Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. Tax sheltering is very similar, although unlike tax avoidance tax sheltering is not necessarily legal. Tax havens are jurisdictions which facilitate reduced taxes.
While forms of tax avoidance which use tax laws in ways not intended by governments may be considered legal, it is almost never considered moral in the court of public opinion and rarely in journalism. Many corporations and businesses which take part in the practice experience a backlash, either from their active customers or online. Conversely, benefiting from tax laws in ways which were intended by governments is sometimes referred to as "tax planning". The World Bank's World Development Report 2019 on the future of work supports increased government efforts to curb tax avoidance as part of a new social contract focused on human capital investments and expanded social protection.
Tax mitigation, "tax aggressive", "aggressive tax avoidance" or "tax neutral" schemes generally refer to multi-territory schemes that fall into the grey area between commonplace and well-accepted tax avoidance (such as purchasing municipal bonds in the United States) and evasion, but are widely viewed as unethical, especially if they are involved in profit-shifting from high-tax to low-tax territories and territories recognised as tax havens. Since 1995, trillions of dollars have been transferred from OECD and developing countries into tax havens using these schemes.
Laws known as a General Anti-Avoidance Rule (GAAR) statutes which prohibit "tax aggressive" avoidance have been passed in several countries and regions including Canada, Australia, New Zealand, South Africa, Norway, Hong Kong and the United Kingdom. In addition, judicial doctrines have accomplished the similar purpose, notably in the United States through the "business purpose" and "economic substance" doctrines established in Gregory v. Helvering and in the UK through the Ramsay case. Though the specifics may vary according to jurisdiction, these rules invalidate tax avoidance which is technically legal but not for a business purpose or in violation of the spirit of the tax code. Related terms for tax avoidance include tax planning and tax sheltering.
The term avoidance has also been used in the tax regulations of some jurisdictions to distinguish tax avoidance foreseen by the legislators from tax avoidance which exploits loopholes in the law such as like-kind exchanges. The United States Supreme Court has stated that "The legal right of an individual to decrease the amount of what would otherwise be his taxes or altogether avoid them, by means which the law permits, cannot be doubted."
Tax evasion, on the other hand, is the general term for efforts by individuals, corporations, trusts and other entities to evade taxes by illegal means. Both tax evasion and some forms of tax avoidance can be viewed as forms of tax noncompliance, as they describe a range of activities that are unfavorable to a state's tax system.
Anti-avoidance measures
An
anti-avoidance measure is a rule that prevents the reduction of tax
by legal arrangements, where those arrangements are put in place purely
to reduce tax, and would not otherwise be regarded as a reasonable
course of action.
Methods
Country of residence
A company may choose to avoid taxes by establishing their company or subsidiaries in an offshore jurisdiction (see offshore company and offshore trust). Individuals may also avoid tax by moving their tax residence to a tax haven, such as Monaco, or by becoming a perpetual traveler. They may also reduce their tax by moving to a country with lower tax rates.
However, a small number of countries tax their citizens on their worldwide income regardless of where they reside. As of 2012, only the United States and Eritrea have such a practice, whilst Finland, France, Hungary, Italy
and Spain apply it in limited circumstances. In cases such as the US,
taxation cannot be avoided by simply transferring assets or moving
abroad.
The United States is unlike almost all other countries in that its citizens and permanent residents are subject to U.S. federal income tax
on their worldwide income even if they reside temporarily or
permanently outside the United States. U.S. citizens therefore cannot
avoid U.S. taxes simply by emigrating from the U.S. According to Forbes magazine some citizens choose to give up their United States citizenship rather than be subject to the U.S. tax system;
but U.S. citizens who reside (or spend long periods of time) outside
the U.S. may be able to exclude some salaried income earned overseas
(but not other types of income unless specified in a bilateral tax
treaty) from income in computing the U.S. federal income tax. The 2015
limit on the amount that can be excluded is US$100,800. In addition,
taxpayers can exclude or deduct certain foreign housing amounts. They
may also be entitled to exclude from income the value of meals and
lodging provided by their employer.
