Navigating Tax Evasion and Avoiding: A Comprehensive Guide

Tax is a mandatory public payment and the principal mechanism for government revenue. Tax evasion is an illegal conduct that causes income distribution imbalance and halts economic progress, resulting in financial turmoil. Tax evasion is commonly connected with the informal economy. The disparity in the distribution of Income broadens the tax discrepancy or a person’s undeclared revenue. It represents the total disparity between what amount was supposed to be reported and the amount that was actually reported. It also investigates the difference between the terms tax evading and tax avoidance.

Further, it examines the notion of tax avoidance and explains how a person or a company can legitimately use tax regulations to decrease their tax liability burden. Both of these operations belong under a category that renders a nation’s tax system disadvantageous—eventually, avoiding the taxes and evading the taxes lower the government’s source of revenue. In contrast, tax evasion significantly decreases the government’s revenue flow.

What Exactly is Tax Evasion?

Tax evasion, in simple terms, can be defined as an illicit practice undertaken by a person or an enterprise to elude the payment of tax which is due. It consists of hiding or fabricating revenue, exaggerating deductions without evidence, failing to state cash deals, and so on. Eluding the tax is a serious crime which might lead to criminal prosecution & significant penalties.

Tax evasion occurs when someone deliberately does not disclose their real earnings in their income tax return. Anyone can save taxes by using legitimate methods that involve investing in various schemes and plans, but engaging in unfair practices is a criminal offence.

There are numerous methods for eluding taxes. 

Bribery: A scenario may occur in which a specific tax amount is due & the assessee is reluctant to pay it. In circumstances like these, the person evading the tax might offer an inducement to the officers in a way to evade the payment of tax or to have it “disappear.”

 Hiding funds beyond India in Foreign Accounts Many people store their Income outside the country in offshore accounts. Offshore accounts can be defined as accounts maintained beyond the nation, & information data regarding the transactions in these accounts is not revealed to the income tax department, enabling the entire amount of taxes payable on that wealth to be evaded. It is illicit as per the law, as such Income is unknown at the time of computation of taxes. Moreover, the Department of Income Tax does not have jurisdiction over Accounts with foreign banks.

Smuggling Numerous individuals and companies resort to smuggling to evade paying taxes of the state, taxes on export export-imports, and customs duties. Under Indian law, smuggling is a punishable offence, and tax eluding can lead to severe penalties.

Neglecting to pay the required tax Regardless of tax obligations, the assessee fails to make the mandatory payments to the government, or the assessee emigrates the country. The Income Tax Department notifies taxpayers of their obligations on many occasions. After offering opportunities, there are measures in place to take action against the defaulter.

 Filing bogus tax returns in some instances, when an assessee pays their taxes, they might furnish untrue /erroneous details in order to minimise or elude in making the payment of the tax. The Aforementioned approach too is the evasion of tax as entire details are not provided, & they might pay fewer amounts in comparison to what they ought to have paid.

 Keeping Spurious Financial Statements

Incorrect financial accounts, like the P&L Account, Cash Flow Statements, Balance Sheet and other accounts might create the impression of a reduced annual income. Few companies also refuse to maintain receipts of sales with the intention of undervaluing their revenue & decreasing their liability of tax for that year.

Using Sham Documents for Getting Tax Deductions Another strategy for eluding from paying the taxes is to get bogus documentation to create an impression that you are eligible for a tax deduction, like a disability certificate to claim deductions. under section 80U of the Income Tax Act 1961.

Undisclosed Income This might be considered one of the most frequently used approaches to tax elusion. In such a situation, the assessee doesn’t disclose any revenue obtained all over the financial year. They are successful in eluding the tax by not disclosing any revenue & without paying any tax. One example to understand this can be where a property owner has kept renters and he has not communicated to the income tax department regarding the rented home & is receiving revenue from it. If he had disclosed this, his Income would have been taxed in the category of Income from House Property.

Case of Wisconsin v. Bullen[1] 

stated When the legislation creates a line, a case is either on one side of it or the other, and if on the safe side, it is no worse legally that a party has taken full use of what the law allows. When an act is labelled as delusion, it means that it is on the incorrect side of the legislation. 

Tax Avoiding

Tax avoidance is a strategy of lowering the amount of tax required to be paid based on the deductions available to taxpayers. It contributes to lowering the tax liability of assessees and corporations, notably significant companies. Avoiding taxes is a legitimate method of reducing a citizen’s or a corporation’s tax responsibilities in a country’s economy.

