Tax planning or tax avoidance? One simple test
Over at Tax Research UK, Richard Murphy offers a simple test to distinguish between tax planning and tax avoidance. As he told a journalist, “That is easy. It’s getting legal opinion.”
With tax planning, Murphy says, you decrease your tax risk. “There are obvious examples: paying money into a pension, for example, does not create tax risk, and nor does putting money into an ISA [a UK individual savings account, which is similar to an IRA but more flexible] within allowed limits.”
By contrast, “Tax avoidance, on the other hand always, and without exception, increases your tax risk.” He gives examples of questionable allowances or use of tax haven structures. “In all such cases, the taxpayer’s risk is increased by undertaking the transaction. That is what tax avoidance involves.”
Murphy sends us further to David Quentin‘s tax blog. Here Quentin points out that there can be effective or ineffective tax avoidance, but that there is no such thing as ineffective tax planning. This, he argues, is an embarrassment for tax avoidance defenders, inasmuch as effective tax avoidance and ineffective tax avoidance are the same activity. With tax planning, there is no question that what you’re doing is legal. With tax avoidance, there is precisely such a question. So, as Murphy said, tax avoidance involves risk. Therefore, your tax adviser will suggest you get a legal opinion to “validate” the legality of what you are doing. While a putative tax avoider will use this opinion in arguing with tax authorities, it is ultimately the latter (and the courts) that will decide on the legality of the action taken.
What do you think? Is the distinction between tax planning and tax avoidance as easy to make as Murphy claims?
I think the question is like that one of beauty. It’s in the eye of the beholder. I would add, that both are determined by what is vogue at any given moment.
To take part in either tax planning or avoidance one must have in intent. Isn’t that the legal conundrum? Especially today when our form of justice is allowing mulligan’s all over the playing field?
In public, we used to call “tax planning” “tax avoidance.” What he calls “tax avoidance” we called “tax evasion.”
No it is not clear and a simple example will demonstrate that.
Lets say I have a Home Business and also use my automobile in the course of that business. Now under the law a certain percentage of the cost of both can be deducted as a business expense but determining that exact percentage is dependent on not only negotiating all the specifics of teh current laws and regulations but also on doing it in the exact same way as any given tax examiner. Which might lead to the following two scenarios:
One. I make my best good faith estimate as to the exact and proper amounts to deduct from my business income and hit the target exactly. Okay clearly that is tax planning.
Two. Understanding that there is a little give in the regulations and that reasonable people might differs and that any given tax examiner might decide that a minor variation in your favor isn’t worth pursuing (or just betting that your return avoids any serious auditing), you take your best case estimate and add 5-10% on top. Well that is tax avoidance.
Unless of course you are not exactly sure to begin with, which given the complexity of the code and the multiple variations in terms of time and scope of use of the home or vehicle is perfectly understandable, you prudently run either case one or case two past an attorney.
Whether that is ‘tax planning’ or ‘tax avoidance’ will depend not on the FACT that you consulted an attorney but on whether you will in fact rely on the advice of that attorney or have chosen an attorney whom you know will give you the opinion you are paying for. Which plunges one into a sea of alternative interpretations that depend on the actual intent and good faith on part of both you and the attorney separately and in combination.
What we can’t say is that Bob the Antique Store Dealer who lives in an apartment above his shop which both are part of a converted Victorian whose former Formal Dining Room is both a showroom and the place that Bob has Thanksgiving Dinner and his annual personal and business combined Christmas Party is doing ‘tax avoidance’ by running his judgement and calculations on the respective use of that space past a second pair of eyes. He might just be prudent, or that rare individual who is determined to pay every single penny of tax owed but also has payroll to meet and utility bills to pay and wants to continue eating on a daily basis. Or he might cynically (and mostly rightly) judging that everyone ‘fudges’ their taxes a ‘little bit’ and so why not?
It all boils down to intent. And there is nothing simple about that.
J. Godwin, could you elucidate the context? Who was the “we” and what role were you/they playing?
Bruce, you are right that consulting an attorney is not a foolproof sign of tax avoidance. But it is something you’ll do at least 99% of the time if you are increasing your tax risk, and I think Murphy is right that tax avoidance is always characterized by increased tax risk.
Public accounting, external auditors.
Tax avoidance means you don’t engage in taxable activity, and therefore have no tax liability.
Tax planning traditionally means you structure activities in such a way as to minimize taxes that will be levied because of variations in treatment of tax in different periods or because tax on one type of investment is different than tax on another type of investment, or because there are tax credits available that would benefit you in one particular scenario. (In other words, you have two projects and you are trying to select a project, you include in your evaluation of those projects forecasts of your tax liability in each scenario, and sometimes this means the way that you finance the project might be different, so it could be one project, but more than one way to do it).
When people talk about estate planning most of the time that’s about tax planning. It’s about how and when to distribute assets to reduce tax liability.
You see another example of this a lot lately. US headquartered companies are sitting on piles of cash they won’t repatriate because they have been waiting for a tax holiday on repatriation of their foreign earnings. The law is intended to permit/encourage companies to use that foreign money to expand their foreign operations, ultimately generating more future taxable income that would flow back into the US.
Now you see them looking for special types of acquisition targets that let repatriate those earnings on the sly. Many tax lawyers would say that’s tax planning (in some cases it is, even internationally), but most normal people who understood the potential goals would say that’s evasion.
Tax evasion means engaging in taxable activity but concealing it in such a way that it appears to not be taxable, in order to not pay taxes.
The difference is, tax planning and tax avoidance are not illegal. Tax evasion is illegal, you are not paying taxes that you definitely owe.
The issue is that because of stupid holes in the international tax system, it’s possible for very large companies to arbitrage activities without most countries attempting to take you task for it, so you can either be “avoiding” “planning” or “evading” taxes right now and it’s not clear which one it is until someone sues you. For individuals and small businesses the lines are much more clear.
I was thinking about this again this morning trying to explain what line companies are now crossing, and how they are breaking “the rules” exactly.
It comes down to a substance vs form accounting argument. Abuse of transfer pricing and setting up offshore entities whose *sole purpose* is to avoid taxes is not a real business activity and is fraudulent. They are similar to both the Qwest fraud and the Boston Chicken fraud. There are elements of a “capacity swap” where money is being spontaneously created/destroyed without a true business transaction, and also elements of “off-balance sheet accounting” where entities are created that are specifically designed only to manipulate fiscal results (fiscal vs financial means local results vs global results, typically this means your “tax books” for a specific taxable entity/region and your “financial statement” books. In a lot of cases they are the same books, but overhead allocations/transfer pricing policies, etc create results on entities that exist in specific countries that do not create a result on a global level.
Generally these policies are created in response to tax authorities, companies have to set up some sort of consistent policy that they adhere to in order to keep most of the countries reasonably happy that they are getting some sort of tax revenue that is reasonably tied to the proportion of the company’s global activity that is taking place in each country.
Increasingly we see companies either not document policies or brazenly manipulating fiscal results in ways that any reasonable person would say are solely to avoid taxes.
If that avoidance of taxes leads to the possibility that the taxes are actually owed but not reported or are reported but will never be paid, then that is generating a fraudulent financial transaction, and misleading investors.
Well, Ireland declares 2/3 of its profits in Ireland, where it has 4% of its employees and 1% of its customers. This is obscene, and the European Commission has begun an investigation of Apple, Starbucks, and Fiat.