- Tax avoidance is defined as legal measures to use the tax regime to find ways to pay the lowest rate of tax, e.g putting savings in the name of your partner to take advantage of their lower tax band.
- Tax evasion is taking illegal steps to avoid paying tax, e.g. not declaring income to the taxman.
In legal terms, there is a big difference between tax avoidance and tax evasion. In practice, the outcome of reducing tax bill may be similar, but tax evasion could lead to penalties under the law.
Some forms of tax avoidance are considered to be morally dubious and can lead celebrities to suffer bad publicity – even if they didn’t break the law.
Examples of tax avoidance could be
- Setting up residence in a country with low-income tax rates. In some countries like America, this may involve giving up their American citizenship.
- Putting assets in your wife’s name so she can pay a lower rate of income tax.
- Setting up a company and pay dividends rather than income to avoid paying national insurance.
- Giving assets to your children before you die to avoid paying inheritance tax.
- Setting up a company in a minor principality, such as Luxembourg to take advantage of lower corporation tax rates. Though, this becomes a blurred line between tax avoidance and tax evasion.
Tax evasion could be
- Hiding income from the taxman
- Over claiming expenses.
- Declaring bankruptcy and restarting company under a different name.
Al Capone was tried for tax evasion because his earnings from gambling and alcohol were not submitted to the taxman.
Tax avoidance and inequality
Often it is high-income earners who are most likely to take part in tax evasion or tax avoidance schemes. They have a greater income to make it worthwhile and also the income to pay tax advisers.
A consequence of tax evasion and tax avoidance schemes is that governments collect less tax revenue than expected leading to a shortfall in tax revenue. This is often particularly a problem for developing countries with poor tax infrastructure.