In this blog post, Saurodeep Mukhopadhyay, a student at Rajiv Gandhi National University of Law, Punjab and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, compares and contrasts between tax planning, tax avoidance and tax evasion,

Introduction

The terms tax planning, avoidance and evasion are closely connected and sometimes used interchangeably, though in legal parlance, these terms are distinct in their meaning as well as their effects. The term tax planning simply refers to structuring any business transaction, the income and the expenses, in a manner so as to incur least or no tax liability on the transaction. It is the art of reducing a person’s tax liability by utilising various provisions of law. This is perfectly legal and wise. In fact, the government promotes such tax planning since it prescribes ways of income utilization which, if used, will lead to reduced tax liability on the person employing such means. Tax avoidance is the use of loopholes in the taxation laws and conducting transactions so as to avoid tax liability or at least reduce the liability as far as possible. Tax avoidance, though perfectly legal, is not advisable since it is contrary to the intention of lawmakers and the taxation statute.

On the other hand, however, tax evasion is the act of avoiding the payment of taxes illegally or by means not specifically allowed under law. This contains in it an element of deceit or an intention to commit fraud on the State by not fulfilling the prescribed obligations of tax payment to the government. The result is that tax evasion leads to further liability on the evader and may even invite criminal liability in most jurisdictions.

Tax Planning

The concept has already been described briefly which clearly indicates that tax planning refers to the use of tax saving measures allowed by law to reduce the tax burden of a person. It is defined by the OECD as “arrangement of a person’s business and /or private affairs in order to minimize tax liability”. This may include certain investments or expenditures which have been specifically declared to be tax-exempt by the government. The idea is to conduct business transactions in a manner so as to fully utilize tax exemptions provided by law. One of the most important provisions in this regard is S.80C which exempts income invested in the form of certain PPF accounts, tax saving fixed deposits, national saving certificates (NSC), infrastructure bonds, provident fund (PF), voluntary provident fund (VPF), principal amount of home loan, life insurance premium, mutual funds, etc. Currently, investments made in the aforementioned avenues are tax exempt till the total amount of Rs.1.5 lacs per person irrespective of the tax bracket the person falls in.

The reason behind such exemptions is the government’s desire to incentivize and channel funds in certain directions. For instance, money collected through infrastructure bonds is utilized in infrastructure development in the country like in the making of roads, water lines, etc. Similarly, provident funds and national saving certificates are encouraged to increase savings of the people and maximize social welfare. These incentives also go a long way in reducing inflation by curtailing the liquid money supply in the economy. Tax planning is encouraged by the government since it not only leads to savings, but also fulfils other governmental needs. Thus, following sound tax planning measures is not only legal but also very prudent, though the limit of savings is rather low.

Tax Avoidance

This refers to the use of loopholes in the tax laws to get exemptions over and above what is legally prescribed, usually by the means of conducting transactions in a particular manner. Thus, even though tax avoidance lowers the tax liability, it is not against the law. Justice Reddy, thus, succinctly put forward that tax avoidance is the “art of dodging tax without breaking the law”.

The Organisation for Economic Cooperation and Development states that it is- “an arrangement of taxpayer’s affairs that is intended to reduce his liability and that although the arrangement could be strictly legal is usually in contradiction with the intention of law it purports to follow.” For example, the S.80C of the Income Tax Act, 1961 prescribes several tax exempt saving instruments as discussed hereinabove. However, a maximum limit of Rs.1.5 lacs is prescribed to the benefits of such investments. Nevertheless, a person may transfer some money to his non-earning wife or minor child and invest in the S.80C prescribed instruments on their behalf. The transfer to such relations is free from gift tax and this effectively allows the person to seek exemption of taxes to the total extent of Rs. 4.5 lacs as compared to the individual limit of Rs.1.5 lacs. One may also transfer a part of their income to their adult children who are not yet earning and claim a further tax exemption for Rs.2.5 lacs since every person, upon reaching 18 years of age, is treated as a separate individual for taxation purposes.  Similarly, one may transfer money to their parents who are not earning and enjoy a tax exemption upto Rs.2.5 lacs per parent if they are below 60 years of age, upto Rs. 3 lacs in case the parents are above 60 years of age, and upto Rs.5 lacs in case the parents are above 80 years of age. The clubbing rules do not apply to parents and there is no gift tax in case of money transfers to parents. Another common way of tax exemption is taking of loans from relatives and friends since gift tax does not apply on the same and the loan may be paid back with a nominal interest rate. Another common means through which corporate giants generally avoid tax liabilities, especially from capital transfers is by routing their investments through shell companies incorporated in countries with favourable tax laws, also known as tax havens. Though the Government enters into several tax treaties with countries to prevent the exploitation of this loophole, the practice is still widely popular.

Thus, there are several ways to exploit the loopholes of the laws to achieve maximum tax benefits and this is what tax avoidance is all about. However, unlike tax planning, tax avoidance is not supported or intended by the government and thus, the laws are regularly rectified through the yearly-finance acts presented with the budget in the parliament. One of the biggest proposed changes in the law to rein in tax avoidance was the General Anti-Avoidance Rules (GAAR) proposed in 2010 along with the Direct Tax Code, 2010 by the then Finance Minister, Pranab Mukherjee. This set of regulations was directed specifically at tax avoidance transactions and significantly restricted the means available to avoid taxation. One of the most controversial aspects of the same was that it sought to tax overseas transactions retrospectively. However, the implementation of the rules remains suspended currently and in 2015, the Finance Minister announced that it would continue to remain suspended for at least 2 more years. Recently, the Income –Tax Rules have been amended to clear the uncertainty over the implementation and implications of GAAR and it has been clarified that it will not apply to Foreign Institutional Investors (FIIs) with respect to income from investment transfers before 1st April, 2017. Thus, to make use of tax avoidance methods, one must be very careful since there is a very thin line between tax avoidance and tax evasion.

