Tax Evasion in India

 

S. Shubhang

Semester V, Hidayatullah National Law University, Raipur, C.G.

 

 

INTRODUCTION:

Tax evasion is an activity commonly associated with the underground economy and one measure of the extent of tax evasion the amount of unreported income, namely the difference between the amount of income that should legally be reported to the tax authorities and the actual amount reported. In the 1970s and 80's, the IRS undertook the Taxpayer Compliance Measurement Program (TCMP) in an attempt to measure unreported income and the tax gap. The tax gap is the difference between the amount of tax legally owed and the amount actually collected by the government.² The TCMP program was believed to produce the most reliable information about noncompliance, but these "audits from hell" were deemed to be overly intrusive and were discontinued in 1988. The National Research Program was undertaken in the 1990s as a less intrusive means of measuring noncompliance and was described as "the most careful and comprehensive estimates of the extent and nature of tax noncompliance anywhere in the world" However, critics point out numerous problems with the tax gap measure. The IRS direct audit measures of noncompliance are augmented by indirect measurement methods, most prominently currency ratio models

 

Tax avoidance, on the other hand, is the legal utilization of the tax regime to one's own advantage, to reduce the amount of tax that is payable by means that are within the law. Both tax evasion and 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.³

 

Tax noncompliance describes a range of activities that are unfavorable to a state's tax system.

 

These include tax avoidance, which refers to reducing taxes by legal means, and tax evasion which refers to the criminal non-payment of tax liabilities.

 

Groups that do not comply with taxes include tax protesters and tax resisters. Tax protesters attempt to evade the payment of tax using frivolous interpretations of tax law, whilst tax resisters refuse to pay a tax for conscientious reasons (because the resister does not want to support the government or some of its activities). Tax resisters typically do not take the position that the tax laws are themselves illegal or do not apply to them (as tax protesters do) and tax resisters are more concerned with not paying for particular government policies that they oppose. Because taxation is often perceived as onerous, governments have always struggled with tax noncompliance since the beginning of civilization.

 

TAX EVASION AND TAX AVOIDANCE

‘Tax avoidance’ and ‘tax evasion’ are terms so frequently referred to in economic and business relationships today that they constitute part of our conversational language and people in general use these terms even without knowing their exact meaning and difference. Whereas tax avoidance implies a situation in which the taxpayer reduces his tax liability by taking advantage of the loop-holes and ambiguities in the legal provisions, in the case of tax evasion, facts are deliberately misinterpreted and the tax liability is understated. Thus, while tax avoidance is perfectly legal and is, at times, referred to as ‘tax planning’, tax evasion is illegal and, therefore, carries with it the risk of penalties and prosecutions under the tax laws. As such, the black economy comprises the sum total of all the various methods of tax evasion but does not include tax avoidance.⁴ Accordingly, whereas the consequences of the two phenomena are different for the taxpayers, both reduce the revenue of the Exchequer and consequently need to be checked to the greatest extent possible.

 

Tax planning is not tax evasion!

“Whatever is valid in the eyes of law cannot become invalid merely because it also results in tax being saved!” Tax planning, tax efficiency and tax avoidance by companies is not equal to tax evasion. These are the different approaches to the same objective that is, tax reduction. However, they have different characteristics and tax planning is perfectly legal as the object of tax reduction is achieved by making use of the beneficial provisions in the tax laws. On the other hand, tax avoidance is also legal though technically satisfying the requirements of law. Tax evasion is the method of evading tax by dishonest means like suppression, conscious violation of rules, etc. the prime objectives of tax planning are: reduction of tax liability, minimization of litigation, productive investment, healthy growth of economy and economic stability. There is a very thin line of demarcation between tax avoidance and tax evasion; though both result in avoidance of tax. The distinction between the two lies in the legality of a transaction.

 

Deliberate attempt to subvert the law or manipulation of records to obtain tax relief is an illegal act and would be regarded as tax evasion and is impermissible. On the contrary, tax avoidance involves arranging transactions within the permissible boundaries of law to secure a tax advantage and is generally accepted as legal. The courts have attempted to provide some distinction between unacceptable tax evasion and acceptable tax avoidance, which is increasingly referred to as tax planning.⁵ However, there certainly exists a grey area between legitimate tax avoidance and planning and illegal tax avoidance and the distinction has become increasingly blurred, in view of varying and often conflicting views of the courts. This leads to increase in uncertainty in the tax system, which is something businesses do not want⁶

 

The Honorable Supreme Court of India gave a landmark judgment on Friday Jan 20th with reference to the taxability of Vodafone’s acquisition of Hutchison’s Indian telecom assets. This judgment is expected to have consequences on many such similar tax disputes. Understanding the difference between tax avoidance and tax evasion:

 

What is tax evasion?

