and other entities to evade taxes by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability, and includes, in particular, dishonest tax reporting (such as declaring less income, profits or gains than actually earned; or overstating deductions).

Tatistics

The difference between the amount of tax legally owed and the amount actually collected by a government is sometimes called the tax gap.

In the United States, the IRS estimated in 2007 that Americans owed $345 billion more than they paid, or about 14% of federal revenues for FY2007. [$345B tax g
http://www.npr.org/templates/story/story.php?storyId=15111003 Random Tax Audits Return to the IRS] , 9 Oct 2007, Morning Edition.
]

Economics of tax evasion

In 1968, Nobel laureate economist Gary Becker firstFact|date=July 2008 theorized the "economics of crime". Based on that Allingham and Sandmo produced in 1972 an economic model of tax evasion. He considered evasion of income tax which is the main source of tax revenue in the developed countries. According to them, the level of evasion of income tax depends on the level of punishment as provided in law. [ Allingham, M. G. and A. Sandmo [1972] ‘Income Tax evasion: A Theoretical Analysis’, Journal of Public Economics, Vol.1, 1972, p.323-38.]

Evasion of customs duty

Customs duties are an important source of revenue in the developing countries. The importers purport to evade customs duty by (a) under-invoicing and (b) misdeclaration of quantity and product-description. When there is ad valorem import duty, the tax base is reduced through underinvoicing. Misdeclaration of quantity is more relevant for products with specific duty. Production description is changed match an H. S. Code commensurate with a lower rate of duty. [Chowdhury, F. L. "Evasion of Customs Duty in Bangladesh", 2006: Desh Prokashon Dhaka. ]

Muggling

Smuggling is importation or exportation of foreign products through unauthorized route. Smuggling is resorted to for total evasion of leviable customs duties as well as for importation of contraband items. A smuggler does not have to pay any customs duty since the products are not routed through an authorized or notified Customs port and therefore, not subjected to declaration and payment of duties and taxes. [Chowdhury, F. L. "Evasion of Customs Duty in Bangladesh", 2006: Desh Prokashon Dhaka. ]

Control of evasion

Level of evasion depends on a number of factors one of them being fiscal equation. People's tendency to evade income tax declines when the return for due payment of taxes is not obvious. Evasion also depends on the efficiency of the tax administration. Corruption by the tax officials often render control of evasion difficult. Tax administrations resort to various means for plugging in scope of evasion and increasing the level of enforcement. These include, among others, privatization of tax enforcement, [ Chowdhury, F. L. (1992) "Evasion of Customs Duty in Bangladesh", unpublished MBA dissertation, Graduate School of Management, Monash University, Australia.] tax farming, [ Stella, P. [1992] "Tax Farming - A radical Solution for Developing Country Tax Problem", IMF Working Paper No. 92/70 ] and institution of Pre-Shipment Inspection (PSI) agencies. [ Alam. D (1999) Introduction of PSI system in Bangladesh: Facts and Documents, Desh Prokashon, Dhaka.]

Corruption by tax officials

Corrupt tax officials cooperate with the tax payers who intend to evade taxes. When they detect an instance of evasion, they refrain from reporting in return for illegal gratification or bribe. Corruption by tax officials is a serious problem for the tax administration in a huge number of underdeveloped countries.Fact|date=October 2007

Role of middleman

It is often alleged that tax lawyers and chartered accountants help taxpayers including firms and companies in evading taxes. In the same vein, the Clearing and Forwarding agents help in evasion of Customs duties. It has been suggested that removal of human interface is a reliable solution to this problem.Facts|date=October 2007

Tax farming

Tax farming is an old means of collection of revenue when it is difficult to determine the leviable amount taxes with certainty. Government leases out the collection system to a private entity for a fixed amount who then collects the revenue and shoulders the risk of attempts at evasion by the tax-payers. It has been suggested that tax farming may be a solution to the problem of tax evasion seen in developing countries. [Stella, P. (1992) "Tax Farming - A radical Solution for Developing Country Tax Problem", IMF Working Paper No. 92/70.]