Legitimate Ways to Avoid the Tax 

Tax deduction under section 80C when getting a home loan: If you utilise section 80C of the Income Tax Act to your advantage when arranging your home loan and lowering your taxable Income, you can earn a benefit of Rs. 1.5 lakhs on the principal amount and ₹ Two Lacs on the interest paid under section twenty-four of the Income Tax Act 1961

According to the former British Chancellor of the Exchequer “Denis Healey” “The distinction between evasion of tax & avoidance of tax is the thickness of a prison wall.”

In other words, the distinction between evasion of tax & avoidance of tax is that the assessee who avoids the tax generally remains on the outside of the prison wall, while some evaders of tax are held inside. Evasion of Tax leads to imprisonment and penalties, whereas tax avoidance is the result of good financial planning

Income earned from Interest on Savings Accounts: Interest earned on savings accounts is normally tax-free up to a limit of Rs. 10,000. This number is the aggregate for all savings accounts. As per Section 80 TTB, it raises the threshold limit for older citizens to Rs. 50,000.

Scholarship for education: Any scholarship provided to worthy students to assist with educational expenditures is exempt from income tax under section 10(16) of the Income Tax Act 1961.

Interest earned on NRE accounts: Non-Residential External (NRE) accounts are held by Indians who do not reside in India. They earn interest on both increasing and fixed deposit balances. The amount of interest earned is known as tax-free Income.

Revenue earned from equity mutual funds/shares: LTCG up to Rs. One lakh is exempted from income tax if “shares or equity mutual funds” are sold after a one-year or longer holding period.

Gifts received on Wedding: According to the requirements of the Income Tax Act 1961, any type of wedding gift received from a “related person” is exempted from taxes. The maximum threshold ceiling for gifts received from friends or strangers is Rs. 50,000. Gifts exceeding ₹ ‘50,000’ would be taxed at the appropriate rate.

Agriculture Revenue: Revenue earned through Agriculture is exempted from income tax. The Income Tax Act, however, provided an indirect taxing approach for such Income. The partial integration of agricultural and non-agricultural Income is what it is termed. It aims to raise taxes on non-agricultural Income.

HUFs are acknowledged as independent tax entities and are entitled to individual tax exemptions for each of its members, as well as a normal tax exemption of Rs. 2.50 lakh, irrespective of the HUN’s domicile status.

Amount obtained by inheritance: Because India has no inheritance tax, any sum of money inherited through a will or as a legal heir is completely tax-free.

Tax planning entails intelligently applying the different provisions of direct tax legislation to actual scenarios in order to minimise the burden of tax on the individual. At the final level, a full comprehension of the propositions, practises & processes of taxation legislations, as well as the capacity to use this knowledge to a variety of practical circumstances, is anticipated.

The boundary separating tax eluding & avoidance of tax is razor-thin. In the following remarks, the Direct Taxes Enquiry Committee (Wanchoo Committee) made an attempt in distinguishing the 2 words.

“The line that separates ‘evasion’ and ‘avoidance’ is thus largely determined by the difference in ways of evasion employed.”

Before delving into the Supreme Court’s pertinent findings on the tax avoidance strategy, it is useful to comprehend the evolution of judicial thought in England, as our own legal opinion on the matter is heavily influenced by English reasoning.

Inland Revenue Commissioner vs. Duke of Westminster[2]

held that “every person is qualified, as long as he can, to order his affairs so that the tax accruing under the relevant Acts is lower than it would normally be.” Suppose the individual is successful in directing them to achieve this objective, he cannot be forced to pay a higher tax, no matter how dismissive the Inland Revenue Commissioners or other taxpayers are of his cleverness.”

Following WW2 & the massive profitability & racketeering, the stance of the judiciary against tax evasion altered and toughened. It was considered that there should be a restriction on the tactics that courts might use to undermine the legislative fiscal aims. 

Ramsay vs. Inland Revenue Commissioners[3] 

marked a considerable shift from the Westminster Principle. In that instance, it was believed that, while the idea that courts were unable to proceed beneath a given legitimate instrument/deal to its alleged hidden content was a key principle, it should not be excessive/ overextended. However, this theory required the judiciary to accept papers/deals proven to be authentic as it didn’t require the judiciary to examine the documentation /deal in isolation from whatever context that it properly connected to.

Nothing in the doctrine prevented a document or transaction from being seen as having impact as a nexus’s component/a chain of events/as a component of a larger deal planned overall. This was not preferring form above content or substance over form. The court had a duty to determine the deal’s legal status in any case where tax repercussions were pursued and if that transaction arose from an ongoing series or collection of transactions, designed separately as such, as that sequence or mixture which may be considered.

