When is it tax evasion or avoidance?

What makes you pay taxes? Morally, it is a good thing to do. It is a civic duty as one enjoys public goods and services.  Besides, taxes are ‘affordable’ and paying them is convenient. Not paying tax risks getting caught and being penalised. You have no option but pay the taxes. It’s perhaps an interplay of factors. We covered some of these in the previous articles. You may also realize that, inversely, these same factors can make you avoid or evade taxes. But is there a difference between ‘tax avoidance’ and ‘tax evasion’? And does it really matter?

From an economic point of view, the effect of ‘tax avoidance’ and ‘tax evasion’ is, arguably, the same – a reduction of tax liability. And so, in economic analysis, the difference may not be so important. To the government, both are economically undesirable. From the taxpayers’ point of view, whether his behaviour or action is viewed as ‘tax avoidance’ and ‘tax evasion’ is important – psychologically, socially, and legally. The difference is also important to policymakers and tax administrators. The tax system needs to be designed in a way that minimizes both evasion and avoidance.

Tax evasion refers to an illegal reduction of tax liability. Think of deliberate under-reporting your income, claims of VAT credits using fake invoices, non-payment of tax and collection VAT from (customers but not remitting the same to the tax authority. Tax evasion is an offence. Normally, tax laws would specifically list actions or inactions that are treated as offences, including tax evasion. In Tanzania, the tax administration law (The Tax administration Act, Cap.438 R.E, 2019) lists several offences in sections 82 to 92. Offences are punishable by either a fine or imprisonment – or both.

On the other hand, tax avoidance refers to an attempt to reduce tax liability by legal means. Tax laws, by design, contain provisions that confer some tax-reducing benefits. Think of tax exemptions, ‘safe harbour’ rules (ranges and thresholds) and residence rules. These are meant to implement a particular policy. The rules create loopholes that can, ‘legally’, be exploited. Unintended persons can use such rules to their advantage.

For example, skills and development levy (SDL) kicks in when an employer has four or more employees. What if you simply outsource and ‘avoid’ employing a single person? The VAT registration threshold is 100 million shillings turnover. What if you decide not to grow your business beyond the threshold or split? And what if you sell the property to a relative at a price well below its market value? All these actions are technically legal, but they certainly reduce tax liability.

However, use of loopholes has some risks. There are several provisions (anti-avoidance provisions) in the tax laws that are meant to curb tax avoidance practices. Including section 8 of the tax administration law. If a particular action by a taxpayer lacks commercial rationale and is solely taken to reduce the amount of tax, the tax authority can treat such action as tax avoidance (i.e. a “scheme for obtaining undue tax benefits”). And accordingly, collect the tax that would otherwise be avoided.

In practice, the distinction between tax avoidance and tax evasion can be fuzzy. For example, selling a house worth 1 billion shillings to your relative at only 100 million shillings – to reduce capital gains tax and stamp duty – may be deemed as tax avoidance. If detected, the tax authority can use the market value (1 billion shillings) to establish correct stamp duty and capital gains tax payable (and maybe charge you interest and penalties).

By Shabu Maurus, Tax Partner, Auditax International.