PSI Agencies

Pre-shipment Agencies like SGS, Cotecna etc. are employed to prevent evasion of customs duty through under-invoicing and misdeclaration. However, in the recent times, allegations have been lodged that PSI agencies have actively cooperated with the importers in evading customs duties. Authority in Bangladesh has found Cotecna, a PSI agency of Swiss origin, guilty of complicity with the importers for evasion of customs duties on a huge scale. [" [http://www.newagebd.com/2007/sep/14/front.html NBR showcauses Cotecna on car import scam] ", New Age] The same company Cotecna was implicated for bribing Pakistan's prime minister Benazir Bhutto for securing contract for importation by Pakistani importers. She and her husband were sentenced both in Pakistan and Switzerland. [New York Times, 06 August 2003]

History of the distinction

An avoidance/evasion distinction along the lines of the present distinction has long been recognised but at first there was no terminology to express it. In 1860 Turner LJ suggested evasion/contravention (where evasion stood for the lawful side of the divide): "Fisher v Brierly". [(1860) 1 de G F&J 643 (England).] In 1900 the distinction was noted as two meanings of the word “evade”: "Bullivant v AG". [(1901) AC 196 (England). ] The technical use of the words avoidance/evasion in the modern sense originated in the USA where it was well established by the 1920s. [Minimising Taxes, Sears, 1922, Vernon Law Book Co.] It can be traced to Oliver Wendell Holmes in "Bullen v Wisconsin". [240 U.S. 625, 630 (1916).] It was slow to be accepted in the United Kingdom. By the 1950s, knowledgeable and careful writers in the UK had come to distinguish the term “tax evasion” from “avoidance”. However in the UK at least, “evasion” was regularly used (by modern standards, misused) in the sense of avoidance, in law reports and elsewhere, at least up to the 1970s. Now that the terminology has received official approval in the UK ("Craven v White" [(1988) 62 TC 1 at 197.] ) this usage should be regarded as erroneous. But even now it is often helpful to use the expressions “legal avoidance” and “illegal evasion”, to make the meaning clearer.

Responses to tax avoidance

Avoidance also reduces government revenue and brings the tax system into disrepute, so governments need to prevent tax avoidance or keep it within limits. The obvious way to do this is to frame tax rules so that there is no scope for avoidance. In practice this has not proved achievable and has led to an ongoing battle between governments amending legislation and tax advisors' finding new scope for tax avoidance in the amended rules.

To allow prompter response to tax avoidance schemes, the US Tax Disclosure Regulations (2003) require prompter and fuller disclosure than previously required, a tactic which was applied in the UK in 2004.

Some countries such as Canada, Australia and New Zealand have introduced a statutory General Anti-Avoidance Rule (GAAR). Canada also uses Foreign Accrual Property Income rules to obviate certain types of tax avoidance. In the United Kingdom, there is no GAAR, but many provisions of the tax legislation (known as "anti-avoidance" provisions) apply to prevent tax avoidance where the main object (or purpose), or one of the main objects (or purposes), of a transaction is to enable tax advantages to be obtained.

In the United States, the Internal Revenue Service distinguishes some schemes as "abusive" and therefore illegal.

In the UK, judicial doctrines to prevent tax avoidance began in IRC v Ramsay (1981) followed by Furniss v. Dawson (1984). This approach has been rejected in most commonwealth jurisdictions even in those where UK cases are generally regarded as persuasive. After two decades, there have been numerous decisions, with inconsistent approaches, and both the Revenue authorities and professional advisors remain quite unable to predict outcomes. For this reason this approach can be seen as a failure or at best only partly successful.

In the UK in 2004, the Labour government announced that it would use retrospective legislation to counteract some tax avoidance schemes, and it has subsequently done so on a few occasions.

