The issue of tax evasion and avoidance is a complex multidimensional problem.

There are many

different reasons why individuals and corporations try to avoid or reduce the amount of tax they have to
pay either by (semi-)legal or illegal practices. Before these different dimensions are analyzed in more
detail, this section provides an overview about relevant terms and definitions as well as measures to
assess the relevance of the problem.

However, distinguishing between tax evasion and mere tax avoidance is not always easy in practice. In
other words, it is not always easy to draw the line between the two. Since tax evasion is where people
intentionally avoid paying their tax liability, perhaps many forms of tax avoidance are also actually
wrong or unethical; but non-punishable. For example, is backdating certain payments in order to fully
optimized tax reliefs considered as tax avoidance or tax evasion? It may be legal, thus it is tax avoidance.
But is it ethical? Is not the amount of tax successfully avoided also evaded?

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Definition

The term "tax evasion" refers to reduction of tax liability by illegal means. The term "tax avoidance" is
usually used to refer to an inappropriate reduction in tax liability and was described by Lord Nolan in the
following terms: "The hallmark of tax avoidance is that the taxpayer reduces his liability to tax without
incurring the economic consequences that Parliament intended to be suffered by any taxpayer
qualifying for such reduction in his tax liability."1

The hallmark of tax avoidance is that the taxpayer reduces his liability to tax without incurring the
economic consequences that Parliament intended to be suffered by any taxpayer qualifying for such
reduction in his tax liability. The hallmark of tax mitigation, on the other hand, is that the taxpayer takes
advantage of a fiscally attractive option afforded to him by the tax legislation, and genuinely suffers the
economic consequences that Parliament intended to be suffered by those taking advantage of the
option.2

TAX PLANNING AND AVOIDANCE

The interface between tax planning and tax avoidance has been a constant subject matter of debate
between taxpayers, tax authorities and judicial authorities. In the recent years, we have been witnessing
a significant change in the approach of tax and judicial authorities across the globe, who are closely
scrutinising transactions entailing reduction of taxes.

Tax incidence can be reduced through tax planning, tax avoidance or tax evasion. To begin with, there is
a thin line separating 'tax planning' from 'tax avoidance'. Legitimate tax planning may reduce the
incidence of tax but impermissible tax avoidance may lead to tax and penal consequences.

Tax planning may be defined as an arrangement of one's financial affairs to take full advantage of all
eligible tax exemptions, deductions, concessions, rebates, allowances permitted under the IncomeTax

1
HC Deb 24 May 2006 ccWA111-2
2
IRC v Willoughby & Another [1997]
Act ,1961, so that the tax burden is minimised in the hands of the taxpayer without violating the legal
provisions.

For instance, tax planning can be done by investing in specified permissible avenues eligible for
deduction under section 80C or investment in an SEZ unit. It is legitimate as the legislature intends
optimum utilization of these deductions and exemptions to promote economic activity in the country.

Tax avoidance is reducing or negating tax liability in legally permissible ways by structuring one's affairs.
Any such transaction would be valid only if it has commercial substance and is not a colourable device.
The Supreme Court, in M/s McDowell and Co Ltd Vs Commercial Tax officer, 1985, (154 ITR 148(SC), held
that for tax planning to be legitimate it must be within the legal framework and colourable devices
cannot be part of tax planning. In deciding whether a transaction is a genuine or colourable device, it is
open for the tax authorities to go behind the transaction and examine the "substance" and not merely
the "form".

The recent Vodafone controversy is an attempt by the tax authorities in this direction. In the case of
Vodafone, the shares of a foreign company were transferred by one nonresident to another nonresident
where the only principal asset of the foreign company was shareholding in the underlying Indian
company.

The tax authorities, disregarding the corporate veil, treated the transfer of shares of the foreign
company as effectively resulting in transfer of shares of the Indian company and taxed the capital gains
arising on such transfer of shares in India. The contention of the tax authorities was upheld by the
Mumbai High Court and the matter is now pending before the Supreme Court.

Tax evasion is the method or means by which the tax is illegally avoided through unacceptable means. It
refers to a situation where a person tries to reduce his tax liability by deliberately suppressing the
income or by inflating the expenditure, recording fictitious transactions, etc.

