INTRODUCTION
While tax is considered one of the major sources of revenue for the governments across the world, it is often looked upon as a huge burden by the consumers and business/ corporate owners. Taxes can broadly be classified as Direct and Indirect Taxes. One of the examples of direct tax is Income Tax for job seekers and Corporate tax for job providers.
Who would like to give away a part of their hard earned money to the state? Even though it is for the benefits provided to us by the state, still people would prefer to give away as little as possible in the form of these taxes. While some of the measures of minimizing taxes are legal, others are illegal and are punishable under the law they are subject to.
DIFFERENCE BETWEEN TAX EVASION AND TAX AVOIDANCE
Legality forms the very basis of differentiating between Tax Evasion and Tax Avoidance.
While Tax Avoidance is basically finding loopholes in the Tax code or tax laws which exempts one from paying taxes and is therefore not illegal,
Tax Evasion refers to not paying the taxes when they actually become due, which is absolutely illegal and punishable by the law. It occurs when organisations or individuals fail to pay the required amount of tax because of false disclosure of income or by window dressing of financial statements.
Taxpayers or taxpaying entities can lawfully save taxes by taking the benefit of various deductions, credits and exclusions provided in the tax codes/ laws. While tax avoidance through legal methods is permissible, false methods lead to tax evasion which constitutes a crime and is subject to penalties such as handsome fines or even imprisonment.
Let us understand this with the help of an example:
Suppose a salaried person earns an annual income of $10000 from his job and also earns a side income of $2000 by freelancing, but the person does not disclose his additional income and only pays tax on his income of $10000. This is a case of tax evasion which is illegal under the law and is a punishable offence.
On the other hand if a person earning an annual income of $10000 contributes $2000 towards a tax favored saving or investment opportunity say a charitable contribution can claim government incentivised deductions on that amount and is liable to pay tax only on the amount of $8000. This is referred to as tax avoidance and is a legal method.
COMMON METHODS OF TAX EVASION
Here are some common methods of Tax Evasion which are absolutely illegal:
1. False disclosure of Income
This is the most popular strategy of tax evasion where some individuals might resort to understating their income in the tax returns or overstating the deductions and exemptions to either pay less tax than what they should or not pay at all.
2. Window Dressing
Window dressing refers to manipulating the financial statements by changing various figures. Since tax is calculated by assessing these financial statements, this method is used by businesses/ corporations to understate their revenue or capital gains than what is actually earned to save taxes.
3. Bribing tax authorities
People might bribe the tax officials/ authorities or make payments to them under the table, to change the amount of tax due or eliminate any tax record due from them. Both paying and accepting bribes is illegal and punishable under the law.
4. Substituting smuggling for imports
Most countries charge a high amount of tax on importing goods and services (these taxes are extravagant on goods like alcohol and drugs) from other countries, to avoid such taxes these goods are smuggled illegally across borders.
5. Forging fake documents
To provide financial equity, governments across various countries may provide deductions and exemptions to taxes for a certain segment of the society, or people falling under an income scale. To claim such benefits, unreserved people might forge fake documents and exempt themselves from paying taxes.
6. Storing wealth outside the country
Income tax authorities do not usually have the access to or jurisdiction over international or foreign bank accounts and the transactions/ dealings through these accounts. This is illegal as that money cannot be accounted for while calculating tax and enables such a person holding a bank account abroad to evade the taxes due on that wealth.
COMMON METHODS OF TAX AVOIDANCE
The methods of tax avoidance vary from country to country and depend on the provisions made by the government of the state for a common man to save taxes legally. Yet, here are some common methods of tax avoidance:
1. Standard Deduction
This is a predetermined amount set by the state or the government which enables the taxpayers to reduce their taxable income and therefore claim reduction in the tax burden.
2. Tax deferred plans
Investing in tax deferred plans or contributing to tax deferred accounts like retirement plans enables an individual to reduce the overall taxable income for the financial year in which such a contribution is made.
