Taxonomy: Avoidance, Fraud and Evasion

The terms “tax avoidance” and “tax evasion” are frequently used.  Often, it seems, these terms are ill-defined, which may arise due to deliberate stretching or distortion to support a particular view. When  terms used in debate are not agreed by the parties  more heat than light is often generated. Clarity, I suggest,  is a  necessary although not sufficient condition for resolution in matters of controversy such as with tax,  I propose the following taxonomy, which I believe offers clarity,  be used so as to assist future discourse in these matters.

Tax avoidance

I suggest this term should refer to cases where UK tax legislation deliberately and explicit provides choices to a tax payer over the allowances/reliefs they can claim. For example, provided certain conditions prevail, a landlord may elect for Rent A Room Relief in preference to the normal basis for assessing taxable rental income.  A landlord is at liberty to compute which basis will result in a lower tax liability and to make their choice accordingly. This is obviously legal because the legislation explicitly offers this choice. Explicit choices over which allowances/reliefs to claim  are offered frequently in UK tax legislation. A rational taxpayer (or more commonly their accountant) will opt for the allowances/ reliefs that deliver the smaller /smallest tax liability.

Tax fraud

I suggest this term is used in cases where taxable transactions are deliberately not reported to the tax authorities  so as to avoid liability to tax,  that is, there is deception. Tax fraud would include plumbers doing “cash jobs” and their like although tax frauds can be much more sophisticated. Tax fraud requires deception and is a criminal offence.

Tax evasion

I suggest this term is used for schemes that are designed by taxpayers and/or their agents to reduce tax liabilities.  These schemes may not depend on deception in which case they should be distinguished from tax fraud. Rather, tax evasion seeks to outwit HMRC whilst simultaneously complying with tax legislation.

Tax evasion may work by transforming a transaction from one form to another, eg from taxable income into a non-taxable loan. Or it may involve transfer pricing, whereby a subsidiary in a high tax jurisdiction is invoiced by its parent company for services provided by the parent. Under such a scheme, the parent company will be located in a low tax jurisdiction.  Such an arrangement has the effect of transferring taxable profits from the subsidiary’s high tax jurisdiction to the parent’s  low tax jurisdiction. In this way, the group’s overall tax liability is reduced.

I suggest that tax evasion should be the term reserved for cases which do not involve criminal deception. However, although a tax evasion scheme may not depend on criminal deception, that scheme  may still be unlawful,  depending on its design. In contrast some tax evasion schemes may be lawful. A tax evasion scheme, assuming HMRC has the  ability to investigate, may be declared unlawful, that is, not compliant with UK tax legislation, even though not  criminal.

Conclusion

The above taxonomy seeks to promote a more constructive discourse by proposing clarity in the terms to which the various phenomena are referred and understood. Some of these terms, I suggest, have become muddled (perhaps deliberately?) and this often generates more heat than light. For example, the term “tax evasion” is commonly used to refer to all illegal tax reduction schemes, with the implication that such scheme are  fraudulent. I propose this should not be the case. Instead, I propose the term “tax evasion” should refer to schemes

  1. which are constructed by private sector agents; and
  2. which transform transactions from one form to another or depend on artificial transactions; and
  3. which are constructed solely so  as to reduce a liability to tax; and
  4.  which purport, or are designed, to be compliant with legislation, and
  5. which may or not be compliant with legislation; and
  6. which do not depend on deception for their success.

In other words, the term  tax evasion should not be used as a blanket term for illegal activity and unlawful schemes.

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