What is The Difference Between Tax Avoidance and Tax Evasion?

No-one likes paying tax – not even those of us who can appreciate that payment for our hospitals and armed forces need to come from somewhere. Be honest – if you were approached by someone who promised a reduction in your tax bill if you joined a ‘tax avoidance scheme’ being sold, wouldn’t you at least listen?

If you do decide to listen, you need to be very wary because TAX AVOIDANCE is legal but TAX EVASION is not. It is sometimes difficult to appreciate the difference between the two but in basic terms tax evasion is deliberately escaping from paying tax that should be paid, whereas tax avoidance is the exploitation of rules in order to reduce the tax that would otherwise be paid.

How Can I Tell the Difference?

There is a clear distinction between the two. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax bill and includes, in particular, dishonest tax reporting (such as under-declaring income, profits or gains or overstating deductions).

The most often quoted ruling on this subject confirming that tax avoidance is acceptable and legal comes from the court case of IRC v Duke of Westminster (1936). The Duke of Westminster paid his gardener a weekly wage and entered into an agreement by which he stopped paying the wage and instead drew up a covenant agreeing to pay an equivalent amount.

The gardener still received the same amount in wages but the Duke gained a tax benefit because under the law that applied at the time the covenant reduced the Duke's liability to surtax.

When the case came before the House of Lords, the judge, Lord Tomlin, stated:

“Every man is entitled if he can to arrange his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure that result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax” (IRC v Duke of Westminster [ 1936 ] AC1 (HL)).

The Duke of Westminster won the case!

Common Law

There is a specific offence relating to the ‘fraudulent evasion of income tax’ in the Taxes Acts, which was originally introduced in 2000. However, this legislation is not frequently used, as the Revenue often prefers to rely on the common law when they prosecute.
Very occasionally, you might find that a taxpayer is prosecuted under the Theft Act for false accounting (or possibly the Fraud Act 2006) but the majority of tax evasion cases are brought under the common law criminal offence of ‘cheating the public revenue’(remember Harry Rednapp and PJ Proby?).

Cases brought under this common law have established that for the offence to be committed there does not have to be a dishonest act – an omission such as the failing to account or register for VAT will suffice provided that the act or omission was intended to reduce the tax bill.

Tough Penalties!

There is no maximum penalty for such an offence if found guilty so a defendant could be sentenced to life imprisonment as well as having to repay the Revenue. The previous Chancellor, Dennis Healey, famously described the difference between tax avoidance and tax evasion as being “the thickness of a prison wall”. 

Unsurprisingly HMRC do not like the idea of tax avoidance and they appear to view all actions taken to reduce a tax bill as suspect unless the action can clearly been seen as taking advantage of a tax relief in the manner intended.

Recent years have seen the government stepping up its efforts to reduce the £42 billion ‘tax gap’ (i.e. the amount of tax they think should be paid in comparison to the amount actually paid). They state that more than a sixth of that amount is due to tax evasion but a further one sixth is due to tax avoidance (the balance being just uncollected taxes).

Tax Avoidance Disclosure

In March 2011, the Revenue issued a document entitled ‘Tackling Tax Avoidance’ which detailed how they would be approaching the problem of tax avoidance in the future.
The document states that they intend to develop the Tax Avoidance Disclosure rules, under which certain tax planning schemes have to be notified to the tax authorities shortly after they are marketed or implemented. The intention is supposedly to assist users so that they can work out the difference between what it terms ‘artificial avoidance schemes’ and ‘ordinary sensible tax planning’.

HMRC describes some specific Tax Avoidance Schemes they have encountered so far in the Spotlights section of its anti-avoidance pages online.

The text states that ‘the schemes featured are generally those which HMRC consider have the widest implications and about which there is the greatest need to warn potential users. They will often be schemes that have been disclosed to HMRC and have been given a Scheme Reference Number (SRN). Please note that the issue of a SRN does not mean either that HMRC ‘approves’ the scheme or that HMRC accept that the scheme achieves its intended tax advantage.’

Under the Spotlight!

One scheme in relation to property matters that has been placed under the ‘Spotlight’ is Spotlight Scheme number 10: ‘SDLT staged completion' (7 June 2010).

HMRC state that they have noted that ‘property sales are apparently being carried out in ways intended to avoid Stamp Duty Land Tax (SDLT) by reducing the purchase price below the SDLT band or threshold. In some cases an intermediate sale, often on the same day, is introduced into the arrangements with the sole intention of removing the true purchase price from tax. These arrangements seek to exploit 'sub-sale relief'. This relief is intended to ensure that, where a property transaction happens in stages, SDLT is paid once on the full amount paid for the property by the person who ultimately acquires it and no double charge arises.

The text goes further by giving the following warning:

‘Where HMRC find property sale arrangements that have been artificially structured to avoid paying the correct amount of SDLT these will be actively challenged, through the courts where appropriate’.

Why is HMRC Targeting Stamp Duty Land Tax (SDLT)?

Spotlight Scheme No 10 was a result of a recent increase in SDLT avoidance schemes attempting to exploit potential loopholes in the rules. HMRC conducted an exercise to determine the scale of the problem comparing data held by the Land Registry with SDLT returns and the exercise revealed that through the use of such schemes, about 1,200 people had avoided paying the right amount of tax due on their property transactions.

Practical Tip

HMRC has sent new tax assessments to those individuals concerned. They have not issued court proceedings, you notice, but closed the schemes by notification on their website. What is interesting is the warning given that ‘We will also be using the full range of HMRC information powers to identify and challenge promoters and scheme users who fail to notify us of the marketing or use of disclosable schemes’. You have been warned!

Those readers who have subscribed to ‘Property Tax Insider’ from the beginning might be wondering which side of the ‘artificial scheme’ or ‘ordinary tax planning’ line ‘Flipping’ falls (see Issue 2 October 2010 – ‘Flipping Marvellous!’). Anyone contemplating undertaking this scheme can put their mind at rest. HMRC accept that this scheme falls on the accepted tax avoidance side of the line (see HMRC website CG64485 – Private Residence Relief) so long as not undertaken too often, as the article points out.

This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.