Meaning and Difference Between Tax Evasion and Tax Avoidance

Introduction

Every individual who has to pay taxes is constantly looking for ways to reduce their tax liability. Some do it legally while others take to illegal methods. That is the primary difference between tax evasion and tax avoidance. The way you choose to reduce the taxes you pay determines which side of the fence you are on.

What is Tax Evasion?

Tax evasion is an illegal method by which you can circumvent the tax that you pay. It is a fraudulent activity by which you reduce the income that you report or inflate the amount of expenses. The meaning of tax evasion can be understood as a deliberate manipulation of the money that you make to eliminate or reduce the amount of taxes that you owe.

Any of the following activities that you undertake can be considered as an attempt of tax evasion:

• Making false statements about your income or expenses

• Hiding relevant documents

• Not maintaining complete records of the transactions

• Concealing income

• Overstatement of tax credit

• Presenting personal expenses as business expenses

 Tax evasion is considered a crime in all parts of the world, punishable by law.

What is Tax Avoidance?

Tax avoidance, on the other hand, is a legal method by which you can reduce your tax liability. Tax avoidance entails using loopholes in legislature, or undertaking various other activities by which you can reduce the amount that you owe in taxes.

For instance, if you invest in financial instruments outlined in Section 80C of the Income Tax Act, such as Public Provident Fund or Equity Linked Savings Scheme, you can claim deductions. This will be considered tax avoidance.

There are various legal methods of tax avoidance that you can undertake, such as taking out a loan for an electric vehicle or an education loan. Through tax planning, you can approach tax avoidance honestly that does not defy the law.

Alternate Read: ELSS vs PPF: Key Differences Between ELSS and PPF

What is the Difference Between Tax Evasion and Tax Avoidance 

To understand what tax evasion is and how it is different from tax avoidance, you can refer to the following points:

1. Nature

Tax evasion is an illegal method of minimizing tax liability. Tax avoidance, on the other hand, is a legal method of reducing the amount of taxes that you owe.

2. Motive

The motive behind tax evasion is to eliminate taxes completely. Tax evasion aims to lie to authorities and find immoral ways to reduce tax liability. Tax avoidance is a moral and legal method to minimize tax liability. The motive is to reduce the amount of tax that you owe.

3. Consequence

Tax evasion is illegal, thereby attracting imprisonment, fines or both, if found out. Tax avoidance can be done legally. If you have deliberately used loopholes to avoid taxes, you may attract legal penalties. Tax avoidance is usually not considered a criminal offence.

4. When Does it Happen?

Tax evasion usually happens once the tax has become due. Tax avoidance, on the other hand, can occur before the tax liability.

5. How it is Done

When it comes to tax evasion, it is usually done through illegal means. Tax avoidance is done legally through acts such as tax planning.

Examples of Tax Evasion

There are creative ways in which you can undertake tax evasion. Some methods may not look illegal, but they are. If you want to know what constitutes tax evasion, here are some examples:

• Not reporting foreign income is tax evasion. For instance, if you have rental property that is outside India, not reporting this income will constitute tax evasion.

• Failure to report income generated from cryptocurrencies is tax evasion.

• Not reporting income generated through all-cash transactions is considered tax evasion.

• If you undertake criminal activities, such as drug sales or running a brothel, you may not report this income. This is tax evasion.

• Making fake reports or false financial statements is also a form of tax evasion.

• If you pay a bribe to a tax official to hide your financial statements, that is a form of tax evasion.

Examples of Tax Avoidance

If you undertake tax planning and find legal ways to reduce your tax liability, it will be considered tax avoidance. Here are some examples of tax avoidance:

• Investing in financial instruments that enable you to save taxes is a form of tax avoidance.

• You could claim various deductions such as interest on home loan, premiums on medical insurance, loan for education, etc. These are methods of tax avoidance.

• Donating to a charitable institution or a political party to claim deductions is tax avoidance.

• Using a financial planner to invest and claim deductions is a way of tax avoidance.

Which is the Best Way to Save Taxes?

Now that you know the difference between tax evasion and tax avoidance, it may be obvious to you that taking the legal route is a better way to reduce your tax liability. Tax evasion can lead to criminal consequences including imprisonment. To avoid that, it is better to undertake tax planning and find a legal way to save taxes.

Conclusion

Tax evasion and tax avoidance are two of the most common ways to reduce taxes. While tax evasion is illegal, tax avoidance is a legal and ethical way to reduce your tax liability. It is always better to find a legal way to reduce your tax liability rather than taking the high road.

Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investments in securities market are subject to market risks, read all the related documents carefully before investing. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.