What is the difference between tax avoidance and tax evasion ?

tax avoidance and tax evasion

Have you ever wondered what is the difference between tax avoidance and tax evasion ? Have you ever wondered what you can do to minimise the tax you owe HMRC without actually committing a felony and getting fined ?

Every business owner must know the difference between tax avoidance and tax evasion, as it literally makes the difference between being on the good side of the law or on the bad side of it.

It is important to distinguish between tax avoidance, which is legal, and tax evasion, which is illegal. Tax avoidance is legal because it involves using legitimate tax rules and allowances to minimize the amount of tax that is due, thus maximize your profits. This could include investing in ISA, so that any interest received is tax free.

What is tax planning ?

Tax planning involves looking at an individual’s or a company’s financial planning from a tax perspective. The purpose of tax planning is to see how to accomplish all the elements of the financial plan in the most tax-efficient manner, and so minimise tax. Tax planning should only involve legal and ethical methods of minimising the tax liability.

Tax planning plays an important part in the finances of every business and this is why as business owner it is imperative to know the difference between tax avoidance and tax evasion.

What is tax evasion ?

Tax evasion though involves using illegal methods to escape paying the correct amount of tax. Examples would include:

(i) entering false information in a tax return, (ii) failing to notify HMRC about a taxable source of income on which tax has not been paid,

(iii) importing goods VAT-free, selling them to customers with added VAT, then failing to report VAT charged to HMRC,

(iv) diverting to other uses instead of the claimed purpose the funds claimed from HMRC through tax-allowable expenditure claims 

(v) filing non-existent expenditure or personal expenditure 

(vi) failing to declare imported goods or dishonestly understating the value of imported goods in order to evade import duties

(vii) avoiding a traceable record of a trading transaction in order to avoid paying tax on income or gain

(viii) assuming the identity of someone else to carry out taxable transactions in their name, retaining the proceeds and then disappearing.

HMRC states that where a scheme relies on concealment, pretence, non-disclosure and misrepresentation of the true facts, then this is illegal and falls under the category of tax evasion.

Needless to say, those who carry out tax evasion risk criminal prosecution.

In general, anyone who suspects that tax evasion is being carried out is advised to report this to HMRC. This can be done anonymously. HMRC advises the person reporting not to attempt to discover any more information about the suspected tax evasion, and not to tell anyone else. Before proceeding to advise HMRC about suspicious business practice, make sure you know the difference between tax avoidance and tax evasion.

The UK Government is in the process of turning tax evasion from a small crime into a serious crime that attracts severe civil and criminal measures.

What Are The Penalties For Tax Evasion in the UK?

Tax evasion can result in heavy fines. The maximum penalty for tax evasion in the UK can even result in jail time. Punishment and the average tax evasion sentence can vary – these are a few examples of penalties that can be incurred:

  • Income tax evasion penalties: summary conviction is 6 months in jail or a fine up to £5,000. The maximum penalty for income tax evasion in the UK is 7 years in prison or an unlimited fine.
  • Evasion of VAT: in the magistrate’s court, the maximum sentence is 6 months in jail or a fine of up to £20,000. Crown Court cases can be a maximum of 7 years in prison or an unlimited fine.
  • Cheating public revenue: due to the serious nature of the crime, the maximum sentence is life in prison or an unlimited fine.
  • Providing false documentation to HMRC: either magistrates’ court or as a summary conviction, HMRC tax evasion penalties can range from a fine of up to £20,000 or up to 6 months in prison.
  • Evasion of duty (more commonly known as smuggling): for a summary conviction the maximum UK sentence is a fine of up to £20,000. Crown Court cases can be a maximum of 7 years in prison or an unlimited fine.

It is always good to know what good business practice is and what the penalties are for various types of tax related felonies that are prosecuted by law in the UK.

How about the tax avoidance schemes?

While tax avoidance and tax evasion may appear to be easily distinguishable at each end of the scale, there will always be situations that may not be so clear cut. In particular, some “tax avoidance schemes” that have been developed may not be legal.

These are normally  “too good to be true” and often end up costing the tax-avoider more in the long run, as well as potentially being found guilty of tax evasion by HMRC, which is a criminal offence.

The government has developed various ways that they hope to prevent so-called “aggressive” tax avoidance schemes. Tax avoidance schemes need to be disclosed to HMRC, who will then investigate the schemes to ensure that they are legal.

HMRC states that using a tax avoidance scheme marks the business out as a high-risk tax payer, and that this in its turn will lead to closer scrutiny of all their tax affairs, not just those involving the tax avoidance scheme.

Legislation was introduced in 2013 to outlaw some schemes that were deemed to be “abusive”. This legislation is known as the General Anti-Abuse Rule (GAAR). It is based on the rejection of the old approach taken by the courts that taxpayers are free to use their ingenuity to reduce their tax bills by any lawful means, however contrived those means might be.

In broad terms, the GAAR outlaws action taken by a taxpayer to achieve a favourable tax result  that Parliament did not anticipate when it introduced the tax rules in question, where that course of action cannot “reasonably regarded as reasonable”.

This “double reasonableness test” sets a high threshold for HMRC to prove that an arrangement is abusive and therefore illegal. HMRC has a system in place to determine which tax avoidance practices should be deemed aggressive as they are perceived as downright unethical because they rely on taxpayers not paying their fair share of tax.

The key to using legal tax avoidance measures is to only use tax rules in the way that they were originally intended by Parliament. Therefore the use of ISAs to avoid paying tax on savings interest is entirely proper, since it is in line with the original intention of the legislation.

What should I do as business owner?

The take away lesson is that the difference between tax avoidance and tax evasion ultimately comes down to legality.

As the law has it at the moment in the UK, simply avoiding tax is perfectly legal, however crossing the line into evading tax is a felony and results in costly fines as well as prosecution. Since it is very easy for tax avoidance to turn into tax evasion, it is dangerous to the taxpayer to step into this minefield.  

An accountant’s greatest duty of care is to the client, however the accountant must always act within the law.

Through wise tax planning, an accountant looks at a business’s financial planning from a tax perspective. The purpose of tax planning is to see how to accomplish all the other elements of the financial plan in the most tax-efficient manner, and in this way minimise the tax due to HMRC.

Of course, tax planning must involve only legal and ethical methods of minimising the tax liability. It cannot be stressed enough that it is very important as business owner to know the difference between tax avoidance and tax evasion.

How can LAS Accounting Ltd help you?

When it comes to navigating complex accounting areas such as taxes, you may find you want professional help. Spending less on tax means you have got more money to put towards your financial goals, and a financial adviser could help you put together a plan.

Now might be the ideal time to engage the services of an accountant to do all the work for you and provide you with all the tax advice you need.

Don’t hesitate to get in touch for any further enquiries at: info@las-accounting.co.uk

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