A large number of tax reduction measures are available for income tax payers – both corporate and personal income tax payers. Some tax reduction measures like tax mitigation, tax planning and tax avoidance are legally permissible. On the other hand, tax evasion is illegal.
These tax reduction measures are widely used by corporate especially tax avoidance. Governments are feeling the heat several big companies are paying only negligible taxes. Recently several governments have introduced tax laws to tackle excessive tax avoidance by corporate. In India, the government is planning to introduce General Anti-Avoidance Rule (GAAR) to counter impermissible avoidance arrangements or the type of tax avoidance that specifically created to avoid taxes.
The different methods adopted to reduce tax liability can be broadly classified into four: tax evasion, tax avoidance, tax mitigation and tax planning. The difference between the four is quite narrow, depending upon interpretations in each tax regimes.
Tax Mitigation: Tax mitigation is a situation where the taxpayer uses a fiscal incentive (tax concession) available to him in the tax legislation so that he need not pay tax. An example of tax mitigation is the setting up of a business by a corporate in Special Economic Zone (SEZ) to claim a tax exemption (sun rise clause). In such a case, the taxpayer is taking advantage of a fiscal incentive in the form of a tax concession offered to him in the SEZ provisions in the Income-tax Act. As per SEZ rules, the business entity need not pay corporate income tax for the first five years. Tax mitigation is, thus, allowed under the tax statute.
Tax avoidance: Tax avoidance is simply avoiding tax payment by taking the legal opportunities provided to a tax payer. Since it is not illegal, tax avoidance is some sort of a legally allowable way to reduce tax burden. It is by and large not defined in taxing statutes. The purpose here is to reduce tax burden. Following are the some of the versions for tax avoidance:
- Tax avoidance involves the legal exploitation of tax laws to one’s own advantage.
- Every attempt by legal means to prevent or reduce tax liability which would otherwise be incurred, by taking advantage of some provisions or lack of provisions in the law.
- An arrangement entered into solely or primarily for the purpose of obtaining a tax advantage.
Taxpayers generally consider tax avoidance as their legitimate right to arrange their economic activities to minimize tax payments. But recent experiences shows that there are larges scale tax avoidance measures by MNCs. The Base Erosion and Profit Shifting initiative by the G20 is aimed to counter tax avoidance. Several countries have, therefore, legislated to prevent tax avoidance in various ways (eg GAAR).
Tax evasion: Tax evasion is unlawful and is the result of illegality, suppression, misrepresentation and fraud. Here, the tax payer is not paying taxes by taking illegal measures.
Tax planning: Tax planning is framing of a financial plan by the tax payer in advance to minimize tax payment. Tax planning contains several ingredients including the timing income and expenditure, selection of investments and types of retirement plans etc.