Terry Baucher on the fine line between tax avoidance and evasion and the harsh consequences separating the two.

Terry Baucher on the fine line between tax avoidance and evasion and the harsh consequences separating the two.

By Terry Baucher*

“Carter evades the onrushing Habana, passes to Gear who avoids a couple of Boks…”  In ordinary use “avoid” and “evade” are interchangeable.   In the tax world, however, there is a very clear distinction between tax avoidance and tax evasion, a point highlighted by the Minister of Revenue’s remark about “legitimate tax avoidance” in the recent 60 Minutes programme on New Zealand’s Foreign Trusts industry. 

The Minister’s remark caused some consternation even though the Prime Minister pointed out he had used “the absolutely correct technical term”.  As the Privy Council remarked in 2005 during Peterson v Commissioner of Inland Revenue “The line to be drawn between “tax evasion” and “tax avoidance” is clear enough.  The former is criminal. The latter is not.  It may be socially undesirable but is within the letter of the law”.

Similarly, the United States Internal Revenue Service, probably the most feared tax authority in the world, has a little quiz on its website explaining the distinction between tax avoidance and tax evasion which begins with the preamble “tax avoidance is perfectly legal and encouraged by the IRS, but tax evasion is against the law.”

So that’s all good then?  Not really.   Just as someone’s terrorist is someone else’s freedom fighter, so too with tax.  A person who organises his or her affairs to reduce the tax payable might be financially astute to some but reprehensible to others who feel such persons are not paying their “fair share”.  

Frankly, what represents a “fair share” of tax is impossible to define.  For anyone who is not taxed solely through PAYE the amount of tax payable on his or her income can be a very moving feast.  Is it “fair” if a person claims all the deductions available or none at all?  Similarly if you are faced with two prices for an item is it “fair” if you pay the highest price or the lowest?   

This is an admittedly simplistic approach to the matter but it’s worth making because if there is one thing I can say after my years in practise,  it’s that when it comes to tax very few people share the same view about what represents “fair”.   For example, back in 1989 after the top UK tax rate dropped from 60% to 40%, I asked a client if he wanted to maximise his pension contributions so as to reduce his tax bill (a perfectly legitimate approach under UK tax law). He declined, responding that he thought 40% was fair enough.  By contrast during the last decade 39% was seen by many here in New Zealand as too high. 

So with that in mind when does acceptable tax planning become unacceptable tax avoidance?  Consider the following examples:

Angela sets up a new software design business structured in such a way that the venture’s annual income tax bill is $50,000 less than would have been otherwise payable under a different structure.

Angela’s friend Brian, who runs a similar business, is always looking for ways to minimise his tax bill so he restructures along identical lines to Angela’s and achieves annual income tax savings of $40,000.  Furthermore he and his family are now eligible for working for families tax credits worth $10,000 a year. 

Cory, a plumber, doesn’t see the need to use “expensive” accountants and advisors.  Instead he offers “discounts for cash” and then under-declares his income “saving” himself $50,000 a year in income tax and GST. 

Where do these three examples lie on the avoidance/evasion continuum? 

Cory’s is the easiest: it’s flat out tax evasion.  When the IRD catches up with him not only will he be liable for the arrears of income tax and GST together with penalties and interest, as tax evasion is a criminal offence, Cory could also face up to five years in jail if convicted.

Brian is also in trouble.  Based on last year’s Supreme Court decision in Penny and Hooper vs. Commissioner of Inland Revenue, the fact that he re-organised his affairs to minimise his tax bill means he would almost certainly fall foul of the general anti-avoidance provision in the Income Tax Act.  But this is not a criminal offence so the maximum shortfall penalty he faces is 100% of the tax avoided.  Compare this with the 150% shortfall penalty for evasion which is likely to be imposed on Cory. 

And Angela? Has she found a path between tax avoidance and tax evasion in the form of tax “avoision”? (Yes, that word really exists outside The Simpsons).  