Tax evasion as the term implies refers to the phenomenon of evading tax. For example some entities collect revenue in cash and do not record the same. The logic behind not disclosing the true income is to avoid paying taxes on the non- recorded income. This example is a clear example of tax evasion and is an illegal act. Tax avoidance on the other hand is a legal activity.

 

What is tax avoidance?

Tax avoidance is structuring one’s income in such a manner that one can legally avoid taxes. The simplest and less controversial example of tax avoidance is when an individual invests in tax saving mutual funds, insurance products, bank deposits etc. In such a case the individual can avoid paying taxes currently to the tune of Rs. 1 lakh. Unfortunately many tax avoidance strategies though legal are controversial in nature.

 

What are the examples of controversial tax avoidance strategies?

Earlier some firms used to compensate their employees by structuring a significant part of the income in the form of allowances and perks. This was a tax avoidance strategy as allowances & perks are less taxed than salaries. Another example is that of investments by FIIs in the Indian stock markets.⁷

 

What are FIIs?

FII stands for Foreign Institutional Investors. These are entities which invest in shares of companies listed on stock exchanges. While investing in India, often FIIs irrespective of their country of origin, route their investments through a firm floated in Mauritius. This has be seen in case of many FII’s which are basically from USA, Japan etc but have routed their Indian investments through new firms registered in Mauritius. This is because India has signed a Double Tax Avoidance Treaty (DTA) with Mauritius. Thus firms registered in Mauritius need not pay any taxes on the capital gains earned in India. These firms pay their taxes in Mauritius where the taxes are significantly lower than that in India.  This again is a tax avoidance strategy which has been deemed legal.

 

What is the case of Vodafone Hutchison?

Vodafone Plc, a British telecom operator had acquired Hutchison’s 67% stake in Feb 2007. The deal was structured in a manner to avoid tax. Vodafone Plc’s Dutch subsidiary, International Holdings acquired Hutchison’s Indian telecom business by purchasing an entity registered in Cayman Islands. In this case the Income Tax Dept of India was of the opinion that the deal is subject to tax as it pertained to the sale & purchase of the Indian telecom business of Hutchison. However Vodafone contended that no tax is payable, as Indian tax laws do not apply to Cayman Islands. This dispute took a legal turn and reached the courts going all the way to the Supreme Court of India.⁸

 

What is the Supreme Court’s (SC) judgment in this case?

The SC in its judgment concluded that no tax is payable by Vodafone Plc as the transaction was a Off- Shore transaction outside India’s territorial tax jurisdiction. The SC was of the opinion that that tax authorities should look at all the aspects of a deal holistically and that tax policy certainty is an absolute must to encourage foreign investments. In short the SC was of the view that that current Indian tax laws do not permit taxing the Vodafone- Hutchison deal. In this context it is worth noting that under the new DTC, a key future tax reform, such transactions will be taxed.⁹

 

Tax Havens

These are foreign jurisdictions that offer financial secrecy laws in an effort to attract investment from outside their borders. These jurisdictions are commonly referred to as “tax havens”, because in addition to the financial secrecy they provide, they impose little or no tax on income from sources outside these jurisdictions. Tax haven service providers and their clients know their actions are veiled from tax authorities by banking and commercial secrecy laws and by lack of tax treaties or tax information exchange agreements. They create paper entities to disguise the real parties to the transactions, and many are willing to create false documents to disguise the real nature of transactions. There are more than 70 tax havens. At least forty countries aggressively market themselves as tax havens. Some have gone so far as to offer asylum or immunity to criminals who invest sufficient funds. They permit the formation of companies without any proof of identity perhaps even by remote computer connections. Generally though such extremes are found in emerging nations where the stability and security of the financial, legal, political systems is questionable. The largest concentrations of assets are attracted to the stable secure environments of the established tax havens –those that existed, a number of years and enjoy the diplomatic protection of former colonial powers. Tax Havens Examples Andorra, Anguilla, Antigua, Antilles, Aruba, Australia, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Canary Isles, Canada, Cayman, Cook Isles, Costa Rica, Cyprus, Dominica, Gibraltar, Greece, Guernsey, Ireland, Isle of Man, Jersey, Latvia, Liechtenstein, Malta, Mauritius, Monaco, Panama, Switzerland, Thailand, Turks-Caicos¹⁰

 

What is Common across these Tax Havens?