Some American parents don’t register their children’s birth abroad
with American authorities, because they do not want their children to be
required to report all earnings to the IRS and pay American taxes for
their entire lives, even if they never visit the United States.
Double taxation
Most
countries impose taxes on income earned or gains realized within that
country regardless of the country of residence of the person or firm.
Most countries have entered into bilateral double taxation
treaties with many other countries to avoid taxing nonresidents
twice—once where the income is earned and again in the country of
residence (and perhaps, for U.S. citizens, taxed yet again in the
country of citizenship)—however, there are relatively few
double-taxation treaties with countries regarded as tax havens.
To avoid tax, it is usually not enough to simply move one's assets to a
tax haven. One must also personally move to a tax haven (and, for U.S.
citizens, renounce one's citizenship) to avoid tax.
Legal entities
Without changing country of residence (or, if a U.S. citizen, without
giving up one's citizenship), personal taxation may be legally avoided
by the creation of a separate legal entity to which one's property is donated. The separate legal entity is often a company, trust, or foundation. These may also be located offshore, such as in the case of many private foundations.
Assets are transferred to the new company or trust so that gains may be
realized, or income earned, within this legal entity rather than earned
by the original owner. If assets are later transferred back to an
individual, then capital gains taxes would apply on all profits. Also income tax would still be due on any salary or dividend drawn from the legal entity.
For a settlor
(creator of a trust) to avoid tax there may be restrictions on the
type, purpose and beneficiaries of the trust. For example, the settlor
of the trust may not be allowed to be a trustee or even a beneficiary and may thus lose control of the assets transferred and/or may be unable to benefit from them.
Legal vagueness
Tax
results depend on definitions of legal terms which are usually vague.
For example, vagueness of the distinction between "business expenses"
and "personal expenses" is of much concern for taxpayers and tax
authorities. More generally, any term of tax law has a vague penumbra,
and is a potential source of tax avoidance.
Tax shelters
Tax shelters
are investments that allow, and purport to allow, a reduction in one's
income tax liability. Although things such as home ownership, pension
plans, and Individual Retirement Accounts (IRAs) can be broadly
considered "tax shelters", insofar as funds in them are not taxed,
provided that they are held within the Individual Retirement Account for
the required amount of time, the term "tax shelter" was originally used
to describe primarily certain investments made in the form of limited
partnerships, some of which were deemed by the U.S. Internal Revenue
Service to be abusive.
The Internal Revenue Service and the United States Department of Justice
have recently teamed up to crack down on abusive tax shelters. In 2003
the Senate's Permanent Subcommittee on Investigations held hearings
about tax shelters which are entitled U.S. tax shelter industry: the role of accountants, lawyers, and financial professionals. Many of these tax shelters were designed and provided by accountants at the large American accounting firms.
Examples of U.S. tax shelters include: Foreign Leveraged
Investment Program (FLIP) and Offshore Portfolio Investment Strategy
(OPIS). Both were devised by partners at the accounting firm, KPMG.
These tax shelters were also known as "basis shifts" or "defective
redemptions."
Prior to 1987, passive investors in certain limited partnerships
(such as oil exploration or real estate investment ventures) were
allowed to use the passive losses (if any) of the partnership (i.e.,
losses generated by partnership operations in which the investor took no
material active part) to offset the investors' income, lowering the
amount of income tax that otherwise would be owed by the investor. These
partnerships could be structured so that an investor in a high tax
bracket could obtain a net economic benefit from partnership-generated
passive losses.
In the Tax Reform Act of 1986 the U.S. Congress introduced the limitation (under 26 U.S.C. § 469)
on the deduction of passive losses and the use of passive activity tax
credits. The 1986 Act also changed the "at risk" loss rules of 26 U.S.C. § 465. Coupled with the hobby loss rules (26 U.S.C. § 183), the changes greatly reduced tax avoidance by taxpayers engaged in activities only to generate deductible losses.
Transfer mispricing
Fraudulent transfer pricing, sometimes called transfer mispricing, also known as transfer pricing manipulation, refers to trade between related parties at prices meant to manipulate markets or to deceive tax authorities.
