Ever since the Panama Papers exposed the underground nexus of global tax evasion, regulators have been trying to figure out how to get ahead of it. The UK Criminal Finances Act, passed in 2017, attempts to shift the responsibility for criminal tax evasion to business.

The offence of failing to prevent facilitation of tax evasion means an organisation can be found criminally liable for a lack of action to stop their staff or contractors hiding money. The proceeds of tax evasion are considered criminal property, and anyone handling it could also find themselves committing money laundering offences. Even though criminal facilitation could be happening without the knowledge of the business, if they fail to expose or prevent it, then they could be prosecuted under the Act.

The Criminal Finances Act requires organisations with a UK nexus to implement reasonable procedures, which is a key defence against prosecution. Organisations must undertake a thorough risk assessment, a top-down commitment and a roll out of staff training. 

Key this is understanding the differences between tax avoidance and tax evasion. Tax avoidance operates within the law, whereas tax evasion is illegal and punishable by severe consequences.

What is tax avoidance?

Tax avoidance refers to the use of legal methods to minimise tax liability. It involves strategic planning to take advantage of tax laws and incentives in a manner that reduces the amount of tax owed. Businesses and individuals use tax avoidance strategies to structure their finances efficiently while remaining within the boundaries of the law.

Key principles behind tax avoidance strategies include:

• Utilising tax deductions and allowances
• Structuring businesses in tax-efficient ways
• Taking advantage of tax treaties and offshore arrangements
• Deferring income to lower tax years

What are examples and penalties for tax avoidance?

Common examples of tax avoidance:

• Offshore accounts: Placing funds in jurisdictions with lower tax rates.
• Tax-efficient investments: Investing in government-approved tax-saving schemes.
• Income splitting: Distributing income among family members to reduce overall tax liability.
• Transfer pricing: Multinational corporations shifting profits to subsidiaries in low-tax jurisdictions.
• Deferring income: Delaying receipt of income to a lower tax year.

Potential consequences:

Although tax avoidance is legal, it may attract scrutiny from tax authorities. Governments frequently update tax laws to close loopholes, and aggressive tax planning may lead to reputational damage. Some tax avoidance strategies may be reclassified as tax evasion if they are deemed abusive or deceptive.

Is tax avoidance legal?

Strictly speaking, tax avoidance is legal when the avoidance strategies stick to the letter of tax laws. However, authorities such as HM Revenue & Customs (HMRC) in the UK, the IRS in the US, and other regulatory bodies closely monitor tax strategies to ensure compliance. The risk of tax avoidance strategies is that authorities may find ways to close down various loopholes and tax avoidance strategies. 

What is a tax risk?

Tax risk is the uncertainty of how much tax will be paid, or the degree to which an action will lead to a different tax outcome than was expected. 

Low risk – A small business owner with a regular income and straightforward accounting procedures has a low tax risk as they will generally know how much tax they will pay and when.

Medium risk – A multi-national company has sold a number of assets in different countries over the last year, some of which were at a loss. There is a degree of uncertainty over what can be deducted and written off, and how much tax will be owed in total.

High risk – A high net worth individual invests in a tax avoidance scheme which is currently under review by the tax authorities. There is a high tax risk since the action of attempting to reduce the tax liability could end up having the opposite effect if the scheme is closed down

Tax avoidance schemes might move money offshore or make financial arrangements to reduce the tax burden outside the intent of the law. Tax avoidance increases the tax risk due to the ambiguity of the transaction.

Potential challenges and risks:

• Tax authorities may dispute aggressive tax planning – Some avoidance schemes can be challenged under anti-avoidance laws.
• Reputational risks – High-profile cases of tax avoidance can damage a company’s or individual’s public image.
• Changes in legislation – Tax laws evolve, and previously legal tax avoidance measures may become restricted or classified as evasion.

What is tax evasion?

Tax evasion refers to illegal practices used to deliberately misrepresent financial information to avoid paying taxes. Unlike tax avoidance, which works within legal boundaries, tax evasion involves fraudulent activity and is a criminal offence.

Common methods of tax evasion include:

• Underreporting income
• Concealing funds in unreported offshore accounts
• Falsifying expenses and deductions
• Engaging in cash transactions to avoid record-keeping
• Failure to file tax returns

What are examples and penalties for tax evasion?

Common examples of tax evasion:

• Underreporting income: Businesses or individuals misrepresenting earnings to lower tax obligations.
• False deductions: Claiming fraudulent expenses to reduce taxable income.
• Unreported offshore accounts: Hiding income in foreign banks without disclosure.
• Failure to pay VAT or payroll taxes: Withholding taxes collected from customers or employees without remitting them to the government.

Legal consequences:

Tax evasion is a serious offence with severe penalties, including:

• Fines and penalties: Substantial financial penalties for underpaid taxes.
• Criminal prosecution: Convictions can result in imprisonment.
• Asset seizure: Governments can confiscate assets to recover unpaid taxes.
• Reputational damage: Public exposure of tax evasion can harm personal and corporate reputations.

What is tax mitigation?

Tax mitigation or tax planning is the perfectly legal use of regulated schemes in order to reduce tax liabilities within the intent of the law. This could include savings in a tax-free ISA, paying into a pension scheme, taking out life insurance, giving gifts or investing in assets which legally qualify for tax relief. Tax mitigation reduces the tax risk as it utilises tax reduction methods in the way they were intended.

What is the difference between tax avoidance and tax evasion?

While tax avoidance and tax evasion both reduce tax liabilities, they differ fundamentally in legality and intent. Below are key distinctions:

Legal vs illegal

• Tax evasion: Illegal, involving fraudulent practices to evade tax obligations.
• Tax avoidance: Technically legal, but likely unethical and increases the tax risk
• Tax mitigation: Legal, using tax planning methods in the way they were intended

Ethical considerations

• Tax evasion: Considered a crime, resulting in severe penalties and legal action.
• Tax avoidance: Although legal, aggressive tax avoidance may be viewed as unethical and lead to reputational damage.
• Tax mitigation: Ethical, using tax systems in the way they were intended. 

Government response

• Tax evasion: Strict enforcement, including audits, fines, and criminal charges.
• Tax avoidance: Tax authorities regularly amend laws to close loopholes.
• Tax mitigation: Encouraging the use of approved schemes 

Learn more with VinciWorks tax training

Understanding the risk of tax evasion is essential for individuals and businesses to remain compliant and avoid legal risks. VinciWorks offers comprehensive tax avoidance and compliance training courses designed to help businesses navigate complex tax regulations, minimise risks, and maintain ethical financial practices.

Explore VinciWorks’ courses to enhance your understanding of tax compliance and stay on the right side of compliance.