What is the difference between tax planning and tax avoidance?
Tax planning vs tax avoidanceAn assessee can reduce his/her tax liability, by legitimate means, in two ways – tax planning and tax avoidance. The tax planning is described as the arrangement of financial activities in a way that the assessee can avail maximum tax benefit by making best possible use of all the legal benefits, i..e deductions, exemptions etc.
On the other hand, the tax avoidance is a technique of refraining from tax liability, through just and fair means, but intends to defeat the fundamental motive of the legislature. The dividing line amidst the two concepts is thin and blur.
The difference between tax planning and tax avoidance primarily depends on the difference in benefits that are availed to minimise tax burden. So, take a look at this article which might help you understand the two terms in detail.
Definition of Tax Planning
By the term ‘tax planing’ we mean the arrangement of one’s financial affairs in such a way that utmost tax benefits can be availed. This can be done by applying the majority of advantageous provisions which are permissible by law and entitles the assessee to obtain the benefit of the deductions, exemptions, credits, concessions, rebates and reliefs so that the incidence of tax on the assessee would be minimum.
Tax planning is an art of logically planning one’s financial affairs, in such a manner that benefit of all eligible provisions of the taxation law can be availed effectively so as to reduce or defer tax liability. As tax planning follows an honest approach, by conforming to those provisions which fall within the framework of the taxation law.
Definition of Tax Avoidance
Tax avoidance implies any arrangement of financial activities, though done within the legal framework, overpowers the basic intention of the law. It involves taking benefit of the shortcomings in the statute, by deliberately parking the financial affairs in a way that it neither violates the tax law nor it attracts more tax.
Tax avoidance includes cases, wherein the assessee seemingly mislead the law, without making an offence. And to do so, the tax payer uses any scheme or arrangement, which reduces, defers and even completely prevents the payment of tax. This may also be done by shifting of tax liability to another person, so as to minimise the incidence of tax.
Methods of Tax Avoidance
Tax Avoidance is a way of avoiding tax payment in a manipulative manner. A taxpayer can avoid tax payment by indulging into different activities such as:
- Hiding facts
- Creation sham transactions without reflecting the true purpose
- Make fictitious contracts or transactions
- Mold actions without falsification of the accounts
Steps of Tax Planning
- Early Planning: Most of the taxpayers start their paperwork when the due date of filing the tax return is close. Thus, taxpayers are encouraged to plan their tax savings early to have a better estimate of the investments and benefits that can be claimed by them.
- Tax Liability: It is the step of the actual calculation of taxability based on income and after claiming all the rebates and deductions. Preparing an estimate of tax liability beforehand can also help in structuring the investment and savings part.
- Risk level: This step involves estimating the optimal level of investment risk as per the current financial situation of the taxpayer. Following factors have to be considered for risk profile:
- The risk associated with the amount of expected return
- Level of risk that the taxpayer is ready to undertake
- Level of risk that is acceptable by the taxpayer
Key Differences Between Tax Planning and Tax Avoidance
The difference between tax planning and tax avoidance can be drawn clearly on the following grounds:
- Tax planning refers to a mechanism through which one can intelligently plan his/her financial affairs in such a manner that all the eligible deductions, exemptions and allowances, as per law, can be enjoyed. Tax avoidance is an act of intentionally structuring one’s financial affairs, in such a way that his tax liability is minimum or even nil.
- While tax planning is both legal and moral, tax avoidance is legally correct, but it is an immoral act.
- Tax planning is basically savings of tax. Conversely, tax avoidance is hedging of tax.
- Tax avoidance is accomplished with a malafide motive. On the flip side, tax planning has the element of bonafide motive.
- Tax planning aims at reducing tax liability, by practising the script and moral of law. As against this, tax avoidance aims at minimising tax liability, by practising the script of law only.
- Tax planning is permissible by law, as it involves adhering to the provisions of tax. In contrast, tax avoidance is not permissible by law as it attempts to take advantage of the defects in the law.
- Tax planning uses the advantages, provided by the law to the assessee. Unlike tax avoidance, which uses the loop holes of the law.
- The benefits of tax planning can be seen in the long run. On the contrary, the benefits of tax avoidance are for short term only.
Tax evasion is deemed as tax fraud
Tax evasion is any illegal method or unlawful attempt to reduce tax liability of taxpayers. It is highly attached to techniques or illicit practices which results in showing fewer profits to minimize the individual or company’s tax burden.
Examples of tax evasion usually are the followings:
- Making false statements and information
- Inflating deductions without legal proof
- Hiding related documents to prove the actually earned business profits like records of transactions or report of cash income
- Concealing or transferring assets illegally
- Magnifying tax credit
- Claiming excessive expenditure
Tax evasion can be deemed as a form of tax fraud which indicates illegitimate and deliberate actions for not paying tax. Due to the fact that employing such unfair means is fraudulent, any taxpayers regardless of individual or business committing tax evasion behaviors would be prosecuted for offence and must be subject to stringent punishments of a heavy fine or imprisonment.