Series: MAR 2024

i) Differences between Tax Avoidance and Tax Evasion
Tax avoidance can be understood as a lawful scheme managed by an individual or by a company to reduce its tax liability. Tax avoidance is “the arrangement of one’s financial affairs to minimize tax liability within the law.” Tax avoidance exploits the loopholes in the laws that were not expected by the legislators.

Tax evasion is an illegal practice whereby someone using unlawful means purposely reduces his or her tax liabilities. This arrangement is exposed to criminal punishment and fines and is considered tax fraud. Tax evasion generally involves either deliberate under-reporting or non-reporting of receipts, or false claims to deductions. A taxpayer can only commit tax evasion if he or she has breached a relevant tax law.

The following points provide a summary of the distinction between avoidance and evasion:

• Legal status: Tax avoidance is legal, but tax evasion is illegal.
• Court cases in support: There are court cases that support the idea of tax avoidance but court cases on evasion show illegality.
• Careful planning: Careful planning can lead to tax avoidance. There is no amount of tax planning that can lead to tax evasion.
• Punishments: There is no punishment for tax avoidance schemes. But there are stiff punishments for tax evasion.

ii) Examples of Tax Avoidance Activities

• Taking legitimate tax deductions to lower business tax liability.
• Setting up a tax deferral plan to delay taxes until a later date.
• Taking tax credits for spending money for legitimate purposes, like taking a credit for hiring fresh graduates for the business.
• Locating a business in a strategic area to avoid paying taxes or pay less tax.
• Increasing retirement savings. Individuals can contribute to retirement funds up to 35% of basic salaries.

iii) Examples of Tax Evasion Activities

• Keeping two sets of books to record business transactions: one with actual transactions and another fraudulent one.
• Doing an extra job for cash and not declaring the income.
• Engaging in barter trade.
• Non-disclosure of major sources of income.
• Submitting false statements and returns to the GRA to reduce tax.
• Making false entries in any books of account or other documents relating to the income subject to tax.

iv) Limitations to Effective Tax Planning
There are various factors that limit effective tax planning. These factors can be legislative, judicial, or uncertainty in character. The following are some examples:

1. Legislative Constraints:
   This refers to circumstances that limit effective tax planning due to restrictions imposed by specific provisions in the tax laws. For instance, the Income Tax Act lists three anti-avoidance rules—Income Splitting, Transfer Pricing, and Thin Capitalization—that restrict some tax advantages.
2. Judicial Constraints:
   Judicial doctrines like the business purpose doctrine, substance over form doctrine, and step transaction doctrine ensure tax planning strategies are not only legal but also consistent with the spirit of the law. For example, the business purpose doctrine disregards transactions with no commercial purpose other than tax avoidance.
3. Uncertainty Constraints:
   Tax planning involves projecting future cash inflows and outflows based on assumptions that may not always be accurate. Fluctuations in income or changes in tax laws can make it difficult to project marginal tax rates, thus introducing uncertainty into tax planning.