Contents
Some sage advice for business owners
The subtle legalities: tax avoidance & tax evasion in the UK
The consequence of crossing the line
Identifying red flags in tax schemes
The role of umbrella companies in tax affairs
How much tax should you really pay
Navigating offshore accounts and international tax laws
The UK tax system is all about the difference between tax avoidance and tax evasion. Avoidance is using legal means to reduce your tax bill, evasion is illegal and can get you into big trouble.
In this article on tax avoidance vs tax evasion, we break it down by what’s allowed and what’s not allowed or illegal so you can make the right tax decisions.
But before we get into the definitions and examples I’ll start with…
..Some Sage Advice for Business Owners
Beware of Ethical Fading!
You might be surprised to hear that not every hardened criminal started out that way, most of them made a mistake, didn’t fix it and then realised no one noticed. It can be very easy to get away with the little crimes and then move on to the bigger ones, business owners need to have strong ethical awareness.
You won’t always know how much trouble you’re in until it’s too late but even then you always have the chance to come clean and make a deal with the authorities, an early voluntary disclosure gets you a lot of brownie points in the UK.
Need Some More Advice?
GET IN TOUCHHave some Credibility!
Tax avoidance is not going to serve you well in your business and the most successful business owners I know have come to terms with the fact they will have to pay some tax and have learned to celebrate the profits that led to the bill.
Tax loopholes take time to find and understand, that’s time that can be better spent elsewhere. But with that in mind many do exist to encourage certain business activities that are in the national interest, which is why the spirit in which you use them is important.
The problem with tax loopholes is they can be closed retrospectively, which means what’s legal today can be deemed an abuse of the system tomorrow with legislation allowing HMRC to recover tax and penalties from when you started using it. There are very few areas of English law that operate like this but tax is one of them.
Key Takeaways
Tax avoidance is the legal act of reducing tax liabilities through legitimate means, tax evasion is the illegal act of misrepresenting or concealing information to reduce tax bills, potentially leading to severe penalties including fines and imprisonment.
Good tax planning involves using legal tax reliefs and strategies such as taking the right dividends and salary, investing in ISAs or using pension schemes, aggressive tax avoidance or evasion will get you into big trouble and financial penalties.
HMRC is tough on tax evasion and aggressive tax avoidance schemes; individuals and businesses should report suspected fraud and make sure tax advisors and umbrella companies are reputable and compliant with UK tax laws.
While tax evasion is illegal, aggressive tax avoidance is also a big problem which is often caused when people use the letter of the law but not the spirit in which it was intended to gain a financial advantage.
Aggressive avoidance would be taking actions that serve no commercial purpose, for example hiring a family member at a much higher than market rate salary just to use up their personal allowance.
The Subtle Legalities: Tax Avoidance and Tax Evasion in the UK
You need to understand the difference between tax avoidance and tax evasion. Both aim to reduce tax liability but are very different in terms of legality.
Tax avoidance is using legal means to reduce the tax owed, for example exploiting loopholes or using deductions and credits. But while it’s legal it can still be penalised by HMRC.
Tax evasion is:
concealing income or information from HM Revenue and Customs (HMRC)
not declaring income or assets
misrepresenting financial information
forging invoices
Tax evasion is tax fraud. It’s a criminal offence and those found guilty can get big fines and imprisonment. So understanding the difference is key to being compliant with UK tax laws.
The Thin Line Between Avoidance and Evasion
Now we know the basics of avoidance and evasion let’s get a bit deeper into avoidance vs evasion.
Is tax avoidance legal?
While tax avoidance is legal people get a false sense of security because they don’t understand the many tools HMRC have to counter compliant abuse of the tax laws. Common methods include exploiting financial arrangements and using legal loopholes not anticipated by the tax legislation.
HMRC reserves criminal investigation and prosecution for the most serious cases of tax misconduct to make tax evasion a serious crime and to act as a deterrent to others. It’s a thin line between avoidance and evasion but crossing it can be costly.
DOTAS
There is legislation around the disclosure of tax avoidance schemes that deals with the abuse of certain government reliefs or an offshore company being used to bend the tax rules.
HMRC are often aware of the schemes being sold to taxpayers but don’t have the resource to investigate them immediately so they are issued with a DOTAS number.
The wrong type of endorsement
The providers of these tax avoidance schemes advertise a DOTAS number as a benefit of the scheme to prove it’s legitimate. Taxpayers need to understand this is a highly unregulated industry and having a DOTAS number means you will get investigated and penalties, it’s not a good thing.
Scheme Providers
In the UK there is no regulation of tax avoidance schemes and when you consider how much money HMRC make from taking legal action and imposing penalties on taxpayers it’s clear why there’s little incentive to do so.
A scheme provider will get away scot free or hide behind their terms and conditions while the taxpayer is left to pick up the pieces, often for things they didn’t even do willfully.
