Tax Avoidance vs Tax Evasion

What is Tax Evasion?

Tax Evasion is an illegitimate way to minimise tax liability through unlawful techniques like inflating expenses or understatement of taxable income. Such fraudulent means are used with the motive of showing lesser profits in order to minimise one’s tax burden. Certain noted illegal practices are concealing of income or relevant documents, making false statements, overstatement of the tax credit, not maintaining complete records of the transactions or accounting personal expenses as business expenses. Tax evasion is an offence for which the assessee could be punished under the law. One common way people adopt to evade taxes is by transacting in cash without accounting for the same in books. However, to track and tax such transactions and the means utilised to evade tax, the government keeps a vigilant watch and picks the cases for assessment. If caught, a heavy penalty may be levied along with taxes.

What is Tax Avoidance?

Tax Avoidance involves using legal methods to minimise tax liability. In other words, it consists in using means within four corners of the tax law to minimise one’s tax burden. 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 in such a way that there will be no violation of tax laws or by finding loopholes in the law. Though lawful, it could be categorised as an offence in some cases.

What is Tax Planning?

Tax planning is a comprehensive evaluation of one’s financial situation using current known and estimated future variables and drawing out a feasible plan. Tax planning, just like tax evasion/avoidance, is also done to reduce one’s tax liability. However, it involves planning regarding investments, expenses etc., legally to avail various exemptions and deductions provided under the tax laws.

E.g., Section 80C allows deduction of up to INR 1,50,000 in the case specified investments are made. The most popular ways of saving tax through planning are investing in Life insurance policies, PPF accounts, National Saving Certificate, Sukanya Samriddhi Scheme, term deposits, Provident Funds, etc. Tax planning involves planning the financial affairs in such a manner that entitles the taxpayer to the benefits of deductions, exemptions, concessions and rebates. Tax planning is a genuine approach to applying all the provisions that come within the framework of tax laws to the taxpayer’s benefit.

Certain common methods of tax evasion or avoidance

• Not paying tax dues: Not paying taxes by the due dates or not paying taxes when called for by the tax authorities.
• Smuggling: Goods or articles are smuggled from one place to another in order to evade taxes.
• Not reporting/misreporting/under-reporting of income: A person may not report the income received during the year or may report less income or misreport the same. These are the common ways of evading taxes.
• Incorrect income tax returns(ITR): Concealing information in the ITR or filing inaccurate or incomplete information leads to tax evasion.
• Inaccurate financial statements: The tax payable is decided on the financial transactions of the taxpayer during a year. Taxpayers adopt ways to manipulate the books of accounts to deflate the income and inflate the expenses. This leads to lower tax liability.
• Fake documents to claim expenses or exemption: Taxpayers try to avoid taxes by providing fake invoices, documents etc. which they manage to get created to claim expenses and exemption.
• Keeping wealth in other countries: Taxpayers store wealth in other countries like tax havens, Swiss Bank accounts and the likes to evade taxes on their income.

Judicial perception

The judiciary condemns such acts done for tax evasion and tax avoidance and recommends a levy of severe penalties to punish such wrongdoers. In the ruling of Calcutta Chromotype Ltd. V. Collector of Central Excise- Calcutta, the Hon’ble Supreme Court observed that dubious methods to avoid paying taxes on what really is income can no longer be applauded and legitimated as a splendid work by a wise man but has to be condemned and punished with the severest of penalties.

In the case of McDowell & Co. Ltd Vs CTO, Hon’ble Supreme Court observed that “Tax planning may be legitimate if it is within the framework of law, but colourable devices cannot be part of tax planning. It is wrong to say that it is honourable to avoid payment of tax by dubious methods. It is an obligation of every citizen to pay tax honestly without resorting to subterfuges.”

Penalties for tax evasion or avoidance

The tax authorities shall determine the penalty amount leviable. However, such a penalty amount will not exceed the amount of tax payable.

The penalty shall be 50% of tax payable on under-reported income, i.e. income declared by the taxpayer is less than the income determined by the tax authorities.
The penalty shall be increased to 200% of the tax payable if under-reporting is due to misreported income.

The penalty leviable is ?25,000 generally.
However, if the taxpayer has entered into any international transaction, then the penalty will be 2% of the value of such international transactions or specified domestic transactions.

In case the income tax authorities find that the books of accounts provided by the taxpayer contain the following:

• forged or counterfeit documents such as a fake invoice or any fake documentary evidence
• a sales invoice or purchase invoice without actual supply or receipt of goods or services.
• a sales invoice or purchase invoice received from a person who does not exist
• an omission of any entry that is significant for computation of taxable income.

Regarding the above cases, the assessee might have to pay the penalty equivalent to the sum of such false or omitted entries.

a. In case of undisclosed income, a penalty @10% is payable.
b. Where search proceeding has been initiated on or after 1/7/2012 but before 15/12/2016:
- If undisclosed income is admitted during search and the taxpayer pays the tax along with interest and files ITR, then a penalty @ 10% of such undisclosed income shall be levied.
- If undisclosed income is not admitted during the search, but the same is furnished in the ITR filed after such search, then a penalty of 20% of such undisclosed income shall be levied. - In all other cases, a penalty shall be levied @ 60%
c. Where Search has been initiated on/ after 15/12/2016
- If undisclosed income is admitted during search and the taxpayer pays the tax along with interest and files ITR, then a penalty @ 30% of such undisclosed income shall be levied.
- In all other cases, a penalty shall be levied @ 60%

In case Income Tax Return is not furnished in full compliance with the relevant provisions of the Act, then the Assessing Officer can penalise the taxpayer with a penalty of INR 5,000.