Avoid or evade?

What do Nicolas Cage, Wesley Snipes, Willie Nelson, Paul Daugerdas, Leona Helmsley, Martha Stewart, and Al Capone have in common? They did not avoid. They evaded.

The line between tax avoidance and tax evasion can be very thin. While the former is legal, the latter is not. And if it is not, this could happen:

In 2006, Nicolas Cage failed to pay more than $6 million in taxes. He attributed it to a bad management team he had in place, and he sued his money manager for fraud and negligence. Although he accepted every role offered to him in the following years, it took him ten years to pay off his bill.

In 2008, Wesley Snipes was convicted on misdemeanor charges of wilful failure to file federal income tax returns, and was sentenced to three years' imprisonment. Tax debt: $7m. He was originally charged with conspiring to defraud the United States and knowingly making or aiding and abetting the making of a false and fraudulent claim for payment, including filing false amended returns and false tax refund claims (totalling over $11.3m) using a tax protester theory called the "861 argument" (an argument that the domestic income of US citizens and residents is not taxable). He was acquitted of these crimes. Snipes tried to escape the remaining charges relating to tax returns he did not file by declaring himself a "non-resident alien" (for my students: such tactics are common with the "Freemen", "Sovereign Citizen", or "OPCA" litigation strategy).

Country music legend Willie Nelson ("On the Road Again") struggled with the IRS for 20 years. In the end, most of his property was seized to pay a $32 million tax debt. His accountant held Nelson's money in tax havens. As part of a settlement with the IRS, Nelson recorded an album ("The IRS Tapes: Who'll Buy My Memories?") designed to pay his debts. Unfortunately, album sales only generated $3.6 million. Fortunately, Nelson's career eventually picked up, and he was able to pay his debt.

Paul Daugerdas was an attorney who helped extremely wealthy clients to evade taxes by creating tax shelters that generated more than $7bn in fraudulent losses (evading taxes of $1.6bn). He received a 15-year prison sentence

TV personality, entrepreneur and writer Martha Stewart is most famous for her conviction of insider trading, but she also had tax issues. She did not pay taxes on real estate she owned in New York state and was fined $221,677.

188 counts of tax fraud: this is what Leona Helmsley and her husband, Harry, faced in 1988. Owning a $5bn hotel empire, Helmsley was finally found guilty of 33 felonies. The outcome: 16 years in prison + a $7.1m fine + 750 hours of community service (she eventually served 21 months after her sentence had been reduced to four years on appeal).

Chicago gangster Al Capone was involved in many things, including murder, extortion, and bootlegging, but never convicted. Tax evasion eventually brought him down and earned him an 11-year sentence for not paying $215,000 in taxes.

Ringing a bell

The modern, corporate version of avoiding taxes is base erosion and profit shifting (a fancy OECD term). Amazon, Facebook, Google, Netflix, Apple, and Microsoft are well-known for making a lot of money while keeping their tax bill low. This is done by registering some of their operations in low-tax countries, but doing substantial business elsewhere. You can utilize many things to divert profits, for example:

• foreign companies
• dividends
• royalties
• loans
• interest
• transfer of intellectual property

Example 1 (abstract):

→a company based in country A (a tax haven) grants a loan to a subsidiary in country B

→the subsidiary makes high interest payments in return

→these payments are deductible in country B and not taxable in country A

Example 2 (Google): Operating from Dublin (a low-tax capital) means their tax bill is low per se, in some cases even non-existent. One of the things they did was selling licences to use its search engine to a subsidiary on the Bermudas (a tax haven), which then sold them to their Irish subsidiary. These payments would normally be subject to taxation, but a company in the Netherlands was placed in between them. Thus, the licences were granted by a company in Europe, exempting them from taxation under the EU Interest and Royalty Directive, which provides for non-taxation of such income between member states.

These and many other other "concepts" help saving money, and they are not illegal. So nobody is fined or goes to prison here. Accounting for earnings at a destination of your choice is possible, but more and more countries are taking measures to make it more difficult to escape taxation. Countries around the world, as well as international organizations, are harmonising rules to deal with this issue. The OECD is working on a minimum corporate tax rate of 15% everywhere. The EU has already introduced legislation mandating this minimum rate no matter where companies are registered. They have also blacklisted "non-cooperative" countries. The UK and Australia passed similar laws, imposing rates of 25% and 40%, respectively. The US Securities and Exchange Commission (SEC) makes businesses publish details on where and how they derive their worldwide income. Authorities of other countries can use this data to identify and tackle tax avoidance measures taken by these businesses.

The digital economy poses a particular challenge. Usually, the concept of permanent establishment (which requires a physical presence) is key to give rise to tax liability. Rules are in the making.

Key vocabulary

acquit | derive | divert

seize | fraud | negligence

tax haven/avoidance/evasion

aid and abet →to help someone to do something wrong or illegal

base erosion and profit shifting →shifting profits to low or no-tax locations where you have little or no economic activity; eroding tax bases through deductible payments (interest, royalties, etc)

felony →a serious crime which can be punished by one or more years in prison

misdemeanour →a less serious crime that has a less severe punishment than a felony

permanent establishment →a fixed place of business giving rise to tax liability