Most Australian’s know this famous quote from the late Kerry Packer’s Senate hearing:
I am not evading tax in any way, shape or form. Of course, I am minimising my tax. Anybody in this country who does not minimise his tax wants his head read. I can tell you as a government that you are not spending it so well that we should be donating extra.
It is the Australian way to minimise tax as much as possible. People talk about it constantly between July and October every year, even at the pub everyone has their favourite tax planning tip. This has come about as a cultural aspect of Australia now as our tax system is one of the longest and most complex in the world.
Some people take it too far and go into tax avoidance and tax evasion territory. We will explain the difference here. Tax planning, tax avoidance and tax evasion vary significantly in their legal standing and implications.
The following table compares all three at a glance:
|Legal strategies to reduce tax liability.
|Using loopholes to reduce tax liability.
|Illegal methods to escape tax obligations.
|Completely legal and compliant with tax laws.
|Often falls into a grey area of legality. Avoidance is often interpreting tax laws in a way that benefits the taxpayer.
|Illegal and subject to civil and criminal penalties.
|Utilising tax deductions, credits, and exemptions. Structuring businesses and investments wisely.
|Exploiting loopholes or ambiguities in tax law.
|Concealing income, falsifying records, not filing tax returns.
|None, as practices are legal.
|An anti-avoidance rule may apply, such as the Personal Services Income rules. If a real loophole is found, Part IVA may apply as the general anti-avoidance rule. Penalties between 25% and 90% of tax that should have been paid.
|Severe legal penalties up to 90% of tax that should have been paid, including fines and imprisonment. Most common charge is defrauding the Commonwealth.
|Superannuation contributions, investment deductions, claiming concessionary tax treatment.
|Using complex financial instruments or offshore entities.
|Not declaring income, using fake documents, the recent TikTok GST scam with fraudulent BAS lodgements.
What is Tax Planning or Tax Minimisation?
Tax planning or tax minimisation is a legitimate approach to reduce one’s tax liabilities within the bounds of the law. It involves a comprehensive understanding of tax legislation and effectively utilising available tax deductions, credits, and exemptions. Common techniques and strategies include:
- Investment Choices: Selecting tax-efficient investments like certain bonds, negative gearing real estate, small business ownership or superannuation funds.
- Income Timing: Deferring income to a future year when one might fall into a lower tax bracket. Companies are often used to pay corporate tax and defer “top-up tax”
- Income Splitting: Distributing income among several family members to reduce the overall tax burden using a family trust.
- Superannuation Contributions: Making additional contributions to superannuation funds as lowed by law, which can be highly tax effective.
- Utilising Deductions: Maximising deductions on expenses related to income generation, such as work-related expenses or investment-related costs.
- Structuring Businesses: Creating an efficient business structure, such as a trust or company, to optimize tax outcomes.
All these can still be considered tax avoidance or evasion in the wrong circumstances. Taxpayers need expert advice from a tax accountant or tax lawyer depending on the complexities.
What is Tax Avoidance?
Tax avoidance, while not illegal, operates in a grey area of interpretation of law. It involves exploiting loopholes or ambiguities in the tax legislation, often bending the rules without breaking them, in a way that achieves a result that usually wasn’t intended by Parliament.
Often the ATO believes it alone can define what tax avoidance is and regularly publishes Taxpayer Alerts, such as Taxpayer Alert TA 2023/1 which related to extracting profits from companies without paying additional tax. Some commonly seen avoidance strategies are:
- Use of Offshore Entities: Establishing companies or trusts in low-tax jurisdictions to shelter income from higher taxes. There are many complex rules that attempt to prevent this including the Controlled Foreign Company rules, corporate tax residency rules and permanent establishments.
- Complex Financial Instruments: Engaging in complicated financial arrangements that obscure the true nature of transactions to minimize tax.
- Stripping Profits from Companies: Taking money from companies without paying additional tax personally is often seen as tax avoidance. However, complying with the anti-avoidance rules in Division 7A, which relates to shareholder loans, allows for some tax benefits that are not avoidance.
- Transfer Pricing: Setting prices for transactions between cross-border related entities in a way to shift profits to lower-tax jurisdictions. Costs are inflated in high-tax jurisdictions (like Australia) and income is realised in low-tax jurisdictions (like the British Virgin Islands).
While avoidance doesn’t always result in legal action, it often leads to increased scrutiny by the ATO. The ATO may apply anti-avoidance legislation, such as Part IVA, to counteract these arrangements and impose additional taxes and penalties.
What is Tax Evasion?
Tax evasion is a deliberate attempt to not pay tax, without regard for what the tax law says. This includes not reporting income, inflating deductions, or hiding money in undeclared offshore accounts. Highly complex tax avoidance can sometimes be considered evasion also. Common evasion methods are:
- Concealing Income: Not declaring income to the ATO or underreporting earnings.
- Falsifying Records: Creating fake invoices or receipts to claim deductions that aren’t entitled.
- Illegal Activity: Engaging in illegal activities like money laundering to hide taxable income.
- Offshore Tax Evasion: Using foreign accounts or entities to hide assets and income from the ATO.
The penalties for tax evasion are very severe, including substantial fines, interest charges on unpaid taxes, and in serious cases, imprisonment. The ATO aggressively prosecutes tax evasion to deter others and maintain the integrity of the tax system – despite what Australian’s anecdotally think.
How does the ATO Responsed to Tax Avoidance and Tax Evasion?
The ATO is proactive in addressing both tax avoidance and evasion.
For avoidance, it issues taxpayer alerts about known or suspected avoidance schemes, educating the public and professionals about the risks involved. Since Project Wickenby in the mid 2000’s, the ATO has prosecuted a string of tax avoidance cases and gained a reputation has a harsh enforcer.
In cases of tax evasion, the ATO’s response is more stringent, often involving prosecution and severe penalties, reflecting the seriousness of these offenses. For example, the recent TikTok GST frauds that were circulation on social media, the ATO have come out saying they will seek criminal charges in some cases.
Any person caught in a tax avoidance or tax evasion scheme should seek advice immediately.
Navigating tax obligations requires a fine balance between minimizing liabilities legally and not stepping into the realms of avoidance or evasion. Understanding these distinctions is vital for compliance and financial wellbeing. The ATO’s role in issuing alerts and enforcing laws is crucial in maintaining the integrity of the tax system.
Disclaimer: This material is produced by Cadena Legal, a NSW-registered legal practice. It is intended to provide general information and opinions on legal topics, current at the time of first publication. The contents do not constitute legal advice and should not be relied upon as such. Contact us here for advice.