Tax avoidance,tax evasion,tax mitigiation - Essay Example

Definition and Comparison of the concepts :Tax Evasion, Tax Mitigation and Tax Avoidance Tax avoidance and Tax evasion are two of the most commonterms and concepts used and utilized by the taxpayers in escaping from payment of taxes. Learning and understanding these terms will help the taxpayers avoid criminal and civil liabilities. Tax avoidance is a means to escape from taxation, which is allowed and sanctioned by law. A taxpayer committing this will not be legally held civilly or criminally liable to the government provided it is used in good faith and within the process allowed by law, otherwise the taxpayer will be committing tax evasion which is a crime. The utilization of the means and methods sanctioned by law would enable the taxpayer reduce the amount due to be taxed. Example of tax avoidance is when the taxpayer structures his/her any legitimate transaction to save tax and such transaction is what would really appear in form. And this transaction if the taxpayer is the vendee or payee could declare this as deduction. Tax Evasion on the other hand, is reduction or elimination of tax due by means outside the law. It is illegally committed and punishable by law. A corporation, individual and other entity may resort to means in order to avoid paying the taxes. And the means employed is always dishonest like declaring less or no income, less profits or no gains than the taxpayer actually earned or it could be committed by inflating deductions. For example, a corporation will evade tax by declaring charitable contributions of $ 2.5 million as deduction although what was actually contributed is $.5 million only. The law does not allow this and anyone caught doing this will be held criminally and civilly liable. The difference between tax avoidance and tax evasion is on the tax itself. In tax avoidance, the taxpayer is legally avoiding the payment of any tax liability that is not in existence at the time. Meaning to say, there is no tax due at the moment of transaction and the taxpayer utilized method within the law so that no tax liability would be incurred later or if there is, it would be less. In tax avoidance, there is already a tax due to be paid and the taxpayer resort to illegal means so that it will not be able to pay the owed tax. This type entails concealment or misrepresentation of earnings that are taxable immediately.. Tax mitigation is also similar to tax avoidance. Both resort to means not prohibited by law. Sometimes, these two concepts are used interchangeably. Tax mitigation is known as tax planning to mitigate or reduce tax liability. It is a conduct made to reduce tax liability without conducting tax avoidance or which is contrary to the intention of the Parliament. There are conducts which are allowed for tax mitigation and which are not in the case of tax avoidance. It is important in distinguishing one from the other, especially the two concepts which are tax avoidance and tax evasion because it will help the taxpayer in understanding the consequences of each conduct to reduce tax liability. Since tax avoidance is a criminal offense punishable by law, knowing the distinction would save one from committing this criminal offense while saving money from taxes without breaking the law. It will help taxpayers to arrange their affairs and keep taxes as low as possible. The tax code is confusing not only for average people but also for those knowledgeable professionals. Hence, it is important to define these two concepts so as not to fall into a criminally punishable offense. The Ramsay Principle: My understanding This principle emanated for two cases : W. T. Ramsay Ltd. v. Inland Revenue Commissioners, Eilbeck (Inspector of Taxes) v. Rawling, [1982] A.C. 300 and IRC v. Burmah Oil Co. Ltd., [1982] S.T.C. 30, H.L.(Sc.)decided by the House of Lords in connection with tax payment and schemes resorted to avoid it. In this case, the company in order to lessen the amount of taxes for the transaction of transfer of assets and payment resorted to scheme by drafting sets of documents, which are in effect revoking the other documents or which are referred to as "self-cancelling series of transactions". A taxpayer has the right to put his or her assets beyond the arms of the law by executing instruments for the transfer so as to eliminate payment of taxes like capital gain tax. Although each transaction does not appear to be avoiding or evading the taxes, the totality of the series of transactions was looked into to examine whether the taxpayers violated the tax revenue statute. The transactions have no commercial purposes or business ends so the method use to tax the series of transaction is to tax it wholly not individually. Court's Ruling or Opinion on Tax Avoidance: In W T Ramsay