What's the difference between tax avoidance and evasion?

There has been a lot of talk in the news recently about tax avoidance and tax evasion. So what’s the difference? 

Well, the most commonly used definition is that tax avoidance is legal while evasion is not.

Common tax avoidance measures

To many people, tax avoidance simply means paying as little tax as possible while remaining on the right side of the law. Avoidance measures are very common, and members of the public are often encouraged to use them by the government.

For example, if you save money into an ISA, then you are taking steps to avoid tax: deposits in cash ISAs get interest paid free of income tax, while any gains in a stocks-and-shares ISA do not attract capital-gains tax. Similarly, money paid into a pension benefits from tax relief, so saving through a pension is a way of avoiding income tax.

In both cases, the government uses these tax avoidance measures as a way of encouraging people to save for the future.

What are the different types of ISA?

There are numerous other steps people can legitimately take to avoid tax. Married couples or civil partners, for example, can transfer assets between themselves in order to minimise tax bills. And HM Revenue & Customs allows people to make financial gifts (up to certain limits) to family members in order to minimise any eventual inheritance tax bills.

What is considered tax evasion

Tax evasion, on the other hand, in its simplest form is generally viewed as a deliberate attempt to pay less tax by illegitimate means. This could involve failing to declare some of your income on your self-assessment form, or hiding the fact that you have certain taxable assets.

One of the forms of tax evasion that people are most familiar with involves tradesmen being paid for work on a cash-in-hand basis, but then not declaring this income to the taxman. (It is worth noting that there is nothing illegal about paying someone in cash: it is up to the tradesman to declare their income. But if you are paying in cash, it does make sense to get a receipt for any payments you make.)

Changes in technology mean that tax officials have had to make the public aware that any income derived from activities such as trading on sites such as eBay is potentially liable to income tax. 

In his most recent Budget, however, Chancellor George Osborne said that there would be a new £1,000 tax-free allowance introduced next year for online trading income.

How to legally reduce your inheritance tax liability.

Grey areas in tax avoidance

With the examples given above, the difference between legal and illegal activity when it comes to tax are clear. But tax law can be very complicated and there are numerous grey areas when it comes to what is and isn’t allowed.

HMRC and the government actually use a stricter definition of tax avoidance: officially, this is described as “exploiting the tax rules to gain a tax advantage that Parliament never intended”.

If tax officials think that someone is acting against the spirit of tax law, they can – and often do – ask them to pay more tax. HMRC recognises that, due to their complexity, tax rules can sometimes be exploited by clever accountants in order to cut their clients’ tax bills.

Six taxes you can legally avoid.

Over the past few years, there have been numerous reports of celebrities and sports stars taking advantage of loopholes found by their advisers in order to pay less tax. Some of these cases have involved investments in schemes that are designed to generate losses that can then be offset against gains elsewhere to cut tax bills.

But HMRC has frequently taken the view that such schemes are designed solely or at least primarily to avoid tax, and has therefore ordered them to be closed and extra tax to be paid. The taxman’s argument is that the schemes are contrary to what Parliament intended to happen when passing the relevant tax legislation.

It is rare, however, for those who take part in such avoidance schemes to face criminal proceedings: their defence is typically that they have not tried to mislead the tax authorities, or to hide income or assets.

Five things you may have to pay tax on.

Offshore investing

Since the UK government permits people to transfer money overseas without restriction, it is fairly straightforward to invest in investment funds or other vehicles which are registered abroad or in tax havens such as Panama or the Cayman Islands.

Such funds often receive significant tax benefits by being registered in places like these, and this means they may be able to deliver higher returns to their investors. 

Tax officials in the UK view this kind of investing as legitimate providing that the relevant taxes are paid on any income or capital gains when money is returned to this country.

For more useful tips and information, browse our money articles.