What’s the Difference Between Tax Evasion, Tax Avoidance, and Tax Planning?

Tax evasion, tax avoidance and tax planning. They’re all probably terms you’ve heard before, usually in a news story involving celebrities and big multinational companies. Though they sound similar, they’re actually very different things and it’s important to understand the differences if you’re to avoid ending up in serious problems with HMRC.

What is tax evasion?

Tax evasion occurs when you deliberately and dishonestly avoid paying the tax you owe to HMRC. This could be income tax, excise duty, VAT, or any other form of tax.

The main point to know about tax evasion is that it’s against the law.

If you’re found guilty of tax evasion you may need to pay up to 200% of the tax due plus additional costs. You might even face time in jail.

What counts as tax evasion?

Tax evasion is deliberate and there are several ways it is committed, covering anything from failing to tell HMRC about cash-in-hand work, to aggressive tax avoidance schemes.

Not reporting your taxable income

This income could be from self-employment, pension income, or rental income to name just three. Essentially, if you have income that hasn’t been taxed at source, you’ll need to tell HMRC about it by submitting a tax return. If you don’t, you could be committing tax evasion.

But this is HMRC we’re talking about, so there’s always an exception. You might not need to report self-employed or property income to HMRC if the total amount you earn from it in a tax year is less than ￡1,000 – even if you also have other income (such as from employment).

Cash-in-hand work

If you do work for a customer (or sell them a product) and they pay cash, it can be tempting to simply ‘pocket it’ without recording it for tax purposes. This is illegal, and a common type of tax evasion which is always best avoided. Make sure your income is accurately recorded!

Tax avoidance schemes

These are very specific financial schemes that are structured to deliberately avoid paying tax. Again, we can’t emphasise this enough: tax avoidance schemes can land you in serious hot water, including fines and prison time. Best avoided.

Claiming tax relief on non-allowable expenses

This is where you deliberately claim business expenses that aren’t actually eligible to claim against tax. Sadly, the fear of getting expenses wrong usually means that most people are missing out on claiming for those which are allowable.

It’s one of the many reasons why we’re so keen on meticulous bookkeeping – it makes it much easier to see what the allowable expenses are, and to claim for them accordingly.

Missing trader fraud/carousel fraud

This is where goods are imported, VAT-free, before being sold on to customers with VAT added on. Tax evasion occurs when the VAT is then not reported and paid to HMRC.

Not reporting imported goods properly

By undervaluing or not declaring imported goods on purpose, you’re committing tax evasion by not paying the right import duties.

Identity theft

This is where a person takes on someone else’s identity so they can carry out taxable transactions in their name.

 What is tax avoidance?

Tax avoidance is a bit different from tax evasion in that it’s not technically against the law, although in some cases it does throw up some moral issues.

Tax avoidance is essentially using a legal tax avoidance scheme in order to reduce the amount of tax you have to pay. This could be by paying extra into a pension scheme for example, which would then work to save tax. This is a really common one and regarded as an acceptable practice.

That said, some tax avoidance schemes, although still legal, are rather more shady. The kinds of practices seen in the Panama Papers leaks showed that although using legal tax havens might not indicate illegal activity, many still consider them immoral, and out of sync with the government’s intentions.

Is tax avoidance legal?

Technically yes but it’s a big grey area, ranging from umbrella payroll schemes to disguised remuneration packages.

Umbrella Payroll Schemes (the potentially illegal kind)

Umbrella payroll schemes are pretty common in the UK. They occur when your pay from the umbrella company is divided into smaller payments which go through the payroll before being subject to PAYE deductions.

It means you’re only paying income tax and National Insurance on a much smaller part of your income, leaving a large chunk of the remaining income untaxed. The larger payments come from a different account to the smaller ones, often from overseas, with the payslip showing the larger payments separately. It will also usually be referred to as something like a credit, investment or loan – and therein lies the issue.

The scheme promoter makes the promise that you can keep as much as 95% of your pay without needing to pay income tax or National Insurance. Some will even try to convince you that HMRC endorse the scheme, when in fact they don’t. Payments may even be sent through a number of companies before they even get to you.

The bottom line here is that umbrella payroll schemes are seriously risky. There’s often an element of non-disclosure and dishonesty, which makes the line between tax avoidance and tax evasion very blurry. If you’ve been involved in one, seek professional financial advice immediately.

Disguised Remuneration Schemes

Disguised remuneration schemes work to avoid income tax and NI by paying people their income as a series of loans. These loans are then intentionally not paid back, but because they were never meant to be, they should attract tax. Often they are known as disguised remuneration loans.

The loan charge is an anti-tax avoidance measure forming part of the government’s Finance Act 2016, designed to recoup HMRC’s losses that are brought about by disguised remuneration schemes.

On average that year, the amount of tax each person involved in these schemes was avoiding was around ￡20,000 per year. The loan charge has since meant many people have faced a significant tax bill, forcing many into bankruptcy.

Aggressive tax avoidance

‘Aggressive tax avoidance’ is again something of a grey area. Though frowned on by the government, the case must be heard in court. This is to decide whether the avoidance is manipulating the law in a way that doesn’t represent the government’s intentions towards tax.

Due to the uncertainty surrounding tax avoidance, you should get a legal opinion before you go ahead. If HMRC finds an individual to be aggressively tax avoiding, they may have to pay back all the tax they owe, plus interest.

What is tax planning?

Tax planning is the term used to describe the practice of (legally) minimising how much tax you have to pay. There are plenty of opportunities to save money on your tax bill without breaking the law, such as being tax-efficient in the way that you pay yourself from your own limited company, and claiming tax relief.

Paying into your pension or an ISA are also examples of effective tax planning. The money you then save on your tax can be either spent or invested as you wish.

What’s the difference between tax planning and tax avoidance?

Well, tax avoidance – although not illegal as such – is riskier. With tax planning, there’s no element of deceit, you’re simply using legal tax policies to save money. Think of it like shopping at a discounter rather than a high-end supermarket; a perfectly legal way to try and save money.

What is personal tax planning specifically?

Undertaking personal tax planning can have several elements. For instance, making sure your tax return is completed accurately so there are no errors, and so that you benefit from any tax reliefs, allowances or expenses claims that can reduce the amount of tax you need to pay.

What is corporate tax planning?

Making more money for your business isn’t just about increasing sales. Careful corporate tax planning is just as important.

Corporate tax planning has the simple goal of reducing your liability for Corporation Tax so that your business is more profitable. It can help you get a better grasp of your company’s finances, allowing you to make more informed decisions, for example how to maximise reliefs and tax credits.

After all, if you don’t have accurate records around how much Corporation Tax you’re paying, it’s going to be really hard to know where you can cut your tax and increase your profit.

Why is it important to get professional tax planning advice?

At some point in life many of us will need professional tax planning advice in some way or another. Anyone starting a new job, moving to the UK from abroad, starting or growing a new business, making investments, or planning their estate will want to arm themselves with the facts. Because quite frankly, nobody wants to pay more tax than they have to.

The fact is that tax planning, evasion, and avoidance are all areas of accountancy that can be incredibly complex. It’s extremely easy to fall foul of the law, which is why professional advice is always the best way to avoid sleepless nights at best, and hefty penalties at worst.