Tax Avoidance, Tax Evasion and Tax Planning  

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What is the difference?

All three refer to forms of tax motivated behaviours. A simple answer may indicate that tax avoidance and tax planning are legal, whilst tax evasion is against the law. This however, only skims the surface, as can be seen by a few examples.

1. Tax Evasion

Let's start with an easy one. If I have taxable income, which I knowingly have not paid tax on, but deliberately omit from my tax return (or fail to tell HMRC about if they have not required a return), then I have evaded my legal duty to pay tax on the income. This is a criminal offence therefore - yep you guessed it - an example of tax evasion.

2. Tax Planning

At the other end of the tax motivated behavioural spectrum, one may argue that investing in an ISA is a form of tax avoidance - a somewhat disingenuous proposition. It is worth noting that ISA’s are designed to encourage saving and investment and, in order to make the tax saving, it is necessary to take part in the encouraged behaviour – i.e. saving or investing. Therefore, this would be classified as tax planning. That is, appropriately utilising the opportunities that are intentionally provided in the tax system to reduce one's overall tax.

3. Tax Avoidance

Tax avoidance may be said to fill the gap between tax planning and tax evasion, and covers a wide range of behaviours. It has been defined as arranging one’s affairs or transactions in such a way as to pay less tax than is intended by parliament [1], whilst attempting to remain within the letter of the law. So what does this mean?

Following the banking crisis in 2008, bank debt traded at significantly under face value. This gave some banks the opportunity to realise a real profit by buying their own debt at undervalue – a good opportunity if the market was willing to sell it to them. The profit on this transaction represented a real economic profit and was, of course, chargeable to corporation tax. However, several banks sought to circumvent the tax charge by buying back their debt through other related companies that had claimed relief for a loss in value and thereby not to recognise any taxable profit. This was clearly not within parliament’s overall intention to offer relief on losses. However, the initial schemes were successful. Following this, the Government (1997-2010) legislated to prevent further instances of this happening and announced that if the legislation was successfully circumvented, retroactive changes to stop this would be implemented. It was alleged by the financial press that Barclays Bank [2] found a way to circumvent this legislation and the then Government of the day (2010-15) followed up on the promise or threat of the earlier Government to use retroactive legislation to nullify the tax advantage.

Another scheme, with more than one promoter, allowed investors to obtain and then reclaim tax credits on income on which no tax had been paid. It is clear that parliament did not intend for the exchequer in this case to ‘repay’ tax it had never received.

These are what HMRC, and no doubt the mythical ‘reasonable observer’, would regard as clear and egregious examples of tax avoidance. The press and public response at the time tended to support this view although the technicalities were somewhat lost in much of the press coverage.

The action of the avoiders in these cases has been defended by those taking the view that the taxpayer is entitled to make what arrangements they like so long as these are not in breach of the letter of the law.

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Is avoidance defensible?

There is however a common view on morality (or ‘the spirit of the law’) outside tax that could be expressed as it being immoral to take advantage of a weaker party. This is expressed in such legislation as the Unfair Contract Terms Act. In most cases of disputes between states and taxpayers, one would consider the taxpayer to be the weaker party, but this is not necessarily the case with large corporate taxpayers.

It is also said by some that “tax is a matter of the black letter of the law” which amounts to a claim that there is no morality in tax – only law. This view is essentially based on the idea that all tax is essentially a form of confiscation of assets by the state – akin to nationalisation without compensation. This view, however, ignores the undeniable fact that we all depend on the state to provide certain services, without which society and the economy as we know it could not exist – the most basic of these being the maintenance a system of law and justice independent of private or commercial interests.

A better view is that of U.S. Supreme Court justice, Oliver Wendell Holmes Jr. (1841 – 1935) who stated in one of his judgements that “Taxes are what we pay for civilised society”. On this basis, the citizen has a duty to pay tax and that duty has a deeper foundation than simply that the state has demanded it through its legislation (although that does not negate the possibility that a particular tax may be unfair or unjust).

This would suggest that avoidance such as that described above where the clear and, we will assume, just and reasonable, intention of the legislators is being circumvented is unacceptable or even immoral.

So we can consider that tax planning is the legitimate use of the tax legislation to gain advantages that are intentionally offered through the tax system and that tax avoidance is the illegitimate use of the system to gain unintended advantages, whilst tax evasion involves operating outside of the legal tax system altogether.

It is reasonably easy then, to identify planning as a legitimate (even laudable) activity and evasion as crime, but avoidance may to some appear to be a grey area in between, although this writer considers much of it tends rather more to the dark grey.

In practice, the situation is complicated further as the boundaries between tax evasion and tax avoidance and between tax avoidance and tax planning can be extremely difficult to define.

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Avoidance or evasion?

Consider a situation where it is considered by the person entering into a transaction or a series of transactions that there will be a particular tax result. However, the person knows that the relevant tax authority does not agree with that view, that is, the taxpayer and the tax authority take a different view as to the effect of relevant law. In the event that the tax authority is later found to be correct by the courts, remembering that a court decision does not create law but states what, in the view of the court, the law is, then can we conclude that the person was always guilty of tax evasion?

Clearly not on this basis alone, or there would be no room for honest disagreement with the views of the tax authority, whose views are not the ultimate determinant of the law.

Equally, if the tax authority loses litigation, this in no way vindicates the behaviour of the person. All that has been decided is that the legislation gives the tax result for which they contended. It remains possible that the transactions were artfully, and in the case in question, successfully, designed to produce a result quite contrary to that which parliament, or possibly even any reasonable person, would have intended, but that parliament simply got the legislation wrong or even just failed to foresee the particular circumstances now considered, possibly many years later.