3. Deductions and Credits
Taxpayers can claim deductions in both taxable income and the overall tax burden by using exemptions provided by the government or credits like charitable contributions, depreciation on assets etc.
Over the past decade tax evasion has evolved as a global challenge as people try to save as much tax as possible by various legal and illegal methods and by taking advantage of loopholes in the taxation laws, this leads to a significant decline in the governments’ ability to collect taxes needed to fund various domains such as infrastructure and public services like healthcare and education.
This can also disturb the concept of equity as it can give unfair advantage to certain individuals, businesses and corporations over the others, therefore rendering the market distorted. This can even question the governance and authenticity of government institutions and the functioning of the judiciary
IMPACT ON THE GOVERNMENT AND ECONOMY
Tax evasion can have a detrimental effect on a country, harming both the nation as a whole and the long-term advancement and development of civilization. Long-term, repeated tax evasion can have a negative impact on social programs, infrastructure development, and economic growth, among other sectors. In this section, we examine the effects of evasion on the workings of government and the health of the economy.
1. Government Revenue
When taxpayers underreport their income, claim false deductions, or hide assets in tax havens, they pay less than owed, leading to the formation of illegal gains. This reduces the amount of tax revenue collected resulting in loss of government revenue. In 2021, an estimated $600 billion in taxes that should have been collected in the U.S. did not; the difference is referred to as the “tax gap” This gap is projected to generate some $7 trillion in taxes lost over the next ten years. The amount of money that is lost is enormous: It amounts to 3 percent of GDP-or what the bottom 90 percent of earners collectively pay in income taxes in the U.S.In South Korea, Australia, and India, the costs of tax evasion are $1.1 billion, $6.1 billion, and $41.2 billion, respectively.
2. Budget Deficit
Less government revenue impels the government to either reduce the public expenditure, or more commonly, resort to public borrowing for maintaining financial stability. Increased borrowing to compensate for the deficit results in higher national debt, creating a perpetual cycle of fiscal dependency. In the fiscal year 2023-24, the budget deficit of India stood at Rs. 9.14 trillions. The loss of revenue of Rs. 2.7 trillions due to tax evasion contributed to the high budget deficit, making up around 30% of it.
3. Welfare programs
With less revenue, Tax evasion causes the government to discontinue development initiatives that were introduced for the benefit of individuals and communities. Evasion infiltrates government policies established for society and twists the management plan by making the primary resources unavailable for the project. It reduces the amount of relaxation that could have been provided to the lower segment of the society. In the US, reduced tax revenue means cuts to social programs such as food stamps, and Medicaid, decreasing health funding and making clinical services less affordable.
4. Infrastructure and public services
Tax evasion affects society as a whole by depriving the government of funds needed for infrastructure development and public services. With less funding available, the government may have to delay or cancel planned infrastructure projects. In the absence of sufficient funding, it may prioritize short-term spending or wasteful projects over long-term infrastructure investments, resulting in inefficient resource allocation and poor-quality public services.
Globally, countries lose a total of $427 billion in tax each year due to corporate tax abuse and private tax evasion, out of which $245 billion is directly lost to corporate tax abuse by multinational corporations and $182 billion to private tax evasion. Multinational corporations paid less in taxes than they owed by shifting the profits generated to other countries with lower tax rates. The individuals did the same by storing their income in offshore financial assets. Additionally, lower income countries lose the equivalent of 5.8 per cent of the total tax revenue they typically collect a year to global tax abuse whereas higher income countries on average lose 2.5 per cent as North America and Europe lose over $95 billion in tax and over $184 billion respectively, while Latin America and Africa lose over $43 billion and over $27 billion respectively.
INCOME TAX ACT 1961
The Income Tax Act of 1961 comprises the guidelines and provisions that the Income Tax Department uses to impose, manage, collect, and recover taxes. It includes 298 sections, 23 chapters, and numerous significant provisions that cover all taxation matters in India.
