Tax Evasion Vs Tax Avoidance: Definitions & Differences Between Tax Evasion and Tax Avoidance

Some taxpayers are guilty of tax evasion by not filing their tax returns or not paying their taxes due even if they’ve filed returns. In summary, the CIT v. McDowell & Co. case established the concept of “business purpose” in tax avoidance transactions. It held that a transaction cannot be treated as tax avoidance if it has a genuine business purpose, even if it also results in tax savings. This decision has had a significant impact on tax law and jurisprudence, shaping the distinction between legitimate tax planning and tax avoidance. But before applying any method, you have to be very careful, as selecting an illegal method can cause some serious trouble for you. Let’s understand the two methods to reduce your tax liabilities, i.e., tax avoidance and tax evasion and how a taxpayer can use these methods to minimise their tax burden in a legal and right way.

Impact of tax evasion on the Indian economy

It is here that a responsible tax approach is particularly important in setting a framework and changing behaviours. When there is transparency and clarity about the criteria used to judge tax planning, it is easier to understand why certain actions are taken and to explore what is and what is not acceptable. No one wants to pay a higher income tax; to reduce tax liabilities, every taxpayer looks for legal or illegal ways. This high rate of taxation gives rise to emotions among taxpayers in terms of tax avoidance and evasion.

Form 1040-X allows you to file an amended return and make any necessary corrections. This often affects people who work or own rental properties outside of the country, Freyman says. With NerdWallet Taxes powered by Column Tax, registered NerdWallet members pay one fee, regardless of your tax situation.

1. If we talk about the latter, it is completely unjustified because it is fraudulent activity, because it involves the acts which are forbidden by the law and hence it is punishable.
2. The act applies to all individuals, Hindu Undivided Families (HUFs), companies, and other legal entities that earn income in India.
3. The Income Tax Act, 1961, has given power to the authorities to initiate audits, investigations, and scrutiny of the assessee in default.
4. This decision has had a significant impact on tax law and jurisprudence, shaping the distinction between legitimate tax planning and tax avoidance.
5. This principle has had a profound impact on the interpretation of tax laws in India and has been cited in numerous subsequent cases.

Plus, you’ll also be responsible for covering the costs of prosecution. Many, or all, of the products featured on this page are from our advertising partners who compensate us when you take certain actions on our website or click to take an action on their website. Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments. If you’ve made an error on your return, the best thing to do is correct it as soon as possible.

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In contrast, tax planning involves legitimate business transactions that also result in tax savings as a secondary benefit. Tax avoidance is a legal method used by taxpayers to reduce their tax liabilities, using the loopholes in the rules and regulations under the act. In other words, tax avoidance is a method to avoid payment of tax by taking advantage of a situation, where rules and regulations are not clearly defined or precise in the act. Although tax avoidance is legal, as there is no violation of the act, it is not advisable as a good practice because taxpayers try to gain an unfair advantage to avoid paying tax. There is in fact a wider dispute about what avoidance actually means. There are also debates about whether or not there is a difference between tax planning, tax mitigation, avoidance and “aggressive” avoidance.

Overstating expenses

Tax evasion can result in fines, penalties, levies, and even prosecution. Tax avoidance can be illegal, however, when taxpayers deliberately make it a point to ignore tax laws as they apply to them. Doing so can result in fines, penalties, levies, and even legal action.

Tax planning, like tax evasion/avoidance, is also done to reduce tax liability. However, it involves legal planning regarding investments, expenses, etc., to avail various exemptions and deductions provided under the tax laws. The CIT v. McDowell & Co. case, decided in 1985, is a significant precedent in the realm of tax law.

They can do so by using the tax credits, deductions, and exclusions that are part of the tax code to their advantage. Using these strategies can help them either avoid paying taxes altogether or lower their tax liability. Tax avoidance can be illegal if tax evasion vs tax avoidance a taxpayer abuses these strategies and doesn’t follow tax laws. For example, John owns a small business and generates significant cash income from his business activities. Instead of reporting the full income and paying the appropriate taxes, John engages in tax evasion to evade his tax obligations.

Taxpayers and their advisors must carefully consider the business purpose of transactions and ensure that they are not primarily motivated by tax avoidance to avoid potential challenges from tax authorities. This decision introduced a crucial distinction between tax avoidance and tax planning. Tax avoidance involves engaging in transactions primarily aimed at reducing tax liability, often through artificial or contrived means.

Claiming allowed tax deductions and tax credits are common tactics, as is investing in tax-advantaged accounts such as IRAs and 401(k)s. The concept of business purpose has also had implications for tax policy and legislation. It has influenced the development of anti-avoidance provisions and rules aimed at curbing aggressive tax planning strategies.

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The U.S. Tax Code allows corporations and high-net-worth individuals (HNWIs) to move their money to offshore tax havens. These are locations that have looser regulations, more favorable tax laws, lower financial risks, and confidentiality. Going offshore by setting up subsidiaries or bank accounts allows taxpaying entities to avoid paying higher taxes in their home countries. They’re subtracted from what you owe the IRS or other tax authorities after you prepare your tax return and figure out what you owe. Tax deductions are subtracted from your gross income to arrive at your taxable income. Tax avoidance refers to the use of legal methods to minimize the amount of income tax owed by an individual or a business.

Although a legal method, it is not advisable as it ultimately aims to reduce the amount of tax that is payable by one for their own personal advantage, which is unfair exploitation of law. Tax avoidance is taking unfair advantage of the lacunae in the tax law by finding ways to avoid the payment of taxes. Tax avoidance is usually done by adjusting the accounts so that there will be no violation of tax laws or by finding loopholes in the law. Though lawful, it could be categorized as an offense in some cases.