This is something people often get confused with – so what is the difference?

TAX AVOIDANCE is legal but TAX EVASION is not. It is sometimes difficult to appreciate the difference between the two but in basic terms tax evasion is deliberately escaping from paying tax that should be paid, whereas tax avoidance is the exploitation of rules in order to reduce the tax that would otherwise be paid.

How Can I Tell the Difference?

There is a clear distinction between the two. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax bill and includes, in particular, dishonest tax reporting (such as under-declaring income, profits or gains or overstating deductions).

The most often quoted ruling on this subject confirming that tax avoidance is acceptable and legal comes from the court case of IRC v Duke of Westminster (1936). The Duke of Westminster paid his gardener a weekly wage and entered into an agreement by which he stopped paying the wage and instead drew up a covenant agreeing to pay an equivalent amount.

The gardener still received the same amount in wages but the Duke gained a tax benefit because under the law that applied at the time the covenant reduced the Duke's liability to surtax.

When the case came before the House of Lords, the judge, Lord Tomlin, stated:

“Every man is entitled if he can to arrange his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure that result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax” (IRC v Duke of Westminster [1936] AC1 (HL)).

The Duke of Westminster won the case!

Common Law

There is a specific offence relating to the ‘fraudulent evasion of income tax’ in the Taxes Acts, which was originally introduced in 2000. However, this legislation is not frequently used, as the Revenue often prefers to rely on the common law when they prosecute.

Very occasionally, you might find that a taxpayer is prosecuted under the Theft Act for false accounting (or possibly the Fraud Act 2006) but the majority of tax evasion cases are brought under the common law criminal offence of ‘cheating the public revenue’ (remember Harry Rednapp and PJ Proby?).

Cases brought under this common law have established that for the offence to be committed there does not have to be a dishonest act – an omission such as the failing to account or register for VAT will suffice provided that the act or omission was intended to reduce the tax bill.

Tough Penalties!

There is no maximum penalty for such an offence if found guilty so a defendant could be sentenced to life imprisonment as well as having to repay the Revenue. The previous Chancellor, Dennis Healey, famously described the difference between tax avoidance and tax evasion as being “the thickness of a prison wall”.

Unsurprisingly HMRC do not like the idea of tax avoidance and they appear to view all actions taken to reduce a tax bill as suspect unless the action can clearly be seen as taking advantage of a tax relief in the manner intended.

Recent years have seen the government stepping up its efforts to reduce the £42 billion ‘tax gap’ (i.e. the amount of tax they think should be paid in comparison to the amount actually paid). They state that more than a sixth of that amount is due to tax evasion but a further one sixth is due to tax avoidance (the balance being just uncollected taxes).

Tax Avoidance Disclosure

In March 2011, the Revenue issued a document entitled ‘Tackling Tax Avoidance’ which detailed how they would be approaching the problem of tax avoidance in the future.

The document states that they intend to develop the Tax Avoidance Disclosure rules, under which certain tax planning schemes have to be notified to the tax authorities shortly after they are marketed or implemented. The intention is supposedly to assist users so that they can work out the difference between what it terms ‘artificial avoidance schemes’ and ‘ordinary sensible tax planning’.

Stay within the law not outside it!