As a result, two principles were determined. The first is a substantial shift in the court’s view of its judicial duty in relation to ways for avoiding taxes. The 2nd thing to consider was that while evaluating a similar strategy, it was critical to conduct sufficient research to discover where the earnings, gains, or losses may be located. It was also said that the court’s acknowledgement that every phase in a transaction was a real step in achieving the desired legal outcomes did not limit the court’s ability to analyse every phase separately for the purpose of evaluating the fiscal outcomes.

Thus, in general, one should examine the sequence of deals to evaluate the monetary effect of a predetermined set of deals intended to operate as such.in its entirety rather than analysing the scheme and taking into account every transaction individually.

A. Raman & Co. vs. Commissioner of Income Tax [4]

The Apex Court adopted the Westminster case’s ruling. It was noted that it is not illegal to avoid paying taxes by conducting business activities in a way that spreads out the tax obligation. The taxpayer may use a mechanism to divert revenue before it accrues or becomes due to him. The device’s efficacy is determined not by moral considerations, but by its implementation of the Income-tax Act of 1961. The legislature’s orders in taxation laws cannot be broken. They can only be broken under the pain of punishment, although they may be legitimately bypassed.

CIT vs. Khanwar[5]

“The taxing body has the right & is definitely obligated to ascertain the real lawful connection arising from a deal, where the involved parties have decided to hide the contractual connection by a device, the taxing agencies are allowed to untangle the tool in order to ascertain the true nature of the connection”. A deal’s ramifications in terms of the law on the other hand, can’t be eliminated by inquiring into its essence.”

Doctrine of Form and Substance

One of the explanations why an assessee could utilise tax planning is the existence of the notion of form & substance. This doctrine’s underlying idea is straightforward. To what extent might a judiciary extend the meaning of a law to embrace a specific set of circumstances if those facts were plainly fabricated by a taxpayer so as to elude/reduce the taxable Income & the precise reading of the law doesn’t appear to safeguard them? Is it possible to disregard a deal’s substance without ascertaining its form?

Landmark decisions where the notion of form was present & substance had a significant influence on the process of decision-making:

Motor and General Stores (P) Ltd. vs. Commissioner of Income Tax[6]

In the absence of any proof of bad intent/deception, the Supreme Court stated that the taxation legislation must be administered according to each party’s legal entitlements as they pertain to the deal. As per the judiciary, when a deal is depicted in a paper. The tax obligation is determined by the significance and substance of the language employed in line with ordinary construction norms. 

Duke of Westminster vs. ICR[7]

The House of Lords held the legal form cannot be ignored when examining the substance of the transaction.

CIT vs. B.M. Kharwar[8]

That the Department of Taxation has the authority and obligation to assess the genuine legal relationship that results after a deal. When both parties decide to hide the lawful connection by a device, the tax department will need to find the gadget & ascertain the real nature of their connection. The legal consequence of a deal, on the other hand, it could not be altered by inquiring at “the substance of the deal” The aforementioned idea equally pertains to circumstances where the lawful relationship is expressed in an official instrument & situations which must be collected based on oral & written proof & also the act of the deal’s participants.

Ram Laxman Sugar Mills vs. CIT[9]

According to Justice Shah, in order to determine the lawful consequence of a deal, the judiciary has to establish the motives of each party initially & if vague words are employed, the judiciary must typically choose an understanding that is consistent with the parties operating on the premise of the legitimacy of the agreement. As a result, every claim made by an assessee will be examined in light of the motive, & if there was a desire to deceive the department, the deal or claims will be deemed fraudulent by the judiciary.

Therefore, unless there is clear proof of malicious intent that creates a shape that is a “colourable device”/ “just a lawful semblance” or “not real” form, the tax department is not warranted in discarding the lawful framework and inquiring about the deal’s details.

Effective Tax Planning Must Meet Two Important Criteria:

(a) Compliance With Current Legislation & (b) Flexibility.

To pass the initial test, a good knowledge of the law, regulations, & rules is necessary for tax planning; this legal expertise includes not just the provisions of tax legislation & the case law that has developed on these acts, along with additional subjects, of legislation, including personal & civil such that the tool employed by the tax planner isn’t undermined by Jurisprudential concepts that apply to everyone.

The 2nd flexibility test attempts to verify that statutory negation does not undermine the efficacy of the tax planning device. However, the tax planner could be efficient in locating a tool that he believes is legal, the following statutory denial may negate his success. To address this need, his tax strategy must be adaptable. The device’s flexibility fundamentally implies that it allows for appropriate adjustments in acceptable forms. Flexibility is a useful idea. Its context and application are determined by the facts of the case. Flexibility may be useless in some situations. In fact, flexibility may render the tax plan null and void. However, where flexibility is permitted, the tax planner should keep this criterion in mind to counteract statutory negation measures. In light of this, tax planning methods should be as flexible as feasible, aiming to prevent irreversible circumstances. As a result, the tax planner must be aware of any noteworthy advances in his sector.