For example, if company A, a food grower in Africa, processes its produce through three subsidiaries: X (in Africa), Y (in a tax haven, usually offshore financial centers) and Z (in the United States). Now, Company X sells its product to Company Y at an artificially low price, resulting in a low profit and a low tax for Company X based in Africa. Company Y then sells the product to Company Z at an artificially high price, almost as high as the retail price at which Company Z would sell the final product in the U.S.. Company Z, as a result, would report a low profit and, therefore, a low tax.
About 60% of capital flight from Africa is from improper transfer pricing.
Such capital flight from the developing world is estimated at ten times
the size of aid it receives and twice the debt service it pays.
The African Union reports estimates that about 30% of Sub-Saharan Africa's GDP has been moved to tax havens.
Solutions include corporate “country-by-country reporting” where
corporations disclose activities in each country and thereby prohibit
the use of tax havens where real economic activity occurs.
Tax avoiders
United Kingdom
HMRC,
the UK tax collection agency, estimated that the overall cost of tax
avoidance in the UK in 2016-17 was £1.7 billion, of which £0.7 billion
was loss of income tax, National Insurance contributions and Capital
Gains Tax. The rest came from loss of Corporation Tax, VAT and other
direct taxes.
This compares to the wider tax gap (the difference between the amount
of tax that should, in theory, be collected by HMRC, against what is
actually collected) in that year of £33 billion.
Figures published by the Tax Justice Network show that the UK had
one of the lowest rates of tax losses due to profit shifting by
multinational companies, with the fourth lowest rate out of 102
countries studied.
According to the figures, the UK lost £1 billion from profit shifting,
around 0.04% of its GDP, coming behind Botswana (0.02%), Ecuador (0.02%)
and Sweden (0.004%).
Large companies accused of tax avoidance
In 2008 it was reported by Private Eye that Tesco
utilized offshore holding companies in Luxembourg and partnership
agreements to reduce corporation tax liability by up to £50 million a
year.
Another scheme previously identified by Private Eye involved depositing
£1 billion in a Swiss partnership, and then loaning out that money to
overseas Tesco stores, so that profit can be transferred indirectly
through interest payments. This scheme is reported to remain in
operation and is estimated to be costing the UK exchequer up to
£20 million a year in corporation tax.
In 2011, ActionAid reported that 25% of the FTSE 100
companies avoided taxation by locating their subsidiaries in tax
havens. This increased to 98% when using the stricter US Congress
definition of tax haven and bank secrecy jurisdictions. In 2016, it was reported in the Private Eye current affairs magazine that four out of the FTSE top 10 companies paid no corporation tax at all.
Tax avoidance by corporations came to national attention in 2012, when MPs singled out Google, Amazon.com and Starbucks for criticism.
Following accusations that the three companies were diverting hundreds
of millions of pounds in UK profits to secretive tax havens, there was
widespread outrage across the UK, followed by boycotts of products by Google, Amazon.com and Starbucks.
Following the boycotts and damage to brand image, Starbucks promised to move its tax base from the Netherlands to London and to pay HMRC £20million, but executives from Amazon.com and Google defended their tax avoidance as being within the law.
Google has remained the subject of criticism in the UK regarding their use of the 'Double Irish', Dutch Sandwich and Bermuda Black Hole tax avoidance schemes. Similarly, Amazon remains the subject of criticism across the UK and EU for its tax avoidance, with a 'sweetheart deal' between Luxembourg and Amazon.com enabling the American company to pay little to no corporate tax across Europe declared illegal in 2015. PayPal, EBay, Microsoft, Twitter and Facebook have also been found to be using the Double Irish and Dutch Sandwich schemes. Up to 1,000 individuals in the same year were also discovered to be using K2 to avoid tax.
Other UK active corporations mentioned in relation to tax avoidance in 2015, particularly the Double Irish, Dutch Sandwich and Bermuda Black Hole:
- Technology: Apple, Microsoft, PayPal, EBay, Intel, Yahoo!, Facebook, Uber, Netflix, Hewlett-Packard, IBM, and Twitter
- Retail: Boots (who moved their registered office to a Swiss letterbox), Kellogg's, and TopShop
- Football clubs: Manchester United, Birmingham City, Coventry City and Cheltenham Town.