Legality of Tax Avoidance Strategies
We’ve established tax avoidance is legal but what are the strategies? A few common tax avoidance strategies are using an Individual Savings Account (ISA), contributing to pension schemes and claiming work-related expenses. These are all legal and tax relieved.
Some ways to reduce tax liabilities are:
Using the Annual Exempt Amount to avoid Capital Gains Tax (CGT)
Transferring assets between spouses or civil partners to reduce tax
Good tax planning means legal tax minimisation, staying within the tax laws while maximising personal or business income.
The Consequences of Crossing the Line
If entities or individuals are found to be evading tax they can face unlimited fines and up to 7 years in prison. If you provide false documentation to HMRC you could get 6 months in prison or a £20,000 fine.
Make sure all documentation is accurate and true as in the worst cases tax evasion crimes can get a life sentence especially if HMRC have been cheated.
One of the biggest changes to UK tax law in recent times is the Criminal Finances Act 2017. Under this act businesses in the UK can be criminally charged and face unlimited fines if they don’t prevent employees or associates from facilitating tax evasion or if they don’t detect tax evasion by their suppliers.
This shift in liability means businesses have more responsibility to comply with tax laws.
From Fines to Freedom Loss: Penalties for Evasion
The penalties for tax evasion are clear. Entities can face unlimited fines, directors can get up to 7 years in prison and either can be required to pay up to 200% of the tax due.
Summary convictions for tax evasion offences like income tax evasion or VAT evasion can get you 6 months in prison or a £5,000 to £20,000 fine. In the Crown court these can get up to 7 years in prison or unlimited fine.
Common forms of tax evasion are:
Not charging VAT when you should
Failing to pay VAT or PAYE to HMRC
Smuggling goods liable to excise duty
Running a business off the books
Claiming personal expenses as business expenses.
When Tax Planning Becomes Tax Fraud
Tax planning can sometimes get confused with tax avoidance and even cross into tax fraud. High profile cases like Gary Barlow and Jimmy Carr have brought aggressive tax avoidance schemes like Icebreaker and K2 into the spotlight. These schemes which were deemed tax fraud after HMRC shut them down reduced tax liability beyond what Parliament intended.
Common aggressive tax avoidance schemes involve treating payments as non-taxable loans, annuities or bonuses when in reality they’re taxable Income Tax and NICs. Contractors and freelancers can get implicated in tax fraud if umbrella companies they work with claim to legally increase take-home pay through complex tax avoidance schemes and leave potential liability for unpaid taxes and NICs. Make sure you can tell the difference between these schemes and legitimate business expenses.
Identifying Red Flags in Tax Schemes
While the promise of lower tax bills is tempting, you need to be able to spot the red flags in most tax avoidance schemes. Some of the warning signs are:
Deceptively low tax bills which will tempt you not to pay tax
Minimal taxpayer effort
Complex transactions
High promoter fees
You can spot specific red flags in employment contracts that don’t have details on income payment and deduction, offer cash for referrals or require you to sign multiple contracts. Tax avoidance schemes can appear in payslips that don’t match the actual bank deposits and have unexplained extra payments.
If you suspect a tax avoidance scheme contact HMRC straight away, get guidance and be prepared to pay any underpaid tax.
Distinguishing Genuine Advice from Schemes
Real tax advice should be based on transparent transactions with a clear commercial purpose and not contrived schemes created for tax benefits. Qualified, independent tax advisers who are members of a regulated professional body will give you real tax planning advice. Be wary of misleading claims like tax schemes endorsed by HMRC or guarantees of increased take-home pay as these can be non-compliant advice.
Aggressive tax avoidance like using fake offshore accounts or hiding assets should be a red flag for anyone getting tax advice. You should research tax advisers and schemes and get independent advice before getting into tax avoidance schemes just to reduce your tax liability.
Reporting Suspicious Activity
If you think you’ve found a fraudulent tax scheme you need to report it. Tax evasion and avoidance can be reported through the government website by filling in an online form or by forwarding suspicious emails to phishing@hmrc.gov.uk. There’s also a HMRC fraud hotline for those who can’t use the online reporting service.
When reporting you will be kept private and confidential. Don’t investigate further or alert the suspected party or anyone else that a report is being made. To avoid getting involved with non-compliant entities HMRC publishes lists of named tax avoidance schemes and their promoters, enablers and suppliers.
Contractors should check if an umbrella company has a government assigned scheme reference number (SRN) which means it’s being investigated for tax avoidance.
The Role of Umbrella Companies in Tax Affairs
Umbrella companies are big in the UK. They are used by recruitment agencies to:
Manage payroll for temps
Handle PAYE taxes
Make sure contractors pay the correct, legal amount of tax and National Insurance contributions (NICs).
Contractors can check if an umbrella company is compliant with HMRC by choosing companies accredited by professional bodies like the Freelancer & Contractor Services Association (FCSA). This means they follow the rules and protect workers’ employment rights.
