First we will define the concept of tax avoidance and tax evasion. There is no uuniversally accepted definitions of tax avoidance and tax evasion. HMRC define tax avoidance as an activity that a person or a business may undertake to reduce their tax in a way that runs counter to the spirit and the purpose of the law, without being strictly illegal. The HMRC has defined a set of �signposts" which include e.g. �transactions or arrangements which have little or no 'economic' substance or which have tax consequences not commensurate with the change in a taxpayer's (or a group of related taxpayers') economic position"7. Tax evasion, in contrast, is usually defined as a violation of the law (see also Slemrod and Yitzaki, 2002). Tax avoidance is the utilization of the loopholes in the countries tax laws to one's own advantage, while tax evasion is not paying the taxes al together. While tax avoidance is within the legal framework of the countries law tax evasion is illegal. Now we will get into more detailed definitions of tax evasion and avoidance.
Tax avoidance is the utilization of the legal loopholes or the legal privileges provided to citizen or company of a country by its government. Tax avoidance is the legal right of an individual provided by the government to reduce the tax burden and decrease the level of tax evasion. Some of the examples of tax evasions are:
One of the ways utilized by an individual or a company to lower the tax burden is by constantly travelling to different countries or by shifting permanently to a country with lower or no tax environment. Such a country is called tax havens. The policy adopted in this case is that an individual or a company shifts its asset or base of operation to tax havens thus avoiding higher taxes. But now many countries such as USA have realized the potential loss of revenue through such a practice of tax avoidance. Hence these countries are now taxing all their citizens and companies on all income generated by them throughout the world.
Double taxation is a policy where in an individual or a company is taxed by the country of its residence and by country of its origin. Most countries impose taxes on income earned or gains realized within that country regardless of the country of residence of the person or firm. Although many countries have entered into bilateral double taxation treaty. In this treaty an individual or a company once taxed by one country is not again taxed by another country. Though, this kind of treaty is rarely done with tax havens.
Another general practice adopted by individuals for tax avoidance is to create a separate legal entity. The separate legal entity is often company, trust, society, NGO or foundation. Under this practice an individual transfer his property and his assets to these legal entities so that the income earned is transferred to this legal entity. 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.
Transfer pricing is simply the act of pricing of goods and services or intangibles when the same is given for use or consumption to a related party (e.g. Subsidiary) There can be either Market-based, i.e. equivalent to what is being charged in the outside market for similar goods, or it can be non-market based. Importantly, two-thirds of the managers say their transfer pricing is non-market based. There can be internal and external reasons for transfer pricing. Internal include motivating managers and monitoring performance, e.g. by putting a cost to imported inputs. External would be taxes and tariffs.
Tax evasion is a general term often used in cases where in an individual or a company evades taxes all together. Here in this case an individual or a company deliberately conceals his or her income from the tax authorities to reduce the tax liability or not to pay taxes all together. Various forms of tax evasion are:
This is the most common form of tax evasion practiced by individuals. Under this form of tax evasion an individual would not declare all his income to the tax officials. Sometime an individual may be working at more than one places and hence has more than one source of income, he may choose not to disclose all the income. This is generally possible only if the extra income he generates comes in form of cash and does not show on the system.
Customs duties are an important source of revenue for any country. In this case the importers avoid paying of custom duty by either under pricing the products that are brought in the country or by understating the quantity of the goods brought in the country.
It is a practice where in an individual do not pay any kind of custom duty on the product that is being brought in or being taken out of the country, it is a criminal offence in most countries.
Under this an individual or a company may evade paying Value added Taxes or sales tax by underreporting the sales of the good.
While the term �Tax evasion and Avoidance" was well established in USA by 1920's (Sears, 1922), in UK there was still no distinction between Tax avoidance and tax evasion by as late as 1950. Till that time the term evasion was regularly used in the sense of avoidance. The official terminology and distinction between avoidance and evasion was established in a case between Craven vs White in 1970. Further in this field a new term was coined tax mitigation. Tax mitigation is a process through which individual tax liabilities are reduced without tax avoidance. Now tax avoidance was redefined as a process which designed to defeat the intention of the parliament. (IRC vs Willoughby, 70 TC 57.) Tax mitigation would include activities like gifts to charity, donations, investment in products designed for tax benefits. These activities are in the spirit of the law.
UK has traditionally attracted a higher level of foreign direct investments, mainly because of its lower corporate taxation and financial stability, this has attracted the envy of other European Union members. The only option EU states have is to go for tax parity with UK or for tax harmonization. The Single Market gives the European Court of Justice the means to, and EMU will, end the UK's autonomy in company tax matters. One member of the influential Ruding Committee which investigated company taxation in the EU in 1992, noted that 'There was no doubt in the ... Committee that a common currency requires at least minimum harmonisation of direct taxation'. The result is that other countries will increasingly be able to decide Britain's tax strategy especially if the UK joins EMU. Any of EMU's economic benefits (no exchange rates, lower interest rates) would be cancelled by the significant increase in UK corporation tax to match the continental average of 43.8% (weighted to take account of population). Whereas recent UK tax policy has lightened the burden and encouraged investment, continental taxes have risen (by the EU's own calculation, 35% � 42% of GDP 1981- 1995 � see Figures 1 & 2). Harmonisation of EU member states' tax rates would mean higher taxes for the UK, since other states are unable or unwilling to reduce the tax burden on their voters (Figure 4) and institutional developments inside EMU would end the need for unanimity among European Union members over tax matters.
Although not a new issue, tax harmonisation has suddenly hit the news. The Austrians, who hold the EU Presidency until January 1999, immediately declared that harmonisation of corporation tax was an important item on their agenda. Several European countries, notably France, Germany and Belgium have expressed concerns that no action has been taken. But late in 1997 the UK along with other EU states, signed a code of conduct pledging action on 'harmful tax competition'. The following day, Jean-Claude Juncker, leader of the European Parliament, announced that he expected the harmonisation of EU business taxes 'within two years'. In March 1998, the European Commission proposed a directive to standardise tax on royalties and interest payments made between related companies operating in different member states.
By early summer, the Commission announced plans for an EU-wide 20% withholding tax on savings. This tax, designed to ensure that all investments in the EU are taxed, immediately attracted criticism, with several banking associations in the UK claiming that it would destroy the profitable Eurobond market by driving savers away from Europe in general and London in particular. In particular, the measure seemed to blur the significant distinction between illegal tax evasion and legitimate tax avoidance, in line with Article L of the 1997 code of conduct which lumped evasion and avoidance together. On 26th September, the Commission announced that harmonisation of the withholding tax on savings should be achieved by the end of June 1999 at the latest. Direct tax harmonisation involves standardising income and company taxation across the whole European Union. On Day One of the Austrian Presidency, Austria's finance minister, Rudolf Edlinger, summarised the issue simply: 'If the EU established minimum taxes, the countries where the level is lower than that will have to raise them. That is a problem' (Electronic Telegraph 2nd July 1998). An effort to set an EU business tax rate would constitute an attempt to change the political philosophy of many national governments, especially in the UK. Harmonising tax in the EU would therefore involve the knotty problem of bridging the considerable gap between 'Anglo-Saxon' and 'continental' beliefs of the role of the state in society.
1. (1988) 62 TC 1 at 197.
2. Minimising Taxes, Sears, 1922, Vernon Law Book Co.
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