Allegations of tax evasion have recently been doing its rounds with various multimillion dollar industries falling under the government scrutiny. Be it on an individual scale or a major player like Ncell, accusation of not paying their due taxes have landed individuals and corporations in trouble with the law. What is important to understand is that there are legal ways in which you can reduce your tax liability and be on the right side of the law. Tax planning evaluates all the available tax options to determine how to conduct business in order to reduce one’s tax liability.
“Tax avoidance is entirely legal, where the tax payers try to minimise their tax burden legally, by taking advantage of the provisions and benefits provided by the tax legislations. To say it’s the grey area of law would be partly correct. To say it’s the grey area of law would be partly correct.”
Us lawyers keep talking about the difference between tax evasion and tax avoidance but what do these terms exactly mean and what can you do to reduce your tax liability? We all would love to reduce our tax burden, can any one of us say we wouldn’t? Let us understand the basics before we move on to our tax calculations. Tax avoidance is entirely legal, where the tax payers try to minimise their tax burden legally, by taking advantage of the provisions and benefits provided by the tax legislations. To say it’s the grey area of law would be partly correct. Better put, it is maximising the utilisation of the current law. You can think of it as finding loopholes in the rules rather than breaking the rules. On an individual scale, you can think of it as having a provident fund account or getting an insurance to reduce your tax slabs. On a large scale, you can think of it as paying a law firm to take advantage of the loopholes present in the current tax legislations. Out of these two methods saving up for a provident fund is encouraged by the government itself but utilising the benefits bestowed by the law is surprisingly frowned upon. Let’s be clear, tax planning, to make it sound more adept, is not only legal but something every prudent business should invest in to maximise profits and growth.
Tax evasion on the other hand is illegal. It is a practice where an individual or a corporation willfully defrauds the tax department by not reporting their taxes or not paying the actual taxable amount. Failing to report one’s income is categorised as tax evasion. In simple terms if someone fails to pay their taxes they owe to the government then it can be termed as tax evasion. In business, tax evasion can come in connection to income taxes, excise duty, value added tax and any other taxes implemented by the government. Tax evasion is a crime and if one is found guilty of evading their taxes, then a penalty or an imprisonment can be imposed. Thus, it’s important to know that you can plan your taxes but you can’t evade them. It may sound like there’s a thin line but in fact it’s vividly diverse.
Now let’s understand where the concept of tax avoidance and tax evasion emerged from. In the famous UK case of the Duke of Westminster, the Duke appointed a gardener on a weekly wage. He then after entered into a covenant with the gardener where he promised to pay him some money for the service. The gardener received his wage and the Duke got a tax benefit because as per the laws at that time a covenant reduced the tax liability. The court in this case brought up the principle where it discussed the difference between a tax evasion and tax avoidance. The case stated that a person is allowed to arrange his tax to minimise their tax liability so far as the person is staying within the boundaries of the law as legislated. In other words, if the law provides opportunities to minimise your tax, you are well within your rights to exercise those opportunities. The Westminster principle then after has been reiterated in numerous cases. It has been adopted as an accepted principle where individuals and corporations are allowed to use the benefit of the provisions/benefits in law to do their tax planning. Over the years there have been a few modifications to this principle and the judges have been looking into the intent of tax structuring.
If the transaction clearly shows that the motive of tax structuring was to avoid taxes then such transactions might come up for review by the tax authorities. Then, how can business determine whether tax avoidance has crossed its legal boundaries and become tax evasion? This depends on the intent of the parties. If business involved had a fraudulent intent then the thin demarcation between tax avoidance and tax evasion fades away. In such a scenario, tax avoidance turns into an illegal act of tax evasion. Herein comes the principle of General Anti Avoidance rules. (GAAR)
Section 35 of Nepal’s Income Tax Act 2058 relates to GAAR provisions.
This section states that for the purpose of ascertaining tax liability, the tax department can re-characterise the tax arrangement or the part of the arrangement made as a part of the tax avoidance scheme. The directives states that while re-characterising the taxes the department should see whether the arrangement so made would fall under the usual business transaction of the company. If it does, then such avoidance is allowed but if a transaction is only made with intent to avoid taxes, then it might be reviewed by the department.
Other than the exception of GAAR provision, a simple tax avoidance scheme is legal and most of the businesses opt for tax structuring to reduce their burden. Tax Planning arrangements are one of the tools used by tax experts to help major businesses calculate their taxes smartly. It is something most individuals and businesses all over engage in to find the best legal solution to get the least amount of tax liabilities. Tax avoidance is allowed but it is important not to cross the thin line as tax evasion gives rise to legal problems. Considering GAAR provisions and the ambiguity inherent in the tax planning business, it is close to impossible to exhaustively interpret all the provisions in this single article, we would strongly recommend all readers to consult their legal counsel prior to making arrangements for planning their tax liabilities. In our following article, we will focus in more detail on the GAAR provisions and its interpretations.
Shraddha Bhattarai and Shikhar Pandit are associated with leading corporate law firm, Gandhi and Associates.