Understanding tax evasion and avoidance

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Most people would've heard the terms tax evasion, tax avoidance. The lines between the two are quite blurred and it means different things to different people. In this podcast, I'm going to outline why it's important to understand the distinction, what tax evasion is, and what tax avoidance is, which one is naughty

:: 00:18

and should be definitely avoided, which one should be encouraged, why it's relevant, and to advise what to do if you find yourself caught in a situation where you may be under the spotlight for being naughty in terms of tax.

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You are listening to the I Hate Numbers Podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.

:: 01:00

Hi folks. Welcome to another weekly episode of I Hate Numbers, the podcast that's there to improve your financial awareness, improve your money mindset, help your business make more profit, save tax, and time. What a fantastic combination we have there. Let's crack on with a podcast. Let's set the scene first of all, as to why tax evasion,

:: 01:19

tax avoidance is of particular interest, not just to individual taxpayers, but to governments, not just in the UK, but around the world. We have to start from the what is called a tax gap. So governments in the UK and around the world will sit down and figure out how much money they should be collecting from the various taxes, whether it's on businesses, whether it's on employment, whether it's on rental property, whether it's on capital disposals, a whole variety of things,

:: 01:44

including VAT should come into the poll. They will then check out what the actual money flow is, the receipts, and typically there is a tax gap. Now eye wateringly, in the United Kingdom in 2019-2020, there was a tax gap of about 35 billion pounds. That's a hell of a lot of naught and that's about just over 5% of all tax liabilities.

:: 02:08

By the way, as a footnote, in the UK tax liabilities for that year were 674 billion pounds, and then again, that's a hell of a lot of zeros. Now, the Exchequer, our friends HMRC dug deeper and according to their calculations, tax avoidance was about one and a half billion pounds of that, and tax evasion is five and a half billion pounds.

:: 02:29

So it's very much in the spotlight for HMRC and I would add, it's also a problem in other countries around the world. Now, it's important to understand the differentiation between tax evasion and tax avoidance to make sure that you as taxpayers don't end up in hot water. Is a very politically charged environment when we discussed these two things and the lines become very blurred.

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It has been said by a famous politician, Dennis Healy, that the difference between the two, evasion and avoidance, is the thickness of a prison wall. Now, tax avoidance as a general statement is perfectly acceptable and it's an established principle in the United Kingdom that a taxpayer is allowed and to arrange their affairs such to minimise their tax liabilities.

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For those of you amongst us that will perhaps claim an allowance against personal income, look at deductions that you can make legitimately against any profits that you make from your business, whatever that business actually is, that's perfectly acceptable and that's a way to minimise your tax burden. If you're a husband and wife,

:: 03:31

you may arrange to share the assets equally such that the income is split equally, and again, that might minimize your overall tax position. So tax avoidance is perfectly fine and it's working within the legal framework that we are provided with. Now, tax avoidance, on the other hand, as I said, can also be interpreted as also slightly naughty, and the governments are taking a much stricter line now to what they call tax avoidance, where taxpayers do not enter into the spirits of the legislation, but effectively are trying to manipulate and bend the rules.

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More of that later on in the podcast. Now, tax evasion is one that's a definite no-no, and that's where somebody is deliberately, with intent, understating their income or overstating their profits or hiding their income completely by non-decoration. So for example, one level, this could be a trader who is registered for VAT and decides to do cash sales.

:: 04:28

Now, making cash sales in their own right is not naughty, it's the not declaring it and not charging the VAT on that. It could be that you're claiming for expenses that you've actually not incurred. Reasonable experts are perfectly fine, by the way, but if you've not even incurred the expenditure, you should not be claiming it. Deliberately, not declaring income from things like second properties, having a business that’s not a hobby, perhaps trading virtually on eBay or other similar platforms and not declaring the income is also tax

:: 04:58

evasion. Hiding money offshore and not declaring it if you're a UK resident, taxpayer, not declaring that to our friends at HMRC is also examples of tax evasion. Now, tax evasion is the definite naughty step, and if you are evolved in tax evasion, apart from it being a criminal offense and some people do go to prison, by the way, you will face fines, penalties, and punitive action accordingly.