- News: Daily Mail
Other corporations mentioned in relation to tax avoidance in later years have been Vodafone, AstraZeneca, SABMiller, GlaxoSmithKline and British American Tobacco.
Tax avoidance has not always related to corporation tax. A number of companies including Tesco, Sainsburys, WH Smith, Boots and Marks and Spencer used a scheme to avoid VAT
by forcing customers paying by card to unknowingly pay a 2.5% 'card
transaction fee', though the total charged to the customer remained the
same. Such schemes came to light after HMRC litigated against Debenhams over the scheme during 2005.
General anti-avoidance rule
Since the late 1990s, New Labour
consulted on a "general anti-avoidance rule" (GAAR) for taxation,
before deciding against the idea. By 2003, public interest in a GAAR
surged as evidence of the scale of tax avoidance used by individuals in
the financial
and other sectors became apparent, though in its 2004 Budget the Labour
Government announced a new "disclosure regime" as an alternative,
whereby tax avoidance schemes would be required to be disclosed to the
revenue departments.
In December 2010, the new Coalition government commissioned a
report which would consider whether there should be a general
anti-avoidance rule for the UK, which recommended that the UK should
introduce such a rule, which was introduced in 2013. The rule prevents
the reduction of tax by legal arrangements, where those arrangements are
put in place purely to reduce tax, and would not otherwise be regarded
as a reasonable course of action.
Following the Panama Papers leak, Private Eye, The Guardian and other British media outlets noted that Edward Troup, who became executive chair of HM Revenue and Customs, worked with Simmons & Simmons in 2004 representing corporate tax havens and opposed the GAAR in 1998.
Historical tax avoidance
Window tax
Avoiding the window tax in England
One historic example of tax avoidance still evident today was the payment of window tax. It was introduced in England and Wales in 1696 with the aim of imposing tax on the relative prosperity of individuals without the controversy of introducing an income tax.
The bigger the house, the more windows it was likely to have, and the
more tax the occupants would pay. Nevertheless, the tax was unpopular,
because it was seen by some as a "tax on light" (leading to the phrase
daylight robbery) and led property owners to block up windows to avoid
it. The tax was repealed in 1851.
Deliberate roof destruction
Other historic examples of tax avoidance were the deliberate destructions of roofs in Scotland to avoid substantial property taxes. The roof of Slains Castle was removed in 1925, and the building has deteriorated since. The owners Fetteresso Castle (now restored) deliberately destroyed their roof after World War II in protest at the new taxes.
United States
An IRS report indicates that, in 2009, 1,470 individuals earning more
than $1,000,000 annually faced a net tax liability of zero or less.
Also, in 1998 alone, a total of 94 corporations faced a net liability
of less than half the full 35% corporate tax rate and the corporations Lyondell Chemical, Texaco, Chevron, CSX, Tosco, PepsiCo, Owens & Minor, Pfizer, JP Morgan, Saks, Goodyear, Ryder, Enron, Colgate-Palmolive, Worldcom, Eaton, Weyerhaeuser, General Motors, El Paso Energy, Westpoint Stevens, MedPartners, Phillips Petroleum, McKesson and Northrup Grumman all had net negative tax liabilities. Additionally, this phenomenon was widely documented regarding General Electric in early 2011.
Furthermore, a Government Accountability Office
study found that, from 1998 to 2005, 55 percent of United States
companies paid no federal income taxes during at least one year in a
seven-year period it studied. A review in 2011 by Citizens for Tax Justice and the Institute on Taxation and Economic Policy
of companies in the Fortune 500 profitable every year from 2008 through
2010 stated these companies paid an average tax rate of 18.5% and that
30 of these companies actually had a negative income tax due.
In 2012, Hewlett-Packard lost a lawsuit with the IRS over a "foreign tax credit generator" which was engineered by a division of AIG. Al Jazeera
also wrote in 2012 that "Rich individuals and their families have as
much as $32 trillion of hidden financial assets in offshore tax havens,
representing up to $280bn in lost income tax revenues ... John
Christensen of the Tax Justice Network
told Al Jazeera that he was shocked by 'the sheer scale of the
figures'. ... 'We're talking about very big, well-known brands – HSBC, Citigroup, Bank of America, UBS, Credit Suisse
... and they do it knowing fully well that their clients, more often
than not, are evading and avoiding taxes.' Much of this activity,
Christensen added, was illegal."
