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Explainer: the difference between tax avoidance and evasion

Microsoft Corporation’s Bill Sample, Google Australia’s Maile Carnegie and Corporate Vice President of Apple Australia Tony King appeared before Senate committee public hearings on corporate tax avoidance last week. AAP/Nikki Short

Within the current discussion of corporate tax there are a number of terms used to describe the corporate strategies and behaviours involved, such as “tax minimisation” or “tax avoidance”.

There are also other terms used in the academic accounting literature on tax. This can result in confusion about what exactly is being discussed or alleged. This is further confounded by some of the terms being used interchangeably, both within the mainstream media and within academic literature.

However, some of the terms used do have specific meaning and there have been recent attempts to categorise and characterise them.

Tax evasion

The first distinction is tax evasion, which usually refers to illegal tax-reducing arrangements. However, this should refer to wilful misrepresentation (of tax affairs), as some companies may enter into such an arrangement inadvertently. In addition, companies can, and do, implement a broad range of tax positions. Many of these arrangements have never been challenged and subject to Australian Tax Office (ATO) or judicial determination, with their status being undefined.

Such determinations, including appeals, may also take many years to complete, leaving similar arrangements elsewhere in limbo. In other words, the distinction as to what constitutes tax evasion is determined by the courts. The ATO is the agency responsible for assessing whether strategies and transactions are tax evasion or legitimate tax-reducing arrangements.

It only becomes “tax evasion” once it has been determined as such by the ATO, or by courts if challenged.

Tax minimisation

The academic literature has adopted the concept of a continuum of tax-reducing arrangements. These range from benign benefits that are actively encouraged by the tax system, such as research and development and capital allowances, through to outright tax evasion, such as artificial inter-company transfer pricing and thin capitalisation.

The starting point for the continuum is the tax outcomes that would exist if tax considerations were totally ignored when entering into business strategies and transactions. Anything that reduces tax liabilities from that point is regarded as “tax minimisation” or “tax planning”. There is no upper limit to the range of tax minimising activities.

There are other terms used to describe the various degrees of tax minimisation. The term “tax aggressiveness” refers to the downward management of taxable income through tax planning activities, disregarding benign activities such as research and development allowances.

Tax avoidance

A further sub-set of tax aggressiveness is “tax avoidance” which refers to tax planning activities that have a low level of probability (less than 50%) of surviving a tax audit, as opposed to those activities that are outright illegal or wilful misrepresentation.

Another term quite often used in the discussion of corporate tax is “aggressive tax planning” which is used in Australia but is known as “tax sheltering” in the US. It is considered to be at the most aggressive end of the tax minimisation continuum incorporating activities that lie within both tax avoidance and tax evasion.

The distinction between these terms is not always clear. The line between “tax avoidance” and “tax evasion” can be very thin and at times indistinguishable. The test applied in judicial determinations is based on the “dominant purpose” of a transaction or activity and this concept underlies the anti-avoidance provisions (Part IVA) of the tax legislation.

In Mills v Commissioner of Taxation [2012] HCA 51 - the best-known case involving the Commonwealth Bank and its issuing of hybrid stapled securities called “Perpetual Exchangeable Resaleable Listed Securities V” (or PERLS V) - the High Court found that the dominant purpose of a scheme was for legitimate capital raising purposes, even though it was set up to provide a bonanza of tax benefits to the investors involved.

These are the types of arrangements that commentators are referring to when they accuse companies of “tax avoidance”.

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