Insights
Tax evasion vs tax avoidance: what’s the difference?
There is a fine line between tax avoidance and tax evasion. One is “legal”, one is not.
In this article, we’ll discuss what the difference is between the two, their definitions, examples of each, and the penalties associated with each.
What is the difference between tax evasion and tax avoidance?
The main difference between tax evasion and tax avoidance is that tax evasion is distinctly illegal, whereas tax avoidance is technically legal.
Tax evasion is the deliberate and illegal effort to avoid paying tax through actions like lying, concealing, and hiding income. Tax avoidance is the exploitation of legal loopholes to pay less tax, without hiding your efforts to do so.
What is tax avoidance?
The UK Government defines tax avoidance as “bending the rules of the tax system to try to gain a tax advantage that Parliament never intended.”
It’s a way of paying less tax without breaking any laws – but it’s considered ethically questionable.
Whilst tax avoidance is technically legal, some tax avoidance measures are considered to be more “aggressive” than others, and can still be penalised under UK law.
Examples of tax avoidance
Tax avoidance measures come in all shapes and sizes, varying in levels of severity. Here are a few tax avoidance examples:
Loan payments
This includes things like “director loans” where a director is given a loan from the company which should be repaid. It is not ever repaid and the company writes it off, making it essentially tax-free money.
Disguised employment
A worker who should be a permanent member of staff poses as a contractor who has set up their own limited company. They pay less tax as a contractor compared to being a permanent employee, and the company pays less in national insurance contributions.
Offshore tax havens
Schemes are established in countries where tax is much lower than in the UK. Money is placed in these schemes though there is no deliberate concealment involved.
What are the penalties for tax avoidance?
Tax avoidance is technically legal, but if HMRC considers a tax avoidance effort to be very deliberate and aggressive, then they can challenge it under a variety of laws. Penalties can be up to 200% of the tax due. Here is a summary of the main regulations and penalties HMRC issue:
General Anti-Abuse Rule (GAAR)
Under the GAAR laid out in the Finance Act 2016, you can be given a penalty of up to 60% of the tax due, in addition to repaying the tax with interest. HMRC uses this when they believe the tax avoidance scheme was overly aggressive. You may have to submit more detailed tax returns in future.
Serial Tax Avoidance Regime (STAR)
Under the STAR, serial tax avoiders are given penalties for each tax avoidance scheme used, are publicly named and shamed for tax avoidance, and can be prevented from claiming tax reliefs for up to 3 years. You may have to submit more detailed tax returns in future.
Failure to Correct (FTC)
If you fail to correct offshore tax liabilities before 30th September 2018, you can be given a penalty of 200% of the tax liability that should have been paid.
Accelerated Payment Notice (APN)
Sometimes HMRC issues an APN which demands the disputed tax upfront before their investigation is concluded. The taxpayer is given 90 days to pay the full tax liability, otherwise they face further penalties.
What is tax evasion?
Tax evasion is a deliberate and calculated effort to avoid paying taxes by illegally concealing your true state of financial affairs.
When HMRC uncovers tax evasion, they can pursue the unpaid tax through civil or criminal proceedings, depending on the severity of the evasion.
Examples of tax evasion
Tax evasion is a wide umbrella term for many illegal activities to get out of paying tax. Here are some examples:
Failing to report income
Underreporting or failing to report income at all is illegal. For example, if you get paid cash in hand and don’t report it to HMRC, this is classed as tax evasion.
Concealing money in offshore accounts
Hiding money and assets in offshore bank accounts is against the law. You are not making HMRC aware of the money so you can’t be taxed on it.
Creating falsified documentation
You can be punished harshly for creating fake documents like receipts, or by manipulating existing financial records, to make it look like you have less income or more outgoing expenses.
Smuggling
Importing goods into the UK without paying custom duties and import taxes at all, or by undervaluing them to reduce your tax liability, is considered tax evasion.
Failing to pay VAT
Not registering for VAT when your business earns more than £90,000 per year, and charging VAT but not reporting it to HMRC, are punishable by law.
What are the penalties for tax evasion?
We’ve explored the penalties for tax evasion in more detail in a separate post, but to summarise, you’ll face fines beginning at £5,000 and can face a prison sentence up to 7 years (or a life sentence for the most serious cases).
Under the Criminal Finances Act 2016, companies can also be charged for tax evasion if they did not have reasonable measures in place to prevent employees and contractors from committing tax evasion. “Failure to prevent facilitation of UK tax evasion” and “failure to prevent facilitation of overseas tax evasion” are criminal offences. The penalty is usually an unlimited fine and criminal conviction.
Concerned about an HMRC investigation?
If you have engaged in tax avoidance or tax evasion activities, it’s important to seek legal assistance as soon as possible. You need expert help to understand your rights and the best way to move forward. Please contact Holborn Adams for assistance regardless of whether or not you are already under investigation by HMRC.
When you instruct our tax fraud solicitors, you’re covered by a legally-binding confidentiality agreement so you have the breathing space to be open and honest with us and work on a plan going forward, without worry that we will report to HMRC. You don’t get this privilege when you consult a tax expert – unless a solicitor instructs them on your behalf.
If you know you have committed a tax evasion offence, are unsure of the legality of a tax avoidance scheme you’ve entered into, or have been notified you’re under investigation by HMRC, please contact Holborn Adams today.