Ltd v IRC [ 1981 ] AC 300 (HL) the House of Lords considered a claim that certain self-cancelling transactions could be used to create a non-taxable gain and a tax relievable loss. The Lords applied what became known as the Ramsay doctrine, stating that the court was entitled to look at the whole transaction and so to conclude that the taxpayer had not suffered a loss.1 In the same case, the House of Lords had to consider a scheme of tax avoidance, which consisted of a series of combination of transactions each of which was individually genuine, but the result of all which was avoidance of tax. 2 Lord Wilberforce, with great force observed: "Given that a document or transaction is genuine, the court cannot go behind it to some supposed underlying substance. This is the well-known principle of Duke of Westminster. This is a cardinal principle, but it must not be overstated or overextended.3 In the two cases of Ramsay (WT) v IRC and Eilbeck v Rawlings [1982] AC 300, the House of Lords had said that in reaching a conclusion as to the true legal effect of a series of transactions regard could be paid to the overall effect of the scheme as a whole. 4 In essence, the Ramsay approach applies the purposive approach of statutory interpretation to tax statutes, particularly relief and exemption provisions therein. And it involves a realistic analysis and assessment of the facts and the transactions in question. These are the fundamentals, which must be borne in mind when considering the application of the Ramsay approach to tax avoidance schemes.5 The Furniss vs Dawson Case My understanding of the case: This is also another important case in the House of Lords wherein the issue is about avoiding payment of capital gain tax by resorting to scheme to avoid direct payment of said tax by structuring their deal. This case involved father and sons who owned clothing companies. Another company ( Wood Bairstow) offered to buy one of the companies of the Dawson. However, the Dawson to make use of the rule on delay payment of capital gain tax formed another company known as Greenjacket and then sold its operating company to the latter in exchange for shares because doing it this way will save the Dawson from payment of CGT which is payable immediately, which method is allowed by law provided that later on, the said shares be sold to Greenjacket, which is subjected to CGT. However, Greenjacket sold the operating companies to Wood Bairstow. When the tax authorities imposed CGT tax to the Dawson, the latter argued that they are not liable for the said tax and that the Ramsay principle did not apply in their case for there is no self-canceling transactions involved. Court's Ruling: The Court ruled the judgment can be viewed as a battle between:  extending the principle in the Duke of Westminster's Case (Inland Revenue Commissioners v. Duke of Westminster [1936] A.C. 1); and extending the Ramsay Principle; two conflicting ideas which could, at their extremes, be expressed as: a) a rule that any taxpayer may organize his affairs in any way he wishes (provided it is legal) so as to minimize tax (Westminster) and b) a rule that a taxpayer will be taxed on the effect of his transactions, not upon the way he has chosen to organize them for tax purposes (Ramsay).6 Lord Brightman came down firmly in favour of an extension of the Ramsay Principle. He said that the appeal court judge (Oliver L. J.), by finding for the Dawsons and favouring the Westminster rule, had wrongly limited the Ramsay Principle (as it had been expressed by Lord Diplock in a case called IRC v. Burmah Oil Co. Ltd.)7 According to Lord Brightman : "First, there must be a pre-ordained series of transactions, or, if one likes, one single composite transaction. This composite transaction may or may not include the achievement of a legitimate commercial (i.e. business) end . . . Secondly, there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax--not 'no business effect.' If those two ingredients exist, the inserted steps are to be disregarded for fiscal purposes. The court must then look at the end result. Precisely how the end result will be taxed will depend on the terms of the taxing statute sought to be applied." 8 Court's Opinion on Tax Avoidance In any case where a predetermined series of transactions contains steps, which are only there for the purpose of avoiding tax, the tax is to be calculated on the effect of the composite transaction as a whole. 9 A scheme would not be effective for tax avoidance purposes if there was a pre-ordained series of transactions and if steps had been inserted which had no commercial purpose apart from the avoidance of a liability to tax. 10 The ruling in the case applies not only to capital gains tax but to all forms of direct taxation. It also applies in most jurisdictions where decisions of the English courts have precedential value, including many of the offshore financial centers. 