Tax shelters

Tax shelters are investments that allow, and purport to allow, a reduction in one's income tax liability. Although things such as home ownership, pension plans, and Individual Retirement Accounts (IRAs) can be broadly considered "tax shelters", insofar as funds in them are not taxed, provided that they are held within the IRA for the required amount of time, the term "tax shelter" was originally used to describe primarily certain investments made in the form of limited partnerships, some of which were deemed by the U.S. Internal Revenue Service to be abusive.

The Internal Revenue Service and the United States Department of Justice have recently teamed up to crack down on abusive tax shelters. In 2003 the Senate's Permanent Subcommittee on Investigations held hearings about tax shelters which are entitled "U.S. TAX SHELTER INDUSTRY: THE ROLE OF ACCOUNTANTS, LAWYERS, AND FINANCIAL PROFESSIONALS". Many of these tax shelters were designed and provided by accountants at the large American accounting firms.

Examples of U.S. tax shelters include: Foreign Leveraged Investment Program (FLIP) and Offshore Portfolio Investment Strategy (OPIS). Both were devised by partners at the accounting firm, KPMG. These tax shelters were also known as "basis shifts" or "defective redemptions."

Prior to 1987, passive investors in certain limited partnerships (such as oil exploration or real estate investment ventures) were allowed to use the passive losses (if any) of the partnership (i.e., losses generated by partnership operations in which the investor took no material active part) to offset the investors' income, lowering the amount of income tax that otherwise would be owed by the investor. These partnerships could be structured so that an investor in a high tax bracket could obtain a net economic benefit from partnership-generated passive losses.

In the Tax Reform Act of 1986 the U.S. Congress introduced the limitation (under usc|26|469) on the deduction of passive losses and the use of passive activity tax credits. The 1986 Act also changed the "at risk" loss rules of usc|26|465. Coupled with the hobby loss rules (usc|26|183), the changes greatly reduced tax avoidance by taxpayers engaged in activities only to generate deductible losses.

Media Representation

" [http://www.pbs.org/wgbh/pages/frontline/shows/tax/ Tax Me if You Can] " - PBS Frontline documentary into tax avoidance

Ee also

* Bottom of the harbour tax avoidance (Australia)
* Civil disobedience
* Gary Becker
* Loophole
* Tax patent
* Stop Tax Haven Abuse Act
* Tax exile
* Tax Farming
* Tax haven
* Corporate Inversion
* Tax incidence
* Tax protester
* Tax resistance
* Underground Economy

References

Further reading

* Taxation of Foreign Domiciliaries (James Kessler QC, 5th edition, 2005, Key Haven Publications) chapter 16 discusses tax avoidance in context of UK anti-avoidance provisions.

External links

* [http://www.taxjustice.net Tax Justice Network] - research into "the negative impacts of tax avoidance, tax competition and tax havens"
* [http://aboutlawenforcement.com/tax-evasion Law Enforcement]

 

Wikimedia Foundation. 2010.

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Tax avoidance and tax evasion

Translation

Tax avoidance and tax evasion

Tax avoidance is the legal utilization of the tax regime to one's own advantage, in order to reduce the amount of tax that is payable by means that are within the law. By contrast tax evasion is the general term for efforts to not pay taxes by "illegal" means. The term tax mitigation is a synonym for "tax avoidance". Its original use was by tax advisors as an alternative to the pejorative term of tax avoidance. Latterly the term has also been used in the tax regulations of some jurisdictions to distinguish tax avoidance foreseen by the lawmakers from tax avoidance which exploits loopholes in the law.

Some of those attempting not to pay tax believe that they have discovered interpretations of the law that show that they are not subject to being taxed: these individuals and groups are sometimes called tax protesters. An unsuccessful tax protestor has been attempting openly to "evade" tax, while a successful one "avoids" tax. Tax resistance is the declared refusal to pay a tax for conscientious reasons (because the resister does not want to support the government or some of its activities). Tax resistors typically do not take the position that the tax laws are themselves illegal or do not apply to them (as tax protesters do) and they are more concerned with not paying for particular government policies that they oppose.

