Tax Evasion vs Tax Avoidance: What’s the Difference?

The terms tax evasion and tax avoidance are often used interchangeably. But they are not the same thing.

Tax evasion is illegal. Tax avoidance is more complicated because it can range from completely legitimate tax planning to highly artificial arrangements that HMRC may challenge.

So where is the line?

What is tax evasion?

Tax evasion is deliberately breaking the law to reduce the amount of tax you pay.

Examples could include:

• Deliberately failing to declare income

• Hiding business takings

• Providing false information to HMRC

• Claiming expenses you know were never incurred

• Concealing assets or transactions to avoid tax

This isn’t tax planning. It is deliberately providing false information or withholding information from HMRC to reduce a tax liability.

Tax evasion can result in substantial penalties and, in serious cases, criminal prosecution.

What is tax avoidance?

This is where the terminology becomes more confusing.

People sometimes describe perfectly ordinary tax planning as “tax avoidance”.

For example, someone might reduce their tax liability by making additional pension contributions or investing through an ISA.

There is nothing inherently wrong with arranging your affairs in a tax-efficient way using reliefs and allowances Parliament has deliberately made available.

For business owners, legitimate tax planning might include deciding how best to extract profits from a limited company, making appropriate pension contributions or making use of available capital allowances.

This is very different from evasion because you aren’t hiding anything from HMRC.

What about aggressive tax avoidance?

There is another category that taxpayers need to be much more careful about: aggressive or abusive tax avoidance.

These arrangements may attempt to exploit legislation in a highly artificial way to produce a tax advantage that was never really intended.

They are often complicated schemes involving a series of transactions that have little genuine commercial purpose beyond obtaining a tax saving.

HMRC has challenged many such arrangements over the years.

This is why something being described as “tax avoidance” rather than “tax evasion” doesn’t automatically mean that HMRC will accept it.

What is GAAR?

The UK has a General Anti-Abuse Rule, usually referred to as GAAR.

GAAR is aimed at counteracting tax advantages arising from arrangements that are considered abusive.

Importantly, it isn’t designed to prevent people from undertaking normal, sensible tax planning.

It is aimed at abusive arrangements rather than simply any decision that happens to result in someone paying less tax.

And GAAR isn’t the only weapon available to HMRC. There are also numerous targeted anti-avoidance provisions within UK tax legislation.

When tax schemes go wrong

Over the years, HMRC has successfully challenged numerous tax avoidance arrangements.

One well-known example involved the Eclipse film partnership arrangements, which ultimately resulted in the courts rejecting the tax treatment being claimed.

Cases like this demonstrate an important point.

A scheme can be supported by complicated documentation, professional advisers and apparently sophisticated tax arguments and still ultimately fail.

If you’re being offered an arrangement promising a very large tax saving with seemingly little commercial substance, you should be extremely cautious.

Tax planning doesn’t need to be aggressive

There are plenty of legitimate ways to reduce tax without entering into complicated avoidance schemes.

Good tax planning should generally start with understanding your circumstances and then making proper use of the reliefs, allowances and structures available under the tax system.

For example, depending on your circumstances, this could involve pensions, ISAs, capital allowances or appropriate business and company structures.

There is a considerable difference between using the tax rules effectively and trying to engineer an artificial arrangement purely to circumvent them.

The bottom line

The distinction is important:

Tax evasion is illegal.

Legitimate tax planning is perfectly acceptable.

Aggressive or abusive tax avoidance can potentially be challenged by HMRC.

My view is that sensible tax planning shouldn’t require you to take unnecessary risks with HMRC.

And if somebody presents you with a tax-saving arrangement that sounds almost too good to be true, that’s normally a very good reason to investigate it carefully before doing anything.

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Need advice on tax planning?

At Paul Marks & Co Chartered Accountants, we help individuals and businesses structure their affairs tax-efficiently while understanding the rules and the risks involved.

If you would like advice about your tax position, please get in touch with us.

Paul Marks & Co Chartered Accountants