I would reply “yes”, but my answer is not as definitive as it would have been a few years ago.   In the past decade the boundary between acceptable tax planning and tax avoidance has shifted markedly in favour of the Commissioner following court decisions such as those in Penny-Hooper and Westpac Banking Corporation.   Ultimately, the distinction between the two is in the eye of the beholder, or as she is more usually called, the Commissioner of Inland Revenue.  If the Commissioner decides that Angela’s structure represents a risk to the tax base then matters may change. 

Back in the 1970s Denis Healey, the then British Chancellor of the Exchequer remarked “The difference between tax avoidance and tax evasion is the thickness of a prison wall”.   Next time I’ll look at how far Brian is testing Healey’s dictum and also whether owning your own home could represent a form of tax avoidance. 

*Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting Ltd.

 

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

8 Comments

..let's not split hairs.  Tax avoidance is when you pay a tax consultant to arrange things...tax evasion is when you organsie things yourself...

Minor note, although similar the two words are slightly different:
 
Evade is of french origin and has in it's meaning the idea of 'getting away''; implying a contact that was made.
 
Whereas ..
 
Avoid is of anglo-french origin coming from the root 'void' which means to be empty; so more implying contact was never made that might require evasion.
 
I do love the depth and subtly of english.

"I do love the depth and subtly of english".
Are you finding the difference between "subtly" and "subtlety" (or “subtleness”) too subtle? :-)

There's many a slip 'twixt the cup and the lip.  :)

Thanks Terry - How your structured in business is very important.
The Supreme court appears to not recognise the changing dynamics of everyday life and business. Everyone is restructuring to some degree in some area of their life for nothing is stationary.  The Supreme Courts ruling in favour of the IRD has set a silly precedent which isn't allowing for established business to efficiently adapt and change.
The IRD needs to be reminded that it is business which is doing all the compliance and paying all the costs of the IRD and that the IRD never pays anyone in business for the work they have to do. The IRD is actually guilty of slavery !!! Wait for that one to be tested in Court !!!
 
One could make the analogy to a person on wages who changes jobs to a lower paid role and therefore pays less tax being labelled a tax avoider simply because they restructured themselves. Add in that the person now receives WFF simply because they took the lower paid job and you have the same situation as Brian. I bet the person on wages would never be taken to court by the IRD.
 
Overcharging taxes should be treated in the same manner as tax evasion.
If some people think there is a moral connotation attached to legally avoiding taxes perhaps these same people are using more than their fair share of publics services and are therefore having their lifestyle subsidised.
 
 
 
 
 
 

There is only one solution and it will get all the big boys like Google, Microsoft, Facebook, Apple and so on. That is scrap ALL tax deductions and just have a flat 5% tax on all income from all sources.
Bring back the treason laws and have tax evasion and tax avoidance (Both) an act of treason. After all you are ripping off the country.

So.....Terry,
Where does the IRD sit on Tax Havens and such which exist around the globe for all the super rich to hide cash and assets? Or is it just one of those "too hard basket" cases?
Until the IRD start addressing this then they can go kiss my a$$!

Similarly, the United States Internal Revenue Service, probably the most feared tax authority in the world,
 
To whom - lowly US citizens?
 
Not Apple!
 
Apple Inc. paid an income tax rate of only 1.9 per cent on its earnings outside the U.S. in its latest fiscal year, a regulatory filing by the company shows.
 
The world's most valuable company paid $713 million in tax on foreign earnings of $36.8 billion in the fiscal year ended Sept. 29, according to the financial statement filed on Oct. 31.
 
The foreign earnings were up 53 per cent from fiscal 2011, when Apple earned $24 billion outside the U.S. and paid income tax of 2.5 per cent on it.
 
 The tech giant's foreign tax rate compares with the general U.S. corporate tax rate of 35 per cent.
 
Apple may pay some income taxes on its profit to the country in which it sells its products, but it minimizes them by using various accounting moves to shift profits to countries with low tax rates.