• Very stringent privacy laws

• Secrecy laws and Non-disclosure policies

• Do not release account information to other governments and law enforcement agencies

• Do not have any financial information exchange policies except where drug trafficking and terrorism are suspected

• Most of these Tax Havens have a legal system based on the British common law¹¹

 

Treaty and Non-Treaty Jurisdictions

The offshore jurisdictions qualify into treaty jurisdictions and non-treaty jurisdictions. Treaty jurisdictions have a network of double tax avoidance treaties concluded with other countries, inclusive many high-tax countries. A double-tax avoidance treaty basically removes or reduces levels of taxation on certain transactions, taking place between residents of both member countries. The most common and tangible benefits granted by a double-tax avoidance treaty are usually the reduction of withholding taxes on the payment of dividends and royalties between the contracting states – thus, great for a targeted establishment of offshore holding companies. Treaty jurisdictions often portray a non-offshore image – usually offering reduced levels of tax instead of a complete exemption. This obviously may provide a better “image” of the jurisdiction. Malta is a typical treaty jurisdiction. Non-treaty jurisdictions are “classic” in the offshore sense. They would usually have zero corporation and income taxes anyway, so there is not much to reduce and no interest for any other countries to negotiate a double-tax avoidance treaty anyway.

 

Tax evasion in india

India loses 14 trillion rupees ($314 billion) from tax evasion annually, depriving it of funds for investment in roads, ports, and power, says Arun Kumar, author of The Black Economy in India. General government tax revenue is an estimated 18 percent of India’s $1.5 trillion in gross domestic product, the lowest among the four BRIC nations, International Monetary Fund data show. With so little revenue coming in, Prime Minister Manmohan Singh is now attempting India’s biggest overhaul of the tax code in half a century.¹² Investors say tax reform would boost their confidence. “If the government does end up making a substantial amount in revenue as a result of the tax overhaul, their deficit requirements should come down and the interest burden will also come down,” says Killol Pandya, Mumbai-based head of fixed income investments at Daiwa Asset Management (India). As finance minister in 1991, Singh accelerated tax cuts and reduced the bureaucracy that many businesses found so suffocating. Thanks to his efforts, the top individual income tax rate is now 30 percent, down from 97.5 percent in 1971. With his Direct Taxes Code legislation, Singh hopes to cut the corporate rate to 30 percent from 33 percent.

 

The new law, if passed, would also phase out tax holiday periods, which many companies exploit. For years, the north Indian state of Uttarakhand, for example, has had a tax holiday for manufacturers. Companies from elsewhere in India have booked their profits in Uttarakhand-based subsidiaries to lower their tax liability, says Kavita Rao, an economist in New Delhi at the National Institute of Public Finance and Policy. “When you give these kinds of tax incentives there is always the possibility for misuse,” says Sunil Gupta, a Finance Ministry official who helped write the legislation. Gupta estimates India loses as much as 800 billion rupees a year because of corporate tax incentives. The bill aims to turn more individuals into taxpayers by dismantling key exemptions. Two of the biggest are the break investors get for buying India’s infrastructure bonds and that they get for putting money into equity mutual funds. In a separate proposal, Singh hopes to impose a nationwide goods and services tax that would replace similar taxes at the state level. Finally, the government wants to rewrite its tax treaty with Mauritius, an Indian Ocean island that authorities in New Delhi believe harbors a lot of unreported income from India.¹³ These reforms will need extra enforcement. “People have to believe that if they don’t pay taxes they will get caught,” says Rao, who will lead one of three studies commissioned by the government of the black market economy. There’s already a proposal to boost the number of tax collectors, and a group has been set up to track untaxed transactions in the underground economy.¹⁴

 

One challenge is the paralysis that’s afflicted Parliament since this year’s scandal over irregularities in the sale of valuable mobile-phone licenses. “The government must start the reform process once again,” says Adi Godrej, chairman of Godrej Consumer Products, a maker of household and consumer products. Another reason for lawmakers’ reluctance is that part of India’s unreported cash bankrolls election campaigns, says N. Bhaskara Rao, chairman of the Center for Media Studies in New Delhi. “Political parties will only be curtailing their spending power by backing proposals to curb black money,”

