Tax Avoidance & Evasion

Difference between Tax Avoidance and Tax Evasion

Tax avoidance is legal way to reduce the tax rate of an individual or company (up to a 0% tax rate). At its most basic form, a lot of people may engage in tax avoidance. For example, in the UK having an Individual Savings Account (ISA) is a legal way to avoid paying income tax because all savings in an ISA are tax-free. Businesses and sole traders can avoid tax by claiming expenses to reduce their tax bills.

At the end of the spectrum, tax avoidance is a murky area at times. In that case, there might be an investigation by the tax authorities (HMRC in the UK) which may demand more taxes to be paid.

Tax evasion is when you use illegal practices to avoid paying tax. This could include not reporting all of your income, not filing a tax return, hiding taxable assets from the tax authorities, or using fake offshore accounts.

This is a criminal offense and not only can you end up in prison, but you could also be “named and shamed“ by HMRC if you’ve avoided over £25,000 in tax. This will then impact the reputation of you and your business, which can then affect sales.

The last type of tax fraud is called money laundering. This is when proceeds from illegal activities are being passed into legal entities and declared as profits by these entities. Money laundering is a criminal offence.

Who can evade taxes

The taxman (or taxwoman) does allow for legal ways to reduce the tax rate (ISAs mentioned above), but for the average individual, it is difficult to avoid taxes beyond a certain level. However, larger companies and wealthy individuals can afford to employ more sophisticated tools as the cost of these tools is much lower than the amount of tax saved.