What’s the Difference Between Tax Evasion and Tax Avoidance?

Taxes – no-one likes paying more than they have to but ultimately, we all acknowledge that they’re a necessity for our current lives.  We therefore need to consider what we can avoid. Is aggressive avoidance something to be lauded, or is it immoral? Where’s the boundary between avoidance and evasion?

This week, we had revelation that former Chancellor Nadhim Zahawi has agreed to pay HMRC some £3 million after a series of investigations by Tax Policy Associates, HMRC and The Guardian.  Was this evasion or avoidance? Are you in danger of the same sort of investigation?

Evasion or Avoidance?

This is a crucial definition. Traditionally there was always a clear line between evasion and avoidance.  This was based on the idea that evasion meant an illegal action, while avoidance would be using legitimate tax planning wrappers like ISAs and pensions.

With the addition of morality as a distinction, this became an even more ambiguous area. In essence, the government decided that immoral avoidance would essentially be treated the same way as tax evasion. What this means is that the use of multiple legal actions to create an effect that would be illegal in a single step can be treated by HMRC as illegal avoidance. There’s a very minor distinction between illegal avoidance and outright evasion, but for most of us both are just as bad, as both deprive HMRC of tax money that they are entitled to.

I’d like to reiterate at this point that the use of pensions, ISAs and offshore bonds for investments is neither tax evasion nor illegal tax avoidance. Using these structures is entirely as intended by legislation, therefore is entirely legitimate. Illegality only comes into play when tax owed is either hidden outright (evasion) or disguised through multiple layers of structuring to make it seem like something less than it should (illegal avoidance).

Legitimate Planning

There are several allowances available to all of us which legitimately allow us to avoid tax.  These include:

• Individual Savings Accounts – These aren’t subject to income tax or capital gains tax on the holdings
• Capital Gains Tax allowance – The first £12,300 of gains realised this tax year are not subject to tax. This is due to fall to £6,000 from April 2023, and £3,000 from April 2024
• Personal allowance – The first £12,570 of otherwise taxable income is ignored for tax calculations
• Savings allowance & dividend allowance – Up to £1,000 of savings interest and £2,000 of dividends is currently tax free
• Nil Rate Bands – The first £325,000 and up to £175,000 of a main residence are exempt from Inheritance Tax. The latter of these is reduced for estates over £2 million in value
• Business, Agricultural or Woodland Relief – There are Inheritance Tax reliefs for owning certain types of property, some of which we can advise on for excess capital that you have no other need for
• Other statutory allowances for Inheritance Tax, including the annual gift allowance and gifts from excess income.

In short, there are plenty of options to legitimately reduce your tax bill.

Illegal Avoidance

While the above options are all examples of legitimate avoidance of tax, it’s possible to compound multiple seemingly legal routes into a reduction of tax which exceeds that intended by legislators.  This is when avoidance becomes illegal.  I’ll not go into detail of any schemes here, as I worry that this might be taken as promoting schemes, but the general rule is that if multiple steps are required to achieve a tax reduction, it’s probably illegal avoidance. This was codified under the General Anti-Abuse Rule (GAAR), which makes for some fun reading for any tax planning geeks like myself!

Evasion

So after reading the above, you might be wondering “how on earth is something evasion then?”. As you can see, the traditional definition of illegality seems redundant given avoidance can be illegal, as outlined above.

To my mind, the difference here must be intentionality. Did the person in question think they had found a clever but little-known loophole and made use of that to reduce their tax bill? If so, I’d suggest that this was illegal avoidance. Did they intend to pay less tax than they knew they should’ve paid?  Clearly evasion.

If you’d like to learn more about how we can support you with planning your taxes please call us on 0370 1500 100 or visit our webpage.