Tax Evasion versus Tax Avoidance
South Africans are taxed daily, whether it's VAT on essential items, fuel taxes, or the feared inheritance tax upon death. Given the ubiquity of taxes, it's understandable that individuals would seek legitimate ways to reduce their tax liabilities. This raises the critical question of what is considered tax evasion versus tax avoidance.
In this piece, we explore the precise definitions of tax evasion and tax avoidance, the distinctions between them, how to identify each, and the warning signs that should instantly raise red flags.
The Westminster Doctrine
The Westminster Principle is a highly recognized concept that originates from Inland Revenue Commissioners v Duke of Westminster (1936) AC 1, and offers us the subsequent quotation:
"Every individual has the right, if possible, to arrange his matters in such a way that the tax imposed under the relevant laws is less than it would otherwise be. If he manages to arrange them to achieve this outcome, then regardless of how the Inland Revenue Commissioners or his fellow taxpayers may view his cleverness, he cannot be forced to pay a higher tax. This so-called principle of "the substance" appears to me to be nothing more than an effort to make a person pay despite the fact that he has arranged his matters in such a way that the tax demanded from him is not legally enforceable."
In essence, the Westminster Principle permits a taxpayer to reorganize their financial matters to reduce their tax burden, provided that such reconfiguration is in accordance with legal stipulations.
Tax avoidance through legislation
Tax avoidance comes from smart tax planning. It means organizing your finances to pay less tax. This helps reduce your tax burden. There is a link between the Westminster Doctrine and tax avoidance.
A taxpayer can lawfully reduce their tax burden by leveraging the benefits outlined in the Income Tax Act 58 of 1962 (“Income Tax Act”). This can be achieved through effective tax planning in accordance with the Act and relevant legal provisions.
In South Africa, stringent regulations are in place to govern tax evasion. The General Anti-Avoidance Rules (GAAR) are broad provisions within the Income Tax Act that tackle widespread tax evasion considered unacceptable by the South African Revenue Service ('SARS').
At present, GAAR's stipulations are located in Sections 80A to 80L of the Income Tax Act. Section 80A of the Income Tax Act offers a criterion to ascertain if there's an unacceptable tax evasion scheme by taking into account the following factors:
(i) Engaging in an 'arrangement' (which is characterized as 'any transaction, operation, or plan').
(ii) A goal leading to a tax advantage.
(iii) The 'setup' is purely for the purpose of gaining a tax advantage.
(iv) The 'setup' was not intended for business reasons.
It's important to highlight that an 'arrangement' must meet all four criteria mentioned earlier to be classified as an 'impermissible avoidance arrangement'. However, the burden of proof rests on the taxpayer. Section 80G of the Act presumes that any 'arrangement' made by a taxpayer is specifically designed to gain tax advantages, and it's up to the taxpayer to demonstrate otherwise.
Consequences of impermissible transactions
The Income Tax Act's Section 80B delineates the repercussions of unauthorized transactions. The essence of the issue is that the taxpayer continues to be accountable for any tax benefits they might have gained. The taxpayer is still obligated to pay any outstanding tax as though the tax evasion transaction never occurred.
It's worth mentioning that the Income Tax Act contains many particular tax evasion clauses that tackle specific anti-evasion schemes. However, these are beyond the purview of this article.
On the contrary, tax evasion pertains to the unlawful reduction or complete avoidance of specific tax obligations. This usually involves an individual participating in deceitful actions, which include supplying false and inaccurate information with the intention to deceive SARS. Tax evasion is a criminal act and can result in a penalty or incarceration.
Differentiating between tax evasion and tax avoidance
The key distinction between tax evasion and tax avoidance lies in the legality and the way the transaction is conducted. Tax evasion is a criminal act, while tax avoidance can be either acceptable or unacceptable as a means of avoiding tax. Only when tax avoidance schemes are deemed unacceptable does the taxpayer become liable for the relevant tax related to that scheme.
While it may seem a subtle distinction for those not in the know, there is a clear difference between tax evasion and tax avoidance. Tax avoidance is a lawful way to minimize tax payments, while tax evasion involves unlawful activities aimed at dodging tax. In both cases, the goal is to lessen the tax load, but the methods used to achieve this vary.
As crucial as tax planning is, the intricacies and risks of improper planning should be evident from the above. Any tax planning should adhere to legislative regulations and be conducted by a tax advisor. This ensures that the tax planning is legal, acceptable, and complies with our tax laws.
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