Tax Evasion

The term Tax Evasion is usually used to mean any illegal arrangement where tax liability is hidden or ignores, i.e., the tax payer knowingly pays less tax than what he is legally obligated to pay, either by hiding income or information from tax authorities or by simply not paying the requisite taxes to the authorities within stipulated time. The OECD defines it as “A term that is difficult to define but which is generally used to mean illegal arrangements where liability to tax is hidden or ignored, i.e. the taxpayer pays less tax than he is legally obligated to pay by hiding income or information from the tax authorities.”

Thus, it refers to the reduction of tax liability by illegal or fraudulent means. In case of tax evasion, there generally exists an intention, or a presumed intention, on part of the taxpayer to not pay the requisite taxes. The Indian tax system is based on voluntary disclosure and compliance and as such, the simplest way of tax evasion is simply not paying the taxes as per the law within the due date of payment of obligations. Many people get away with this since it is not possible for tax authorities to scrutinize every earning individual in the country. Other means include-

• Submitting false tax returns: This refers to misrepresenting facts or submitting false information in the tax returns filed to the authorities to lessen the tax burden.
• Inaccurate financial statements: The taxes that are payable by an individual or an organisation may be decided on the financial dealing that have taken place during the assessment year. If false financial documents or accounts books are submitted, ones that show incomes less than what was actually earned, the tax liability may be considerably lowered.

• Using fake documents to claim exemption: The government often provides certain exemptions or privileges to certain strata of society or persons of a specific category to give these persons financial benefits or freedom. This may include senior citizens, socially backward communities, etc. However, persons who do not qualify for such privileges or tax exemptions often produce false documents to this regard and claim the exemptions, which is for all means and purposes, tax evasion.

• Not reporting true income: This is, perhaps, the most common way of evading taxes in India wherein individuals do not disclose their true income to the tax authority during a financial year. For instance, a seller may be able to sell goods worth Rs.50 lacs in a year while showing that he sold goods worth only Rs.30 lacs. Similarly, the owner of an apartment or some other immovable property may give out his property on rent without informing the same to the authorities and in this way, the entire income from rent is kept under wraps and tax liability does not accrue.
• Smuggling: Certain taxes or charges accrue when goods or services cross international or state borders. These taxes are often hefty and significantly raise the market prices of the goods. Thus, evading these taxes by means of smuggling the goods into the requisite territory becomes a lucrative way of transporting goods without paying taxes for the same.

The above is merely an illustrative list of common ways in which taxes are evaded and are not nearly comprehensive. However, despite the various ways in which taxes may be evaded, one of the most distinctive features of tax evasion is that it invites penalties on persons found to be indulging in such evasion. The penalty ranges from taxing in the range 100%-300% on income not disclosed as per law as well as penalties and fines due to late filing of tax returns. In case a person or a company fails to follow the various provisions of the statutes, for example, failing to maintain accounts as per S.44AA, Income Tax Act, 1961, the penalty which may be levied may be up to Rs. 25000. If a company fails to get itself audited or fails to provide a report of the said audit, a penalty of up to Rs. 1.5 lakhs or 0.5% of the sales turnover, whichever is lesser, may be charged.

Summary Comparison

The distinction between tax planning, avoidance and evasion has been a long discussed topic in the field of taxation law and one of the foremost Indian case in which the discussion was taken up was in the landmark case of McDowell & Co. Ltd. v. Commercial Tax Officer, wherein Justice Reddy stated- “Much legal sophistry and judicial exposition, both in England and India, have gone into the attempt to differentiate the concepts of tax evasion and avoidance and to discover the invisible line supposed to exist which distinguishes one from the other.” The distinction between the two arose in the early 20th Century England where the perception arose that tax avoidance was legitimate since it did not expressly violate a law even though it may have been the exploitation of a lacunae in law. However, as it was observed by the SC in the aforementioned case, the distinction between the two began to waiver as tax avoidance led to widespread profiteering and fall of government revenue. Currently, the stance is that tax avoidance is as bad as tax evasion, though penalties may not be prescribed yet for the same. However, as has been discussed, GAAR has been adopted by several countries and India too is all set to adopt the regulations so as to prohibit transactions with the sole purpose of avoiding tax liabilities. Tax planning on the other hand, refers to the use of tax saving avenues like investments in provident funds, national saving certificates, etc. which are specifically exempt from taxation by law.

It may be concluded that while the object of all the three is the same, i.e. to reduce the liability of taxes on a person, the three are distinguished based on the means they entail. The methods involved in tax planning are sanctioned by law and the actions taken are not only envisaged by law but supported by it. On the other hand, tax avoidance implies the exploitation of the loopholes in the laws so as to reap benefits which were not intended by the law. Finally, tax evasion refers to the illegal actions to reduce tax burden which invite stringent legal penalties and punishment. Out of the three, tax evasion is the only means which is illegal though tax avoidance rules to prevent common means of tax avoidance are in the pipeline and upon their implementation, the fine line between evasion and avoidance will further disappear into ambiguity.