Umbrella Companies
There are a few red flags to look out for. An ‘enhanced’ pay scheme option from an umbrella company is likely a tax avoidance scheme and should be a red flag. Non-compliant umbrella companies will promote tax avoidance by claiming to offer a ‘legitimate’ or ‘tax efficient’ way to keep more of your income by reducing your tax bill.
Make sure the umbrella company is paying your Income Tax and National Insurance contributions, pension and student loan repayments. You should also compare your payslip amounts with your personal tax account, student loan repayment account and pension accounts.
Ensuring Compliance with National Insurance Contributions
A real umbrella company will process pay with deductions for PAYE, National Insurance Contributions and possibly other contributions to comply with UK tax laws.
There are many tax calculators online where you can input your pay and it will give you your take home and tax amounts, these can be a useful tool when checking if you’ve had the correct tax deducted.
How Much Tax Should You Really Pay?
You’re probably thinking, “How much tax should I pay?” To answer this question we need to consider various parts of your income, apply reliefs and allowances, calculate the tax on each part of your income and adjust for any tax reducers or additional taxes. This will give you the correct amount of income tax to pay.
Key deductions from income parts are the personal allowance and the blind person’s allowance. Income included for tax is employment, pensions, social security benefits, trading or business income, property income, savings, dividends and other miscellaneous income.
UK tax rates for 2023 to 2024 are 20%, 40% and 45% with respective income bands.
Understanding Your Tax Bill
Your tax bill isn’t as scary as it sounds. It’s breaking down all parts of your income, wages, bonuses and other forms of pay. Once you’ve got all the income parts, you need to apply the reliefs and allowances which can legally reduce your taxable income.
Calculating the tax involves:
Applying the correct tax rates to the remaining income after reliefs and allowances have been applied
Considering tax reducers which can reduce the tax bill
Any additional tax due from other taxable sources or circumstances.
Tax Efficient Planning vs. Avoidance
Tax planning is reducing tax liability through legal means, such as investing in Individual Savings Accounts (ISAs) or using other tax breaks. Good tax governance in businesses is minimising tax liability by using government resources and frameworks, including allowances, deductions, rebates and exemptions, whilst paying tax responsibly.
Tax planning uses tax reliefs, allowances and reducers within the law to minimise the tax liability, tax avoidance is bending or stretching the rules to reduce tax.
Tax planning looks to the future and is for long term or short term gain, tax avoidance though similar in nature is usually short term gain and should be distinguished based on legality and features to avoid complications and penalties.
Navigating Offshore Accounts and International Tax Laws
Offshore accounts are often associated with tax avoidance schemes and tax evasion but actually serve many legal purposes. They not only allow you to save money and do transactions in different currencies but also to expand global business, invest and grow.
However using offshore tax havens can deprive governments of tax revenue and harm the economy of the account holder’s home country, so public services are affected and businesses are put at unfair competition.
UK residents hold offshore accounts in the Crown Dependencies of Guernsey, Jersey and the Isle of Man as well as in Monaco, Switzerland and Liechtenstein.
The Legality of Offshore Banking
Offshore banking is legal but setting up an offshore company in a tax haven to exploit tax loopholes is tax avoidance. However investing in offshore pensions such as QNUPs (Qualifying Non-UK Pension Schemes) can provide tax advantages like exemption from Capital Gains Tax and Inheritance Tax.
Exempt Property Unit Trusts (EPUTs) allow you to invest in property with tax free status, no UK tax.
Risks Associated with Offshore Tax Havens
Offshore tax havens may offer benefits but also come with big risks:
Significant loss of tax revenue for governments
Perpetuating income inequality
Financial instability
Limited protection
Legal and reputational hazards
Diminishing effectiveness due to international crackdowns and treaties.
Summary
Remember tax planning should be based on transparent transactions with commercial intent and you need to look out for tax scheme red flags.
Offshore accounts can serve many legal purposes but come with big risks. Always seek professional advice when dealing with these complex issues.
Frequently Asked Questions
What is the difference between tax avoidance and tax evasion?
Tax evasion is hiding income or falsifying records and is illegal, tax avoidance is using the system to reduce tax liability by exploiting the rules and legislation.
What is worse tax evasion or tax avoidance?
Tax evasion is worse than tax avoidance because tax evasion is illegal, tax avoidance is legal to some extent. So while both involve paying less tax, tax evasion is breaking the law, tax avoidance is not.
What is the penalty for tax avoidance in the UK?
In the UK the penalty for aggressive tax avoidance is usually a percentage of the tax lost to HMRC plus interest. Note however if HMRC take you to a tax tribunal then there are many other costs involved that you probably can’t recover.
What is a real life example of tax avoidance?
A real life example of tax avoidance is when individuals or businesses use legal strategies such as exploiting loopholes in the tax system to reduce their tax liability as per UK government website.
What are some red flags in tax schemes?
Unusually low tax bills, minimal effort required from the taxpayer, complex transactions, high promoter fees.
