In India, individuals and entities earning income above a threshold limit are required to pay income tax based on the applicable rates. Taxpayers look for several ways to save taxes. However, not paying the applicable tax can attract a penalty. One may come across terms, such as tax avoidance and tax evasion. These two terms cannot be used interchangeably. While tax avoidance is legal, tax evasion is not. In this article, we understand the meaning of tax avoidance and tax evasion through examples.
Tax avoidance vs tax evasion: Difference
| Parameters | Tax avoidance | Tax evasion |
| Legality | Legal | Illegal |
| Intent | Used for tax hedging by using a legal approach to reduce tax liabilities | Used for tax concealment through fraudulent approaches to hide income |
| Methods | Taking advantage of loopholes in the income tax laws | Deliberate attempts to manipulate financial details |
| Implications | Fine or penalty in case ethical boundaries crossed | Severe legal consequences, including fees and imprisonment |
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What is tax avoidance?
Tax avoidance is the legal approach to reduce tax liabilities. One can adopt a safe approach by participating in government programmes and incentives, offering exemptions, deductions and other tax benefits.
Furthermore, one may adopt legitimate strategies within the boundaries of law. Some of the methods may include modifying the financial records to avoid conflict with any tax regulations while reducing the taxes. While tax avoidance is regarded as legal, it may raise ethical questions.
Types of tax avoidance
Tax deductions and exemptions
By investing in financial products or schemes, individuals and businesses can avail of tax deductions and exemptions as per the income tax laws. One may be eligible for tax benefits or exemptions for certain investments, business expenses or allowances.
For example, schemes, such as the National Pension System (NPS), Public Provident Fund (PPF) or Equity-linked Savings Scheme (ELSS), allow tax deductions up to Rs 1.5 lakh under Section 80C of the Indian Income Tax Act, 1961.
Corporate restructuring
Businesses or entities may go for restructuring to avail of tax incentives in certain industries or regions.
Through professional assistance
Taxpayers may seek professional services from a tax expert or a financial advisor for making smart investments and filing for tax deductions.
Transfer pricing
Transfer pricing is adopted by multinational companies to shift profits out of the countries where they operate to avoid getting taxed. Companies involved in international transactions may manipulate transfer prices on goods or services to transfer profits to jurisdictions with lower tax rates.
Tax credits
One can use tax credits to reduce tax liability for investments in specific sectors or activities.
What is tax evasion?
Tax evasion refers to the illegal approach adopted by taxpayers to avoid actual tax dues, thus, subject to criminal charges and penalties. Some fraudulent methods may include falsifying information, hiding documents or income proofs and having excess tax credits.
Types of tax evasion
- Underreporting of income to lower tax liability. A shop owner earning in cash may hide the details and report lower income.
- Offshore accounts: Individuals may hide their earnings in offshore accounts to escape tax scrutiny.
- Fabricating financial documents: Individuals or entities may issue false invoices or manipulate their financial statements to lower their taxable income.
- Fraudulent schemes: One may engage in fraudulent schemes to manipulate their tax obligations.
- Incorrect reporting: One may claim personal expenses as commercial/corporate expenses to reduce tax liability. Failure to report earnings from cryptocurrency may be an approach towards tax evasion.
FAQs
What is a tax avoidance example?
One may invest in financial products and make use of tax deductions to lower tax liability.
Is tax avoidance legal?
Tax avoidance is considered a legal approach to reducing one’s tax liability.
What are the causes of tax avoidance?
Due to various factors, including inflation and higher tax liability, one may adopt ways to reduce their tax liability.
Is tax avoidance punishable?
In some cases where one may have violated income tax laws, there may be penalties.
Is tax evasion a good practice?
Tax evasion is considered illegal and may attract several legal consequences, including imprisonment.
How can tax avoidance be prevented?
Tax avoidance may be prevented by implementing stricter tax laws, closing the loopholes and enforcing methods for fair and equitable taxation.
| Got any questions or point of view on our article? We would love to hear from you. Write to our Editor-in-Chief Jhumur Ghosh at jhumur.ghosh1@housing.com |
