For as long as taxes have existed, people have sought to avoid paying them. The term tax avoidance can be traced back to the early 1900s, and the issue has gripped the public, press and politicians ever since. Today, tax avoidance is considered to be one of the most important economic issues of our time.
However, although the term tax avoidance is familiar to most people, the precise definition of tax avoidance been a vexing issue. The term seeks to describe a number of different behaviours, and is often misused by people seeking to legitimise behaviour considered distasteful. This gives rise to the most common misconception, that all tax avoidance is legal. There is often a dissonance between how the public view tax avoidance and how people administering the tax system view it, leading to public anger about government inaction.
The difficulty in finding a definition which adequately describes tax avoidance has led some to compare it with hardcore pornography – the definition of which was once described by a US Supreme Court Justice as “you know it when you see it.”
To some extent, the idea that tax avoidance can be judged by common sense is not a bad one. So much of tax avoidance relies on the construction of complex structures which may seem logical in the minds of the tax lawyers who construct them, but when viewed from outside seem ridiculous.
A common sense approach could serve as a useful guide to members of the public approached to engage in tax avoidance schemes. Even HMRC encourage this approach, warning the public about schemes that are ‘too good to be true’ in their guide on how to identify a tax avoidance scheme.
However, when taking decisions, tax authorities, judges and policy makers can’t rely purely on common sense.
For our purposes we propose the following definition:
Tax avoidance is an abuse of the tax system, a deliberate attempt to get out of an obligation to pay tax by entering into a set of artificial financial arrangements which have little or no commercial purpose other than the reduction of a tax bill.
Tax avoidance is unethical in that it seeks to undermine tax law and public policy. It frequently is found to be unlawful.
An important part of this definition is the idea of obligation. If the government intended for a transaction to be exempt from tax, then there is no obligation to pay tax on that transaction. It therefore follows that a person or company can not be engaging in tax avoidance by using a tax exemption in the normal way.
It is possible for people to abuse tax exemptions to produce an outcome which was never intended.
A good example of this are the film schemes which used by many celebrities. Film tax relief was originally intended to support film producers by providing tax relief on their production costs. However, tax advisors were able to abuse the relief by creating schemes which transferred the benefit to investors rather than producers.
People who defend tax avoidance often draw an equivalence between they types of artificial tax avoidance schemes designed by tax advisors and individuals using a government scheme which exempts a taxpayer from tax such as an Individual Savings Account (ISA). They are entirely different because there is no intention of any individual to get around government policy though the use of an ISA. People putting money into ISAs are doing precisely what the parliament intended to them to do.
People may view ISAs, which allow people to invest £20k a year in stocks and shares, and exempts the profits from those investments from tax forever, as an unreasonable tax break which disproportionately benefits those who are already wealthy, but that does not make it avoidance.
Tax avoidance and the law
A number of popular definitions of tax avoidance which make reference to the law. Tax avoidance is often defined in opposition to tax evasion, with tax evasion being illegal, and tax avoidance being legal.
The HMRC definition is similar in this regard, making reference to the spirit of the law:
“Tax avoidance involves bending the rules of the tax system to gain a tax advantage that Parliament never intended.
It often involves contrived, artificial transactions that serve little or no purpose other than to produce this advantage. It involves operating within the letter, but not the spirit, of the law.”
As we set out in our article on the legality of tax avoidance, defining tax avoidance in opposition to illegal tax evasion is highly problematic.
As we argue, although tax avoidance operates in the margins and gaps of the law, and as a result may not be explicitly prohibited by law, most tax avoidance is unlawful in the true meaning of the word. That is that the tax arrangements in question should be disregarded in the eyes of the law when calculating a tax liability.