It is to be noted that the proposed Direct Tax Code (DTC) provides for general anti-avoidance rules
(GAAR) to address the concerns of tax avoidance. The provisions of GAAR may be invoked by the
commissioner of income tax, wherein a taxpayer has entered into an arrangement to obtain tax benefit
and such arrangement fulfils any one of the following conditions:

it is not at arms length or

it represents misuse or abuse of the provisions of DTC or

it lacks commercial substance or

it is entered into or carried on in a manner not normally employed for bonafide business purpose.

To avoid arbitrary application of GAAR, it is expected that the Central Board of Direct taxes will provide
the threshold limit and the guidelines to specify the circumstances under which GAAR may be invoked.

Accordingly, the new rules under DTC (ie, GAAR) shall have farreaching implications on the transactions
that lack commercial substance or represent abuse of tax provisions. As such, it is important for the
taxpayers to understand the distinction between tax planning and tax avoidance to avoid unwarranted
tax and penal consequences.
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one reason for the steady increase of tax gap may simply be because taxpayers do not perceive tax
evasion as a particularly serious offence, and people seemed to view taxevasion more like a violation
than a crime and fail to see the seriousness of the act.

Since the impact of tax evasion may actually be detrimental to a countrys economy, there is a need to
examine the factors contributing towards tax evasion.

FACTORS AFFECTING TAX EVASION

The difficulty to distinguish between tax evasion and tax avoidance, there are several other reasons why
people seem undecided about the seriousness of tax evasion, for example the inadequacy of
enforcement practice, arbitrariness of enforcement, the sense that everyone is doing it, demonization
of taxes, perceived unfairness of the tax code, and dissatisfaction with the use of revenues. Meanwhile,
it is concluded that attitudes toward taxation have turned out to be an important predictor of tax
evasion and tax compliance behavior.

The factors contributing towards tax evasion are weakness of tax rules, accumulation of tax cases,
complexity of tax laws, lack of proper tax culture, and corruption of tax agents.

Based on literatures, the factors affecting tax evasion can actually be categorized into two internal and
external. Examples of external factors are the inadequacy and arbitrariness of enforcement, and the
loopholes and complexity in the tax laws. However, much more important is the internal factors
factors inside the individual doing the act; for example the need for more money, the knowledge on
how to break or bend the tax laws, and the rationalization of the act.

Rationalization, which is a very dominant internal factor, is when people find reasons to justify their
wrongful acts. Examples of rationalizations are denial of responsibility, denial of injury, denial of the
victim, condemnation of the condemners, and appeal to higher loyalties, everyone else is doing it, and
entitlement (Brooks & Dunn, 2012).

Examples of rationalizations among taxpayers may be as follows:

Denial of injury no one gets hurt if I do not pay tax

Denial of the victim no one is a victim if I do not pay tax since I am not stealing from anyone

Condemnation of the condemners it is alright not to pay tax since the tax laws are unfair, the tax
collected will not be used appropriately

Everyone else is doing it many other people, with more income than me, actually cheat on their tax

Entitlement I have the right to reduce my tax payment, the country has already collected substantial
amount of tax
Meanwhile, for tax agents, the rationalizations may be as follows:

Denial of responsibility I am not actually responsible for this, my clients asked me to do so

Denial of injury no one gets hurt if my client does not pay the actual amount of tax

Denial of the victim no one is the victim if my client does not pay the actual amount of tax, my client
does not steal from anyone

Condemnation of the condemners the tax laws are unfair and the tax collected will not be used
appropriately, therefore it is alright if my client does not pay the actual amount of tax

Appeal to higher loyalties my main duty is to help my clients reduce their tax payment, I was paid to
do just that

Everyone else is doing it all other tax agents are also assisting their clients to reduce tax

Entitlement I have the right to assist my clients in reducing their tax payment

While external factors can be controlled by constant improvement of the tax laws and more effective
enforcement of the laws, it is more difficult to do so for the internal factors. Ideally, the presence of
internal self-controls and supportive professional self-regulatory controls are very much needed in order
to curb tax evasion intentions (Stuebs & Wilkinson, 2010). When internal factors such as rationalizations
and intentions are concerned, perhaps a better way to address the tax evasion problem is by cultivating
an ethical culture towards the payment of tax. Taxpayers and tax agents alike should first ask
themselves whether what they intend to do is ethical or not, rather than whether it is legal or not.
Ethical values should be used to help draw the line in deciding what can or cannot be done to reduce tax
payments.