The courts are not moral arbiters but will, in a case where legislation is unclear, attempt to interpret legislation in a purposive manner, that is in a manner consistent with the end it was originally intended by parliament to achieve.

The courts may also interpret a person’s behaviour in a purposive manner, if that is open to them. For example if a simple transaction would have achieved a commercial end, but the same end has been achieved by a (possibly circular) string of transactions, where some of the transactions appear to the court to have no other purpose than to gain a tax advantage, then the court may take the view that the ‘real’ transaction is the obvious one and that all others should be ignored [3]. In such a case each of the steps are legal and effective in themselves but, taken as a whole, all that has been achieved is (say) the sale of an asset in exchange for cash and the tax consequences should therefore be the same as if the ‘simple’ transaction had been carried out.

Typically in such a case, whilst the courts may find in the tax authority’s favour, there will be no suggestion of evasion because the case will not be clear cut and the taxpayer will have given full information to the Revenue. So then this becomes unsuccessful avoidance.

It has been noted on many such similar occasions however, that the taxpayer (or should we say non-taxpayer) fails to disclose all details to the Revenue and, initially at least, argues for an interpretation of events that could not be supported by a reasonable person knowing all the circumstances. That is, their case for the position that they argue depends on the Revenue (and possibly later the courts) having incomplete knowledge of the facts. Any claim that this fact pattern amounted to avoidance and not to evasion would be difficult to sustain.

Evasion typically requires false, misleading, or incomplete information to be provided to the tax authority or the simple lack of reporting, when there was obligation to report.  

In practice, some avoiders, knowing that the tax authority may disagree with their view of the legal outcome, may devise a scheme which might be held reasonably within the law, yet also deny the tax authority full knowledge of the facts. Effectively this is a delaying tactic and if deployed with the purpose of enabling the taxpayer to place profits out of reach before the issue is finally resolved, would also amount to evasion. Alternatively, the purposeful concealment of facts may be to utilise the scheme for as long as possible, before Parliament legislates its prevention. In any case where a reasonable taxpayer would expect that Parliament would legislate against it as soon as discovered is clearly an attempt to frustrate Parliament and could be reasonably regarded as extremely egregious avoidance.

What if the avoidance scheme works but the argument is obviously weak? This becomes increasingly complex still. An avoider may use initial incomplete disclosure and misleading information in an attempt to persuade the tax authority of the legality of the scheme and, if this fails, eventually concede the case, once the full facts are clear to both sides. There is a strong argument that this too constitutes attempted evasion as the avoider (or their adviser) always knew the full facts and cannot produce a reasonable case that the full facts as eventually disclosed have the originally alleged tax consequences.

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Avoidance or tax planning?

It is implied above that avoidance may be regarded as immoral even where legal. Whether one accepts this view or not, ‘tax planning’ or ‘legitimate tax planning’ is often used as a term for an arrangement of financial affairs that, whilst giving a better tax outcome than other possible financial arrangements, is understood and accepted by the tax authority to be not only effective in law, but within the intention of the law.

This is fine in circumstances where it is clear what was intended by the law and indeed can be very helpful to a taxpayer where the policy intention of legislation has been clearly stated in advance of enactment by government (so that Parliament must be presumed to have been aware and in agreement with it in allowing legislation to pass) and the taxpayer’s actions are in line with the policy but the drafting of the legislation leaves it unclear whether the tax outcome is what the taxpayer and parliament intended.  However, if the intention of Parliament was indeed that simple to divine, then the parliamentary drafters would probably have got it clear in the plain words of the legislation to start with!

What it is hoped is clear from the discussion above, is that any attempt, even though it be judged by the courts to be successful, to circumvent the intention of Parliament, perhaps by the use of legislation not originally considered or intended to be relevant to the circumstances, is at least in the category of behaviour known as avoidance.

Where the taxpayer considers that arrangements would be intended by parliament to have the tax result planned by the investor; or at the least would not have a result not intended by parliament then the taxpayer has concluded that the arrangements are legitimate tax planning. If HMRC does not agree but finds that it has to accept that the legislation allows the arrangements in question then the legality is determined by the courts, but the ethics of the arrangements in question have not been settled (or even considered) by the courts, and there remains room for moral disagreement which the law cannot settle.

Of course, an honest taxpayer should at least be willing to disclose all facts and arrangements to HMRC in any situation where there may be any doubt.

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An afterthought – the effect of the General Anti-Abuse Rule (GAAR)

Arguably in a case where it is clear that parliament has already attempted to stop what it sees as abuse of, for example, a tax incentive and a taxpayer finds a flaw in the legislation – that is the policy intent is clear but the legislation is not despite the best efforts of the drafter then, then there is no doubt about the morality and possible doubt only about the legality.

This is where the general anti-abuse rule, that is now incorporated into tax law, may be relevant but only as far as to transform behaviour that falls clearly and without doubt in to the avoidance category (rather than into ‘legitimate tax planning’) into behaviour that is effectively treated as attempted tax evasion.

The rule should never have the effect of re-labelling behaviour that could reasonably be considered as legitimate tax planning into either avoidance or evasion even if it is successfully challenged by the tax authority.

(The UK anti-abuse rule should not be confused with the General Anti-Avoidance Rules that have been introduced in Canada, Australia and now some other jurisdictions which have wider scope than the UK GAAR.)