Tax avoidance

Tax avoidance is the legal utilization of the tax regime to one's own advantage, in order to reduce the amount of tax that is payable by means that are within the law. The United States Supreme court has stated that "The legal right of an individual to decrease the amount of what would otherwise be his taxes or altogether avoid them, by means which the law permits, cannot be doubted." See Gregory v. Helvering. Examples of tax avoidance include:

Country of residence

One way a person or company may lower their taxes due is by changing one's tax residence to a tax haven, such as Monaco or Switzerland, or by becoming a perpetual traveler; however, some countries, such as the U.S., tax their citizens, permanent residents, and companies on all their worldwide income. In these cases, taxation cannot be avoided by simply transferring assets or moving abroad.

The United States is unlike almost all other countries in that its citizens, and legal permanent residents, are subject to U.S. tax on their worldwide income even if they reside temporarily or permanently outside the United States. U.S. citizens therefore cannot avoid U.S. taxes simply by emigrating. According to "Forbes" magazine some nationals choose to give up their United States citizenship rather than be subject to the U.S. tax system; [cite web|url=http://web.archive.org/web/20060227051231/http://www.frissell.com/taxpat/FORBES1.HTM|title=The new refugees. (Americans who give up citizenship to save on taxes)|publisher=Forbes|date=1994-11-21|accessdate = 2006-12-23] however, U.S. citizens who reside (or spend long periods of time) outside the U.S. may be able to exclude some salaried income earned overseas (but not other types of income) from U.S. tax. The 2007 limit on the amount that can be excluded was US$85,700.

Double taxation

Most countries impose taxes on income earned or gains realized within that country regardless of the country of residence of the person or firm. Most countries have entered into bilateral double taxation treaties with many other countries to avoid taxing nonresidents twice -- once where the income is earned and again in the country of residence (and perhaps, for US citizens, taxed yet again in the country of citizenship) -- however, there are relatively few double-taxation treaties with countries regarded as tax havens. [There are certain well-known exceptions to this: Cyprus has a heavily exploited double taxation relief treaty with Russia; another frequently used treaty is the double taxation relief treaty between Mauritius and India. There are also a number of other less well known and less frequently utilized treaties, such as the one between the British Virgin Islands and Switzerland.] To avoid tax, it is usually not enough to simply move one's assets to a tax haven. One must also personally move to a tax haven (and, for U.S. nationals, renounce one's citizenship) to avoid tax.

Legal entities

Without changing country of residence (or, if a U.S. citizen, giving up one's citizenship), personal taxation may be legally avoided by creation of a separate legal entity to which one's property is donated. The separate legal entity is often a company, trust, or foundation. Assets are transferred to the new company or trust so that gains may be realized, or income earned, within this legal entity rather than earned by the original owner. Usually one is only personally taxed on property and earnings that one actually owns; thus, by donating assets to a separate legal entity, personal taxation can be avoided, although corporate taxes may still be applicable. If the legal entity is ever liquidated and the assets transferred back to an individual, then capital gains taxes would apply on all profits.

The company/trust/foundation may also be able to avoid corporate taxation if incorporated in an offshore jurisdiction (see offshore company, offshore trust or private foundation). Although income tax would still be due on any salary or dividend drawn from the legal entity. In order for a settlor (creator of a trust) to avoid tax there may be restrictions on the type, purpose and beneficiaries of the trust. For example, the settlor of the trust may not be allowed to be a trustee or even a beneficiary and may thus lose control of the assets transferred and/or may be unable to benefit from them.

Tax evasion

By contrast tax evasion is the general term for efforts by individuals, firms, trusts and other entities to evade taxes by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability, and includes, in particular, dishonest tax reporting (such as declaring less income, profits or gains than actually earned; or overstating deductions).

Tatistics

The difference between the amount of tax legally owed and the amount actually collected by a government is sometimes called the tax gap.

In the United States, the IRS estimated in 2007 that Americans owed $345 billion more than they paid, or about 14% of federal revenues for FY2007. [$345B tax g
http://www.npr.org/templates/story/story.php?storyId=15111003 Random Tax Audits Return to the IRS] , 9 Oct 2007, Morning Edition.
]



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