As a result of the tax sheltering, the government responded with Treasury in Treasury Department Circular 230. In 2010, the Health Care and Education Reconciliation Act of 2010 codified the "economic substance" rule of Gregory v. Helvering (1935).
The US Public Interest Research Group said in 2014 that the United States
loses roughly $184 billion per year due to corporations such as Pfizer,
Microsoft and Citigroup using offshore tax havens to avoid paying US
taxes. According to PIRG:
- Pfizer paid no US income taxes 2010–2012, despite earning $43 billion. The corporation received more than $2 billion in federal tax refunds. In 2013, Pfizer operated 128 subsidiaries in tax havens and had $69 billion offshore which could not be collected by the Internal Revenue Service (IRS);
- Microsoft maintains five tax haven subsidiaries and held $76.4 billion overseas in 2013, thus saving the corporation $24.4 billion in taxes;
- Citigroup maintained 21 subsidiaries in tax haven countries in 2013, and kept $43.8 billion in offshore jurisdictions, thus saving the corporation an additional $11.7 billion in taxes.
Public opinion
Tax
avoidance may be considered to be the dodging of one's duties to
society, or alternatively the right of every citizen to structure one's
affairs in a manner allowed by law, to pay no more tax than what is
required. Attitudes vary from approval through neutrality to outright
hostility. Attitudes may vary depending on the steps taken in the
avoidance scheme, or the perceived unfairness of the tax being avoided.
In 2008, the charity Christian Aid published a report, Death and taxes: the true toll of tax dodging,
which criticised tax exiles and tax avoidance by some of the world's
largest companies, linking tax evasion to the deaths of millions of
children in developing countries. However the research behind these calculations has been questioned in a 2009 paper prepared for the UK Department for International Development. According to the Financial Times
there is a growing trend for charities to prioritise tax avoidance as a
key campaigning issue, with policy makers across the world considering
changes to make tax avoidance more difficult.
In 2010, tax avoidance became a hot-button issue in the UK. An organisation, UK Uncut, began to encourage people to protest at local high-street shops that were thought to be avoiding tax, such as Vodafone, Topshop and the Arcadia Group.
In 2012, during the Occupy movement in the United States, tax avoidance for the 99% was proposed as a protest tool.
Prem Sikka, Professor of Accounting at the Essex Business School (University of Essex) and scientific advisor of the Tax Justice Network pointed to a discrepancy between the Corporate Social Responsibility
claims of multinational companies and “their internal dynamics aimed at
maximising their profits through things like tax avoidance”. He wrote
in an article commenting the Lux Leaks publications: “Big corporations
and accountancy firms are engaged in organised hypocrisy.”
Fair Tax Mark
As a response to public opinion regarding tax avoidance, the Fair Tax Mark
was established in the UK during 2014 as an independent certification
scheme to identify companies which pay taxes "in accordance with the
spirit of all tax laws" and not to use options, allowances, or reliefs,
or undertake specific transactions, "that are contrary to the spirit of
the law". The Mark is operated by a not-for-profit community benefit society.
Awardees of this mark include The Co-op, SSE, Go-Ahead Group, Lush Cosmetics, Marshalls, several large regional co-operatives (East of England, Midcounties, Scotmid) and The Phone Co-op.
Government and judicial response
Countries with politicians, public officials or close associates implicated in the Panama Papers leak on April 15, 2016
Tax avoidance reduces government revenue, so governments with a
stricter anti-avoidance stance seek to prevent tax avoidance or keep it
within limits. The obvious way to do this is to frame tax rules so that
there is a smaller scope for avoidance. In practice this has not always
been achievable and has led to an ongoing battle between governments
amending legislation and tax advisors finding new scope/loopholes for tax avoidance in the amended rules.
