Ever wonder what the difference between tax avoidance and tax evasion? This guide will explain in the UK context:
Overview of Tax Evasion
Tax evasion is the use of illegal methods to conceal information or income from HMRC. It’s a form of tax fraud and is used to avoid the payment or assessment of taxes.
If someone is found to be evading tax they can be fined or given a prison sentence.
What Activities Are Classed As Tax Evasion?
Cash-in-hand work involves taking payment from a customer in cash and not recording it for tax purposes. It’s one of the most common forms of tax evasion and should always be avoided.
Failure to report taxable income
This is where someone fails to tell HMRC about income that hasn’t been taxed at source. This could be rental income, pension income, or self-employment income, for example.
To make sure you pay income tax, you need to submit a tax return. Failure to do this could mean you’ve committed tax evasion.
However, HMRC does have some exceptions. For instance, if your self-employed income is less than £1,000 in a tax year, you might not need to report it.
Still, it’s always best to check if you need to report it to avoid any trouble.
Tax relief claims on non-allowable expenses
One way of reducing your tax bill is by claiming business expenses. Yet, if you’re claiming tax deductions on non-eligible expenses then you’re committing tax evasion.
Missing trader fraud
This is when goods are imported without any VAT and then sold to customers with VAT. It’s classed as tax fraud if the VAT isn’t reported to HMRC.
Overview of Tax Avoidance
So, what are the differences between tax avoidance and tax evasion?
Well, tax avoidance is a way of reducing your tax bill through legal methods.
Tax avoidance may not be illegal but some tax avoidance schemes are considered to be immoral. For example, sheltering your funds in a legal tax haven isn’t against the law but is considered to be immoral by many people.
Doing this means you’re avoiding your tax liability to the government of the country you actually live in.
What Activities Are Classed As Tax Avoidance?
Disguised remuneration schemes
These schemes are used to get around paying National Insurance and income tax. They work by paying employees their taxable income as a series of loans.
These loans aren’t expected to be paid back and, therefore, they should be taxed.
The loan charge is part of the UK government’s Finance Act 2016. It’s designed to prevent this form of tax avoidance from continuing and to recoup HMRC’s losses from disguised remuneration schemes.
Umbrella payroll schemes
Umbrella payroll schemes are a way of avoiding payroll tax payments. In the UK, they are fairly common.
So how do they work?
The umbrella company that pays you splits up your pay into smaller payments instead of paying you it all at once. These payments then go through the payroll before they’re subjected to PAYE deductions.
This means that you’re only paying tax and National Insurance on a small part of your income. A big part of your income remains untaxed.
A different account is used to make the larger payments and they will often come from overseas. Your payslip shows the larger payments separately from the smaller ones. Plus, the large payments are usually referred to as a loan or investment.
Those in charge of the scheme will often tell people that they can make sure you don’t pay any tax on up to 95% of your income.
Some scheme organisers will even tell people that HMRC themselves endorse these schemes. This is certainly not the case.
Umbrella payroll schemes come with a lot of risks. Usually, they involve some level of dishonesty and non-disclosure. So, it can be hard to tell whether a scheme would be classed as tax avoidance or constitute tax evasion.
If you have been involved in one of these schemes then it’s highly recommended you seek professional advice.
Aggressive tax avoidance schemes
The term aggressive tax avoidance refers to exploiting loopholes in the law to reduce tax liability. Aggressive tax avoidance is considered to be unethical but isn’t necessarily illegal.
If someone is found to be aggressively avoiding tax then the case must be heard in court to decide if the methods used were illegal.
Again, these schemes are very risky. If you’re found guilty of aggressive tax avoidance then you might have to pay all of the tax you owe back to HMRC with interest.
Due to this, you should always seek legal advice before agreeing to any scheme that could be classed as aggressive tax avoidance.
As you can see, the line between tax evasion and avoidance can be quite blurry. While some tax avoidance schemes are legal there are others that exist in a much greyer area.
The best way to make sure you’re not breaking the law when it comes to your taxes is to hire an accountant. They’ll be able to give you professional advice about your taxes and make sure everything is above board.
Tax evasion is a serious offence and you should take all necessary measures to ensure you’re not evading tax.
If tax avoidance is legal then why do some think it is wrong?
It’s argued that paying your taxes is a social obligation. So, if you avoid paying them, you’re not making your financial contribution to the society in which you live.
When companies are found to be avoiding tax, they’re often accused of selfishness and greed. This can badly hurt a company’s reputation and could mean they lose the public’s trust.
What’s an example of aggressive tax avoidance?
Using offshore tax havens may not be considered to be tax evasion but it can be considered to be aggressive tax avoidance. You should always seek professional advice before using a tax haven.