 

CONCLUSION:

Law makers cannot practically envisage all possible situations while drafting the laws. For example the current tax code we follow in India has been drafted way back in 1961. Thus it is preferable that tax laws have to be amended periodically to reflect the changing times. This will reduce the frequency of such disputes.  However it needs to be noted that such disputes cannot be totally eliminated as the same law can be subject to different interpretations by different individuals. The difference between tax avoidance and tax evasion is that tax avoidance is legally permissible by law while tax evasion is not. Judicial pronouncements within India and outside India have always marked out this distinction between the two. The predominant feature in deciding the nature of any transaction is not the underlying motive but the legality of such transaction. However, this position is now going to be changed with DTC coming into force in coming years where the distinction between tax avoidance and evasion has been blurred to a great extent in order to restrict not only tax evasions but also tax avoidance. This is correct but only to the extent that it should not make the restriction and its scope so wide so as to include tax planning also within it, which otherwise is always should be encouraged. Further, there are certain concerns with the DTC and GAAR, which should be overcome by the possible ways mentioned.

 

REFERENCES:

·        James Andreoni & Brian Erard & Jonathan Feinstein, 1998, "Tax Compliance," Journal of Economic Literature, American Economic Association, vol. 36(2), pages 818-860, June

·        Gary Becker (1968). "Crime and Punishment: An Economic Approach". The Journal of Political Economy 76: pp. 169–217

·        "Fraud". Irs.gov. Retrieved 2011-03-15

·        http://ideas.repec.org/p/pra/mprapa/29672.html

·        Chowdhury, F. L. (1992) Evasion of Customs Duty in Bangladesh, unpublished MBA dissertation, Graduate School of Management, Monash University, Australia

·        http://www.moneycontrol.com/news/management/taxplanning-is-not-tax-evasion_438940.html

·        http://www.investopedia.com/terms/t/taxevasion.asp

·        Black's Law Dictionary, p. 673 (5th ed. 1979)

·        http://www.moneycontrol.com/news/management/tax-planning-is-nottax-evasion_438940.html

·        Internal Revenue Service of United States Department of Treasury http:// www.irs.gov/businesses/small/article/0,,id=106568

·        www.fedpol.admin.ch

·        Vyas D (2004). The law Practice of income Tax. Lexis Nexis, Buttersworth, 9th Edition.

·        http://blogs.telegraph.co.uk/finance/ianmcowie/100003388/taxavoidance-or-terrorism-which-is-the-biggest-Threat/

·        http://www.thehindubusinessline.com/mentor/2009/10/19/stories/20091/01950171100.htm

Journals

1.       James Andreoni & Brian Erard & Jonathan Feinstein, 1998. "Tax Compliance," Journal of Economic Literature, American Economic Association, vol. 36(2), pages 818-860, June

2.       Gary Becker (1968). "Crime and Punishment: An Economic Approach". The Journal of Political Economy 76: pp. 169–217

3.       "Fraud". Irs.gov. Retrieved 2011-03-15

4.       http://ideas.repec.org/p/pra/mprapa/29672.html

5.       Chowdhury, F. L. (1992) Evasion of Customs Duty in Bangladesh, unpublished MBA dissertation, Graduate School of Management, Monash University, Australia

6.       http://www.moneycontrol.com/news/management/taxplanning-is-not-tax-evasion_438940.html

7.       http://www.investopedia.com/terms/t/taxevasion.asp

8.       Ignorantia legis neminem excusat, or "ignorance of law excuses no one." Black's Law Dictionary, p. 673 (5th ed. 1979)

9.       http://www.moneycontrol.com/news/management/tax-planning-is-nottax-evasion_438940.html

10.     Internal Revenue Service of United States Department of Treasury http:// www.irs.gov/businesses/small/article/0,,id=106568

11.     www.fedpol.admin.ch

12.     Vyas D (2004). The law Practice of income Tax. Lexis Nexis, Buttersworth, 9th Edition.

13.     http://blogs.telegraph.co.uk/finance/ianmcowie/100003388/taxavoidance-or-terrorism-which-is-the-biggest-Threat/

14.     http://www.thehindubusinessline.com/mentor/2009/10/19/stories/20091/01950171100.htm