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Short notes on:
TAX AVOIDANCE AND TAX EVASION –
WHAT IS THE DIFFERENCE?
Introduction
In the case of IRC v Duke of Westminster [1936] AC 1, Lord Tomlin stated: “Every
man is entitled, if he can, to order his affairs so that the tax attaching under the
appropriate Acts is less than it otherwise would be. If he succeeds in ordering them
so as to secure this result, then, however unappreciative the Commissioners of
Inland Revenue or his fellow-taxpayers may be of his ingenuity, he cannot be
compelled to pay an increased tax.”
In our law, it is an accepted principle that people may organise their affairs in such a
way that they minimise the amount of tax they pay − as long as they stay within the
confines of the law and do not cross the line into tax evasion. But, the question that
needs asking is: where do we draw the line between tax avoidance on the one hand
and tax evasion on the other?
Tax avoidance
Essentially, tax avoidance amounts to an attempt by a taxpayer to minimise his/her
tax liability legally. Therefore, a taxpayer can use the provisions of the Income Tax
Act 58 of 1962 and other relevant legislation to his/her advantage to arrange his/her
affairs tax-effectively. An example of legal tax avoidance would be bequeathing
assets to public benefit organisations to avoid paying estate duty on those assets.
Tax avoidance and tax planning are similar concepts in that a shrewd tax planner
can organise his/her affairs in such a way that he/she pays no tax or a minimal
amount of tax. In such a case, the question is whether the taxpayer has avoided tax
in such a way that his/her avoidance can be considered impermissible and,
therefore, amount to tax evasion.
© Luise Ostler – Schoeman Attorneys 2013
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The moral question of tax avoidance is contentious in that some court decisions
imply that a taxpayer is entitled to avoid tax where possible, while others describe
tax avoidance as an evil which imposes a heavier tax burden on the fiscus and the
avoider’s fellow taxpayers. I would suggest the correct view is that a taxpayer is free
to arrange his/her affairs to minimise his/her tax burden. It is up to SARS to employ
the provisions at its disposal to counter measures where a taxpayer crosses the line
and becomes more than just a shrewd tax planner.
Tax evasion
Essentially, tax evasion amounts to using illegal means to reduce tax liability. These
illegal means could include non-disclosure of income, falsification of accounts books
and claiming deductions for expenditure that was not actually incurred.
Tax evasion is an offence and a taxpayer who is found guilty will be subject to
severe penalties. An example of illegal tax evasion would be where a taxpayer
claims the cost of an overseas business trip as a deduction from his/her gross
income when, in fact, the trip was not undertaken for business purposes but, rather,
for pleasure.
Applicable legislation
The so-called ‘anti-avoidance provisions’ comprise specific sections of the Income
Tax Act, known as the ‘specific anti-avoidance measures’, as well as the GAAR or
‘general anti-avoidance regulations’, which are set out in sections 80A-80L of the
Income Tax Act.
The need to develop these anti-avoidance provisions may best be explained by the
words of Lord Houghton in Taxes, the Journal of the Inland Revenue Staff
Federation, which stated: “Tax-gatherers dislike people who get the better of them.
They see themselves as the custodians of the fiscal morals of the nation. Tax
avoiders, they say, are bad citizens who dodge the column and put part of their
burden on to others. While the small fry get up to minor tricks, the big boys employ
specialists to launch tax-avoidance rackets on a scale which makes bank robbers
envious.”
© Luise Ostler – Schoeman Attorneys 2013
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The specific anti-avoidance measures curb tax avoidance by preventing certain
transactions from resulting in a tax benefit. For example, sections 7(2) to (10) deal
with income derived from donated assets. By way of illustration, sections 7(3) and (4)
provide that where a parent donates assets to a minor child, any income derived
from such assets will be taxed in the hands of the donor parent.
The GAAR, on the other hand, are designed to deal with illegal tax avoidance by
providing in clear terms what will amount to an impermissible, and therefore illegal,
avoidance arrangement. The GAAR specify that, in the context of business, an
arrangement will be impermissible if it was entered into or carried out by means or in
a manner that would not normally be employed for bona fide business purposes,
other than obtaining a tax benefit; or if it lacks commercial substance, in whole or in
part. The GAAR further provide that, in a context other than business, an
arrangement will be impermissible if it was entered into or carried out by means or in
a manner which would not normally be employed for a bona fide purpose, other than
obtaining a tax benefit. An arrangement carried out in any context will be
impermissible if it has created rights or obligations that would not normally be
created between persons dealing at arm’s length or if it would result directly or
indirectly in the misuse or abuse of the provisions of this Act.
It goes without saying that the wording of the GAAR provides for a broad application
of the anti-avoidance provisions and allows SARS to attack arrangements from a
variety of angles. SARS’ powers are equally broad when it comes to the remedies at
its disposal, namely those contained in section 80B.
Important principles
There are certain principles that are applied by SARS when it is considering whether
a particular act of tax avoidance amounts to tax evasion.
Firstly, there is the principle of totality versus individual steps. When this principle is
applied, it involves considering the totality of a scheme when the individual steps
themselves appear to be genuine transactions. Secondly, there is the similar
principle of substance over form. This involves SARS considering the intentions of
© Luise Ostler – Schoeman Attorneys 2013
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the parties involved and what they are aiming to do instead of the form that their
transaction takes.
The reasoning behind both these principles is that, as was held by the court in the
case of Commissioner of Customs and Excise v Randles Brothers and Hudson
Limited 1941 AD 369, ‘a disguised transaction is in essence a dishonest transaction,
inasmuch as the parties to it do not really have, inter partes, the legal effect which its
terms convey to the outside world. The purpose of the disguise is to deceive by
concealing what is the real agreement or transaction between the parties. The
parties wish to hide the fact that their real agreement or transaction falls within the
prohibition or is subject to the tax, and so they dress it up in a guise which conveys
the impression that it is outside of the prohibition or not subject to the tax.’
Conclusion
Whether it happens in a business context or not, whenever a tax benefit is obtained,
the taxpayer should ensure that the benefit has been derived by legal and bona fide
means so that if SARS questions it, a suitable explanation can be provided. As
stated above, every taxpayer is allowed to arrange his/her affairs so that they pay
the minimum possible amount of tax. But, he/she should not get carried away and try
to minimise his/her liability beyond the allowable limits set by SARS.
As a taxpayer, if you are uncertain whether your tax planning arrangements are open
to attack or not, we recommend approaching a tax consultant for advice.
© Luise Ostler – Schoeman Attorneys 2013