To allow prompter response to tax avoidance schemes, the US Tax
Disclosure Regulations (2003) require prompter and fuller disclosure
than previously required, a tactic which was applied in the UK in 2004.
Some countries such as Canada, Australia, United Kingdom and New Zealand have introduced a statutory General Anti-Avoidance Rule (or General Anti-Abuse Rule, GAAR). Canada also uses Foreign Accrual Property Income
rules to obviate certain types of tax avoidance. In the United Kingdom
many provisions of the tax legislation (known as "anti-avoidance"
provisions) apply to prevent tax avoidance where the main object (or
purpose), or one of the main objects (or purposes), of a transaction is
to enable tax advantages to be obtained.
In the United States, the Internal Revenue Service distinguishes some schemes as "abusive" and therefore illegal. The Alternative Minimum Tax
was developed to reduce the impact of certain tax avoidance schemes.
Furthermore, while tax avoidance is in principle legal, if the IRS in
its sole judgment determines that tax avoidance is the 'principal
purpose' for an expatriation attempt, 'covered expat' status will be
applied to the requester, thereby forcing an expatriation tax on
worldwide assets to be paid as a condition of expatriation.
The IRS presumes a principal purpose of tax avoidance if a taxpayer
requesting expatriation has a net worth of $622,000 or more, or has had
more than $124,000 in average annual net income tax over the 5 tax years
ending before the date of expatriation.
United Kingdom
In the UK, judicial doctrines to prevent tax avoidance began in IRC v Ramsay
(1981) which decided that where a transaction has pre-arranged
artificial steps that serve no commercial purpose other than to save
tax, the proper approach is to tax the effect of the transaction as a
whole. This is known as the Ramsay principle and this case was followed
by Furniss v. Dawson
(1984) which extended the Ramsay principle. This approach has been
rejected in most Commonwealth jurisdictions even in those where UK cases
are generally regarded as persuasive. After two decades, there have
been numerous decisions, with inconsistent approaches, and both the
Revenue authorities and professional advisors remain quite unable to
predict outcomes. For this reason this approach can be seen as a failure
or at best only partly successful.
In the judiciary, different judges have taken different
attitudes. As a generalisation, for example, judges in the United
Kingdom before the 1970s regarded tax avoidance with neutrality; but
nowadays they may regard aggressive tax avoidance with increasing
hostility.
In the UK in 2004, the Labour government announced that it would
use retrospective legislation to counteract some tax avoidance schemes,
and it has subsequently done so on a few occasions, notably BN66.
Initiatives announced in 2010 suggest an increasing willingness on the
part of HMRC to use retrospective action to counter avoidance schemes,
even when no warning has been given.
The UK Government has pushed the initiative led by the Organisation for Economic Co-operation and Development (OECD) on base erosion and profit shifting. In the 2015 Autumn Statement, Chancellor George Osborne
announced that £800m would be spent on tackling tax avoidance in order
to recover £5 billion a year by 2019–20. In addition, large companies
will now have to publish their UK tax strategies and any large
businesses that persistently engage in aggressive tax planning will be
subject to special measures. With these policies, Osborne has claimed to be at the forefront of combating tax avoidance. However, he has been criticised over his perceived inaction on enacting policies set forth by the OECD to combat tax avoidance.
In April 2015, the Chancellor George Osborne announced a tax on
diverted profits, quickly nicknamed the "Google Tax" by the press,
designed to discourage large companies moving profits out of the UK to
avoid tax. In 2016, Google agreed to pay back £130m of tax dating back to 2005 to HMRC, which said it was the "full tax due in law". However, this amount of tax has been criticised by Labour, with Labour leader Jeremy Corbyn saying that the rate of tax paid by Google only amounted to 3%. Former Liberal Democrat Business Secretary Vince Cable also said Google had "got off very, very lightly", and Osborne "made a fool of himself" by hailing the deal as a victory. Although claiming that it was "absurd" to lay blame onto Google for tax avoidance, saying that EU member states should "[compete] with each other to offer firms the lowest corporate tax rates", Conservative MP Boris Johnson said it was a "good thing" for corporations to pay more tax. However, Johnson said he did not want tax rates to go up or for European Union countries to do this in unison.