:: 05:22

Now let's come back to this idea of tax avoidance where governments are getting very shaky and getting very aggressive, I would say, in tackling tax avoidance. Now, this is where tax avoidance has no commercial substance, has no real economic reality to the tax planning. It’s an established principle in British law, certainly that an individual is perfectly entitled to go within the framework of the law

:: 05:47

and to arrange their fares such to minimize tax. So things like claiming gift day donations, allowances, putting money into pension schemes, or ICEs, again, there's no real objection from our friends at HMRC. Where the objection comes to is bending and manipulating the rules. Now what do we mean by that

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exactly? Now, this could be such that if we take something like an example of personal service company legislation, what it says is, is that if you provide services as a genuine self-employed contractor, then any income you are charging to your client is not gonna be subject to deduction of tax at source.

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Now, some people may arrange contracts and say, this is what the relationship is actually like, but if there's no actual reality there and it's merely a paper document, then that is likely to be challenged quite aggressively and that is an example of not going into the spirit of the law. So governments definitely these days are looking at what they call the spirit of the legislation.

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And again, this is where the lines become very blurred because morality now enters into the conversation. Now, morality and tax aren't naturally good bedfellows. We all have our personal opinions about big corporates, about not paying their fair share of tax. However, you count that up. Again, tax comes in many forms.

:: 07:04

Tax comes in terms of taxes levied on employees, tax in terms of VAT, taxes in terms of profits, and those big companies such as Amazon, such as Google, will enter into tax avoidance schemes to minimise their tax liability and they're going within what the legal framework is saying. HMRC will challenge those potentially and say that actually there is no actual economic substance to what you're doing.

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Again, that's a conversation for another time. Check out previous podcasts where we talked about personal service company legislation. Now my advice is if you are in a situation where you haven't declared income, you may have caught yourself into a corner, meaning to get round to do that, but you've not actually done that yet,

:: 07:47

what you've gotta be very careful of is that HMRC, not quite GCHQ perhaps, but they have access to an abundance of data, abundance of intelligence. They do monitor what goes on in the world in the internet. They do have the authority to gather data from companies, banks report to them in terms of each annual year,

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so there's a whole wide variety. They've got access to local property registers, council tax records, et cetera. So if you've got a footprint out there, at some point in time, you are likely to be caught. HMRC are definitely investing, putting more resources to intelligence gathering, gathering data, and it's a clock that's ticking.

:: 08:27

Then my advice would be if you've got yourself caught in a trap where you've not quite declared. When I say you're not quite i.e. you haven't, then my advice is always step forward, take responsibility. If you step forward and declare that, then you will mitigate any penalties that will be levied. If you are caught and you haven't declared, then HMRC

:: 08:46

have the right to levy penalties equivalent to the amount of tax they're collecting, plus interest and any potential punitive action thereafter. Prosecution is always an option, but that's obviously for serious cases and serious doesn't mean the amount of money, but in terms of the behavior that's going on. If you are going to volunteer yourself, do a voluntary declaration, I will strongly urge you to get the support of an accountant, an advisor who's experienced here.

:: 09:13

I will mention that I have done this for quite a number of years here, but you need to take the front foot and you need to voluntarily declare within the frameworks that you're allowed. So folks, let's just summarise here. Evasion, well get used to prison food at worst case, and it's definitely not to be recommended. Tax avoidance.

:: 09:30

Again, I would recommend that you do that. Have a review, have an audit of what your tax position is, and see if you can maximise the tax allowances you can claim, minimise your tax burden and look to see what's around you. Tax is a very moving face, a very complex environment, but there are opportunities there.

:: 09:47

Things that you enter into which have got no real commercial substance behind them, let me just mention Jimmy Carr, Gary Barlow, Ken Dodd, and Chris Miles being high profile examples of tax avoidant schemes that fell apart, then be very, very, very careful there. So I hope you got some value from this podcast.

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I'd love it if you give me some feedback. Share it with those who you feel will benefit. Until next time, guys, see you on the other side. We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode.

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We look forward to you joining us next week for another I Hate Numbers episode.