The Income Tax Act of 1961 is characterized as a direct tax, meaning that taxpayers are required to pay direct taxes at a specified percentage determined by their income.
The primary goals of the Income Tax Act of 1961 are as follows:
1. Price Stability
The Income Tax Act fosters price stability within the economy by establishing guidelines for direct taxes. It acts as a tool to regulate private expenditure, thereby helping to control inflation in commodity prices.
2. Full Employment
This Act lowers income tax rates to stimulate greater demand for goods and services. Consequently, this leads to more job opportunities, supporting the aim of achieving full employment.
3. Non-Revenue Objective
Wealthier individuals face higher tax rates compared to those with less income. This structure of the Income Tax Act promotes a progressive taxation model that tackles wealth disparity among citizens, fulfilling its non-revenue goal.
4. Cyclical Fluctuations Control
During economic expansions, income tax rates are raised, while they are lowered during downturns. In this manner, the Act effectively manages cyclical fluctuations in monetary value.
5. Reducing Balance of Payment Issues
The Income Tax Act levies customs duties on certain imported goods. This approach encourages domestic production, which helps alleviate balance of payment challenges for the government.
6. Penalties For Tax Evasion
In India, evading taxes is against the law. To deter tax evasion and guarantee adherence to tax regulations, the Indian government has established a number of penalties for those who are discovered dodging taxes.
Depending on the seriousness of the violation and the amount of tax avoided, tax evasion consequences can include steep fines, legal action, and even jail time.
One of the most frequent penalties imposed is for the late submission of income tax returns. If a taxpayer does not file their return by the designated deadline, they may incur a penalty ranging from Rs. 1,000 to Rs. 10,000 under Section 234F of the Income Tax Act, with the specific amount depending on the taxpayer’s income level. The penalty may escalate if the return is submitted after the conclusion of the assessment year.
Another major penalty concerns the underreporting of income. If a taxpayer either knowingly or inadvertently reports less income than they should, the penalty can reach as high as 50% of the tax amount deemed to be evaded, according to Section 270A of the Income Tax Act. In instances of deliberate tax evasion, this penalty can increase to 200%.
Penalties are also applicable for failure to remit tax payments. Under Section 221 of the Income Tax Act, if a taxpayer fails to pay the assessed tax, the assessing officer may impose a penalty corresponding to the outstanding tax amount. In severe situations, this penalty could even lead to prosecution.
Tax evasion is met with severe consequences in India. Section 277 permits prosecution, with potential imprisonment ranging from 3 months to 7 years and the imposition of a fine if the taxpayer is convicted of intentionally providing false information to avoid tax obligations.
For false declarations or document falsification, Section 271(1)(c) enforces a penalty that could range from 100% to 300% of the amount of tax that is sought to be evaded. This regulation holds taxpayers responsible for giving incorrect information or fabricating documents.
Additionally, interest on overdue payments is levied under Sections 234A, 234B, and 234C. These interest charges are incurred when a taxpayer fails to make timely tax payments, potentially leading to a substantial increase in their total liability.
To sum up, tax penalties in India act as a deterrent against non-compliance, ensuring that taxpayers meet their responsibilities. It is essential for taxpayers to stay informed about deadlines and regulations to prevent incurring penalties and interest.
GOVERNMENT INTERVENTION IN REDUCING TAX EVASION
Governments need to create robust tax laws and regulations to eliminate any existing loopholes and deter tax evasion. It’s crucial to regularly and promptly review tax laws to ensure they remain relevant with the evolving financial practices and new methods of evasion. Training tax officials, utilizing advanced data analytics and artificial intelligence tools, and fostering better collaboration between tax authorities and law enforcement agencies are vital to enhance tax administration and enforcement. Raising public awareness about their rights and obligations can encourage voluntary compliance, which may help to deter tax evasion. This awareness can be enhanced through public campaigns, taxpayer assistance programs, and educational initiatives, helping individuals and businesses appreciate the significance of tax payments and the repercussions of evasion.