To be a successful enterprise, tax strategies shouldn’t neglect legal purposes; rather, they ought to be directed to each circumstance.to ensure that not just tax advantages are acquired, but additionally tax responsibilities are fulfilled without failure to ensure penalties are not attracted.

C.W.T. vs. Arvind Narottam[10]

Justice Sabyasachi Mukherji the following noteworthy observations:

(i) There can be no place for tax avoidance decisions when the wording of the document of settlement is clear & devoid of confusion.

(ii) In McDowell’s situation, Chinnappa Reddy asserted, one would want to have Justice Holmes’ enthusiasm that taxation is the cost of civilised society & that one prefers to spend that money to purchase civilization. However, there is a problem that numerous regular taxpayers frequently pose in a society of scarcity (with showy expenditure and deprivation for the vast majority) is whether he buy civilization with taxes or facilitate the waste and ostentation of the few. 

McDowell and Co. Ltd vs. CIT [11]

In this decision, the Apex Court ruled that planning of tax is permitted provided as long as it falls within the legal structure. As a result, colourable tools aren’t useful in planning for taxes & one shouldn’t harbour the belief that they may avoid paying taxes by using questionable methods. Every individual who meets the criterion for paying taxes is expected to do so honestly.

CIT vs. High Energy Batteries (India) Ltd.[12]

The Madras High Court ruled in the present case that the sale and leaseback transaction is not a fake transaction, and it followed the Supreme Court’s decision, which stated that in deciding the legal nature of a transaction, courts should look at the transaction in its entirety rather than dissecting it.

Consolidated Finvest and Holdings Ltd. Vs. ACIT[13]

In this case, the Delhi Tribunal examined multiple transactions between two connected corporations that resulted in the capital loss to one firm and decided that no tax evasion occurred. Furthermore, the officer was unable to provide any explanation or proof to indicate that it was a hoax.

Conclusion

Considering all the extensive discussions, we can now conclude that India requires a more effective legal structure, as well as stronger legislation and rules, in order to reduce the number of offences committed by persons who are blameless but are not legally allowed to be. As we already mentioned, there are several methods by which people try to evade taxes, and these methods are so stiff that the government is unable to prohibit them entirely.

Avoiding taxes and evading taxes share a common goal of lowering taxes. However, one does this through legitimate methods & the other by using unlawful means. The Indian government has made provisions for a person or a legal body to limit taxes on revenue, whilst the administration has mandated numerous fines for evading the taxes. The biggest source of low government revenue is tax evasion. Because of dishonest tax collectors and ineffective tax frameworks, the majority of countries that are developing throughout the globe are impacted by tax evasion.

This leads to unaccounted money and the establishment of an alternate economy. If a nation’s economy desires to evolve, the system of taxation and collecting sections must be altered. Tax relief is needed to minimise the quantity of eluding the taxes, and more serious consequences for the offences of eluding the taxes are needed to close the discrepancy. Offences associated with Taxes are like a hazardous sickness that steadily consumes the economy of a nation & cannot be readily prevented by ineffective government policies. Additionally, nationals play a vital part as long as they are mindful of such offences & obey legislation & government; they are simply prevented and destroyed. It is a jinx that promotes the rise of black money.

Footnotes

[1]Wisconsin v. Bullen, (1916), 240 U.S. 625 para no 630.

[2]Duke of Westminster,v..Inland Revenue Commissioner, (1936) AC.

[3]Inland Revenue Commissioners v. Ramsay, (1982) AC 300.

[4]A. Raman & Co. vs.CIT, 1 SCR 10.

[5]CIT vs. Khanwar, (1969) 72 ITR 603 (SC).

[6] Motor and General Stores (P) Ltd.Vs.CIT, (1967) 66 ITR 692.

[7]ICR vs. Duke of Westminster, (1936) 19 ATC 498.

[8]B.M. Kharwar v. Commissioner of Income Tax.(1969) 72 ITR 603 (SC).

[9]Commissioner of Income Tax.v..Ram Laxman Sugar Mills (1967) 66 ITR 613, 617 (SC).

[10]Arvind Narottam vs. C.W.T [1988] 173 ITR 479 (SC).

[11]McDowell and Co. Ltd vs. CIT, 1986 AIR 649, 1985 SCR (3) 791.

[12]CIT vs. High Energy Batteries (India) Ltd., (2012) 348 ITR 574 / 74 DTR 9 / 208 213 (Mad) (HC).

[13]Consolidated Finvest and Holdings Ltd. Vs. ACI, ITA 2792/DEL/2014.

This article has been contributed by Nikhil Raghav.