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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. A tax shelter is one type of tax avoidance, and tax havens are jurisdictions that facilitate reduced taxes. Tax avoidance should not be confused with tax evasion, which is illegal.
Forms of tax avoidance that use legal tax laws in ways not necessarily intended by the government are often criticized in the court of public opinion and by journalists. Many businesses pay little or no tax, and some experience a backlash when their tax avoidance becomes known to the public. Conversely, benefiting from tax laws in ways that 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 multiterritory schemes that fall into the grey area between common and well-accepted tax avoidance, such as purchasing municipal bonds in the United States, and tax evasion but are viewed by some as unethical, especially if they are involved in profit-shifting from high-tax to low-tax territories and territories recognised as tax havens. "MPs publish report on Google's tax avoidance". UK Parliament. Since 1995, trillions of dollars have been transferred from OECD and developing countries into tax havens using these schemes.Jesse Drucker (21 October 2010). "Google 2.4% Rate Shows How $60 Billion Is Lost to Tax Loopholes". Bloomberg.com.
Laws known as a General Anti-Avoidance Rule (GAAR) statutes, which prohibit "aggressive" tax avoidance, have been passed in several countries and regions including Canada, Australia, New Zealand, South Africa, Norway, Hong Kong and the United Kingdom. UK’s general anti-avoidance rule process on schedule. T Magazine. In addition, legal doctrine 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 United Kingdom in Ramsay. The specifics may vary according to jurisdiction, but such rules invalidate tax avoidance that is technically legal but is not for a business purpose or is in violation of the spirit of the tax code.For example, a Canadian organization describes Canada's law, first passed in 1988 in Section 245 of the Canada's federal income tax act (described here), as invalidating the tax consequences of a tax avoidance transaction if "not conducted for any primary purpose other than to obtain a tax benefit".
The term "avoidance" has also been used in the tax regulations examples of some jurisdictions to distinguish tax avoidance foreseen by the legislators from tax avoidance exploiting tax break in the law such as like-kind exchanges.correct The US Supreme Court has stated, "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.
According to Joseph Stiglitz (1986), there are three principles of tax avoidance: postponement of taxes, tax arbitrage across individuals facing different tax brackets, and tax arbitrage across income streams facing different tax treatment. Many tax avoidance devices include a combination of the three principles.
The postponement of taxes is the present discounted value of postponed tax is much less than of a tax currently paid. Tax arbitrage across individuals facing different tax brackets or the same individual facing different marginal tax rates at different times is an effective method of reducing tax liabilities within a family. However, according to Stiglitz (1986), differential tax rates may also lead to transactions among individuals in different brackets leading to “tax induced transactions”. The last principle is the tax arbitrage across income streams facing different tax treatment.
Anti-Tax Avoidance Directive (ATAD): On 20 June 2016 the European Council adopted the Directive (EU) 2016/1164 which contains five legally binding anti-abuse measures that should be applied as common forms of aggressive tax legislations. The member States must have applied these measures as from 1 January 2019. ATAD contains the following five anti-abuse measures: 1. Interest deductibility, to discourage artificial debt arrangements which are design to minimise taxes, 2. Exit taxation, for preventing the avoidance of taxes when companies are re-locating assets, 3. Incorporation of the GAAR for disregarding of non-genuine arrangements, 4. Controlled Foreign Company Rule (CFC), to deter that the profit is transferred to a low or no tax country, 5. Switchover rule, to prevent double non-taxation.
However, a small number of countries tax their citizens on their worldwide income regardless of where they reside. , 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.Moran Harari, Markus Meinzer and Richard Murphy (October 2012) "Financial Secrecy, Banks and the Big 4 Firms of Accountants" Tax Justice Network
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." Foreign Earned Income Exclusion", Internal Revenue Service, United States Department of the Treasury. Some American parents do not 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.
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.
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 ) 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 . Coupled with the hobby loss rules (), the changes greatly reduced tax avoidance by taxpayers engaged in activities only to generate deductible losses.
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%).