Utilizing technology can greatly aid in modernizing tax administration and minimizing tax evasion. This can involve the deployment of digital platforms for tax filing, payment, and scrutiny, leading to improved transparency, efficiency, and accountability within India’s tax system. For instance, the adoption of blockchain technology can create transparent and tamper-proof records, thus reducing the chances of tax evasion.
As tax evasion frequently involves cross-border transactions and offshore tax havens, it’s essential to establish strong international cooperation with tax authorities. Engaging in the Common Reporting Standard (CRS) and the Automatic Exchange of Information (AEOI) can facilitate the sharing of financial information between nations to help identify tax evaders.
Tax authorities often encourage whistleblower programs, allowing individuals who are aware of tax evasion to report anonymously via hotlines. Financial incentives are provided to these whistleblowers, which enables quicker intervention by tax authorities to combat tax evasion.
THE LAFFER CURVE
In the field of economics, there exists a fascinating and elegant curve known as the Laffer curve. The Laffer curve represents a theoretical connection between taxation rates and the subsequent levels of government revenue, as shown in the figure. When the tax rate is below a certain threshold, increasing the tax rate can lead to heightened government tax revenue. However, once this limit is surpassed, an increase in the tax rate will result in a decline in government tax revenue. Higher tax rates tend to inhibit economic growth, shrink the tax base, and ultimately lower tax revenues. On the other hand, tax reductions can foster economic growth, broaden the tax base, and enhance tax revenues.
Hence economic principle suggests that governments should set tax rates at a moderate level to extract high tax revenue.
Real Life Example : The Brockman Tax Evasion Case
The best way to get a clearer picture of how tax avoidance and tax evasion can impact individual and corporate behaviour in practice is to consider an example taken from the real world. The critical case of Robert Brockman can shed light on the strategies, consequences, and legal reverberations that frequently follow these sorts of actions.
Robert T. Brockman, a Texas billionaire who was the former CEO of Reynolds and Reynolds, was accused in 2020 of running the largest tax evasion scheme in U.S. history—$2 billion. Brockman was accused of hiding his investment income from the IRS using a series of offshore companies based in Bermuda and Nevis since 1999.
He used secret bank accounts he maintained in Bermuda and Switzerland to funnel the untaxed profits from asset sales and other financial crimes. Brockman allegedly communicated with offshore money handlers via encrypted communications and code names, making it more difficult to track his illegal activity. It did not take long for authorities to track Brockman down and arrest him, and Brockman, however, was deliberate and intentional in his methods to avoid detection. He then advised his handlers to go paperless, ordering that all paperwork be in digital form rather than given in hard copy, thereby making it more complicated to tie him to the off-the-books assets. He also allegedly backdated documents and used certain types of paper to obscure evidence of his actions, like the manufacturer and production date. The strategy was designed to leave him with no identifiable paper trail with reference to the illegal activity.
Robert Smith, Brockman’s business partner and the CEO of Vista Equity Partners, was found to be a part of this case, who signed a non-prosecution agreement and paid $139 million. This case is considered one of the largest tax evasion scandals in history.
THE CONCLUSION
Tax evasion and avoidance continue to be seen as crucial challenges to governments all around the world, threatening the revenue collection, fairness and integrity of financial systems. While legal tax avoidance can be a tool for strategic financial planning, the misuse of loopholes and outright evasion undermines economic equity, strains public resources, and erodes trust in institutions. As shown by global statistics and high-profile cases like Robert Brockman’s, the impact is not confined to any one country, it has proved to be systemic and far-reaching.
To safeguard public finance and promote a culture of compliance, governments should adopt a multi-pronged approach: closing legal loopholes, leveraging technology and data analytics, enhancing international cooperation, and educating citizens. Ultimately, a fair and effective tax system must strike a balance which will encourage economic participation while ensuring that every individual and corporation contributes their due share toward national development.
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