11 The House of Lords applied the Ramsay approach to a scheme of tax deferral as opposed to avoidance, which was not circular or self-cancelling. 12 The approach of the Lords to 'linear' tax avoidance in Furniss v Dawson marked a significant extension of the Ramsay principle, which hitherto had been founded upon 'circular' or self-cancelling schemes. The principle could be applied to both tax deferral and avoidance, and to situations in which the legal implications of the intermediate steps continued beyond the scheme itself. 13 Referring to the previous criteria for the Ramsay principle to apply Lord Brightman redefined the necessary conditions: 1) a preordained series of transactions (or one single composite transaction); into which there must be 2) steps inserted which have no commercial (business) purpose (as distinct from a business effect) apart from the avoidance (or deferral) of a liability to tax. 14 CRAVEN VS. WHITE CASE My understanding of the Case: In this case, in anticipation of the merger or sale of the business, the taxpayers exchanged their shares in a trading company known as Q Ltd for shares in an Isle of Man holding company (M Ltd). The taxpayers later entered into a contract of sale the share of Q Ltd and at the same time abandoning negotiation with an interested party. The taxpayers were assessed capital gain tax by the taxing authority when the entire sale proceeds were loaned to them. The ruling in this case when it reached the House of Lords was in favor of the taxpayers because there was no certainty that the Q Ltd shares of the taxpayers will be sold. The Court's Ruling or Opinion on Tax Avoidance: The majority view was that a scheme was preordained if it was planned as a whole and carried through as a whole, ie where the avoidance transaction was undertaken at a time when there was no "practical likelihood" that the subsequent transaction would not take place. 15 The Lords noted that when the share exchange took place, there was no certainty that the shares in Q Ltd would be sold. In his judgment, Lord Oliver interpreted the following requirements for Ramsay to apply, ie "...the circumstances the court can be justified in linking the beginning with the end so as to make a single composite whole to which the fiscal results of the single composite whole are to be applied": 1) that the series of transactions was, at the time when the intermediate transaction was entered into, preordained in order to produce a given result; 2) the intermediate transaction had no other purpose than tax mitigation; 3) there was at the time no practical likelihood that the pre-planned events would not take place in the order ordained, so that the intermediate transaction was not even contemplated practically as having an independent life; and 4) that the preordained events did in fact take place. 16 The House was unanimously of the view that although there had been an initial disposal with no commercial purpose, except to lay the ground for an avoidance of tax if and when there should be a further disposal to a third party, the transactions were so separate in fact as well as in law as to make it impossible to treat them, even in a commercial sense, as a single disposal to the third party. 17The lapse of time between the two transactions, the lack of contemplation of any specific later disposal at the time of the first transaction, were commercial realities. The division of opinion in the House over how the third transaction should be categorized did not detract from the agreement that it had to fall within the statutory language’.18 REFERENCES Ramsay Principle. [Date Accessed: June 1, 2011]. Retrieved from website: http://law.jrank.org/pages/17077/Ramsay-principle.html Statute. [Date Accessed: June 1, 2011]. Retrieved from website: http://statutelaw.blogspot.com/2011/05/14wt-ramsay-ltd-v-irc-1982-ac-300-hl.html Furniss vs Dawson. [Date Accessed: June 2, 2011]. Retrieved from website: http://www.lawgazette.co.uk/news/furniss-amp-dawson-where-does-tax-planning-go-now Melissa Pang and William Ong. Construction of Revenue Statute: The Ramsay Principle. Available at CFTL website. [Date Accessed: June 3, 2011]. Website: http://www.cftl.cn/show.asp?c_id=555&a_id=3852 Statute on Furniss vs Dawson. [Date Accessed: June 2, 2011]. Retrieved from website: http://statutelaw.blogspot.com/2011/04/5-exact-scope-of-ramsay-principl.html The Ramsay Principle. [Date Accessed: June 3, 2011]. Available at website: Taxation Web Co. UK. Website: http://www.taxationweb.co.uk/tax-articles/general/the-ramsay-principle.html Macniven v Westmorel and Investments Ltd. [Date Accessed: June 3, 2011]. Retrieved from http://www.hartpub.co.uk/Updates/MacNiven/05.htm Read More