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.Rajeev Syal. "MPs attack Amazon, Google and Starbucks over tax avoidance". The Guardian. 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.Rajeev Syal. "Amazon, Google and Starbucks accused of diverting UK profits". The Guardian.Juliette Garside. "Amazon UK boycott urged after retailer pays just £4.2m in tax". The Guardian. 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. In October 2017, the EU ordered Amazon to repay €250 million in illegal state aid to Luxembourg following a 'sweetheart deal' between Luxembourg and Amazon.com enabling the American company to artificially reduce its tax bill. 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:
Tax avoidance has not always related to corporation tax. A number of companies including Tesco, Sainsbury's, WH Smith, Boots UK 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.
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 in 2016, Private Eye, The Guardian and other British media outlets noted that Edward Troup, who became executive chair of HM Revenue and Customs, had worked with Simmons & Simmons in 2004 representing corporate tax havens and opposed the GAAR in 1998.
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 Northrop Grumman all had net negative tax liabilities. Additionally, this phenomenon was widely documented regarding General Electric in early 2011. "G.E.’s Strategies Let It Avoid Taxes Altogether". The New York Times. 25 March 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. "U.S. Business Has High Tax Rates but Pays Less". The New York Times. 3 May 2011. 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. HP Loses Battle with IRS Over Tax Shelter Designed by AIG. Insurance Journal. 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 Department Circular 230. In 2010, the Health Care and Education Reconciliation Act of 2010 codified the "economic substance" rule of Gregory v. Helvering (1935).Rose CA. Tax Lawyer’s Dilemma: Recent Developments Heighten Tax Lawyer Responsibilities and Liabilities . Columbia Business Law Review. Volume 2011, Issue 1.
The US Public Interest Research Group said in 2014 that the United States government 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:
According to an analysis by the Institute on Taxation and Economic Policy, global companies in the US are paying an effective tax rate of about negative 9 percent per annum.Ingraham, Christopher (5 April 2021) "Dozens of America’s biggest businesses paid no federal income tax — again" The Washington Post. Retrieved 30 April 2021.
An investigation by ProPublica published in 2021 based on leaked IRS documents revealed techniques by which billionaires accumulated massive wealth while paying lower rates than middle-income people, or no tax, or in some cases getting paid refundable childcare tax credits.
These include:
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.”The conversation, Luxembourg leaks reveal the organised hypocrisy of the modern corporation, 10 November 2014
The Mark is operated by a not-for-profit community benefit society, the Fair Tax Foundation.
Awardees of this mark in the UK include The Co-op, SSE plc, Watches of Switzerland, Ecology Building Society, Lush Cosmetics, Richer Sounds, Scottish Water, United Utilities, Marshalls, several large regional co-operatives (East of England, Midcounties, Scotmid) and The Phone Co-op.
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.
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. HMRC goes on £1bn retro warpath , Accountancy Age, 18 February 2010
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 ex 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.
General:
Public sector appointments
In January 2012 a review of the tax arrangements of people engaged on public sector appointments was undertaken, in order to "ascertain the extent
of arrangements which could allow public sector appointees to minimise their tax payments" and make recommendations accordingly.Cabinet Office, Procurement Policy Note – Tax Arrangements of Public Appointees - Action Note 07/12 24 August 2012, accessed 8 February 2021 The review was published on 23 May 2012, advising that:
Historical tax avoidance
Window tax
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. p. 416 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" (allegedly leading to the phrase daylight robbery) and led property owners to block up windows to avoid it. The tax was repealed in 1851. Encyclopædia Britannica (1911), vol. 28, p. 713.
Deliberate roof destruction
Other historic examples of tax avoidance were the deliberate destructions of roofs in Scotland to avoid substantial . The roof of Slains Castle was removed in 1925, and the building has deteriorated since. The owners of Fetteresso Castle (now restored) deliberately destroyed their roof after World War II in protest at the new taxes.
United States
The term tax avoidance indicates a situation in which a taxpayer legally minimizes the amount of his income tax owed. This circumstance occurs by declaring as many deductions and credits as permitted or prioritizing investments with tax advantages.George S.K., The fine and hazy line between tax avoidance and tax evasion UNCOURT 19,(2018)
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.
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 and recognise 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".
Government and judicial response
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 finding new scope/loopholes for tax avoidance in the amended rules.
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.
See also
Further reading
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