Author: Niall Hearty
6 February 2024
9 min read
Each and every business has to pay tax, as do the individuals that are part of it. For the individuals, they are likely to have to pay income tax and National Insurance while companies may have to pay corporation tax, value added tax (VAT), tax on company share dividends or capital gains tax.
Not paying tax can, depending on the circumstances, be classed as either tax evasion or tax avoidance. This article outlines the differences between tax evasion and tax avoidance and gives some examples of each.
It is important to say that in recent years the UK government has been taking a firmer approach to tax evasion and tax avoidance. The Criminal Finances Act 2017 created a new corporate criminal offence of failing to prevent the facilitation of tax evasion by associated persons.
The UK’s tax authority, HM Revenue and Customs (HMRC), has been increasingly targeting tax avoidance schemes in an attempt to hold to account those who are taking advantage of them.
Businesses and their owners have a legal duty to collect and/or pay any tax they owe to HMRC. Individuals have a similar duty, although their tax is likely to be collected from their salary and paid directly to HMRC, unless a person is self-employed.
Failing to meet these requirements can lead to fines being imposed. More serious penalties can be imposed if it is found that there has been illegal activity in order to avoid paying tax.
While most businesses (and those who work for them) want to work within the rules and ensure they pay the minimum legal amount of tax, many find themselves accused of tax avoidance or tax evasion because they have not complied with the rules.
This is why it is important to know what behaviour may be viewed as tax avoidance or tax evasion.
The UK government has said that tax avoidance involves “bending the rules of the tax system to gain a tax advantage that Parliament never intended.’’
It can involve deals or arrangements that have little or no purpose apart from creating such a tax advantage. While these transactions do not break the law, they are considered to be against the spirit of the law.
According to most recent figures, tax avoidance costs the UK an average of £1.4 billion a year.
Tax avoidance has made the news on numerous occasions through reports of the avoidance schemes used by celebrities and public figures to reduce the tax that they pay. This has led to many well-known individuals having to pay more tax than they hoped to under their tax avoidance scheme, with some also having to pay financial penalties.
Tax avoidance schemes can vary in how they work, where they are based and the supposed tax savings they claim to make. There are many companies that will offer such services.
Some of the most common tax avoidance schemes are:
Director’s Loans: A director’s loan is money that is taken from a company's accounts that the director will eventually have to repay. It is a legal activity that is done with the approval of the senior figures at the company. But if the loan is never repaid and the company writes it off – meaning it does not expect it to be repaid – the director has received that money without it being taxed in any way.
Disguised Employment: This is when a person does the same work as if they were a permanent member of a company’s staff but they are hired as a contractor and paid through their own limited company. This can lead to both sides paying less tax: the person will not have to pay as much as they would if they were a company staff member and the company does not have to pay the person’s National Insurance contributions.
Offshore Tax Havens: Such havens involve a scheme or structure being created in places where the taxes paid by individuals or companies are very low - so that a person or a firm can benefit by only having to pay that very low level of tax. Offshore tax havens are usually found in countries or places where outsiders can easily set up businesses and where not much information is disclosed about companies and their owners.
Contractor Loan Schemes: This is a situation where someone is paid for their work for a company in the form of a loan. This loan will not come directly from the company but will be moved through a chain of companies, trusts or partnerships. The company may tell the person that they will not have to pay tax on the money because it is a loan.
The penalties for tax avoidance will vary, depending on the circumstances of each case. Paragraphs 30 to 44 part 5 schedule 18 of the Finance Act 2016 introduced a new series of penalties for users of tax avoidance arrangements. There is a serial tax avoidance regime (STAR) process in place that will determine the penalty to be imposed. There are also special rules for determining the size of the penalty for corporate groups, associates and partners in partnerships.
Tax evasion is where businesses, their owners or their staff or advisers commit a criminal offence in order to avoid paying some or all of the tax that should be paid.
Government estimates in recent years say that tax evasion costs the UK about £5.5 billion every year.
Some of the most common forms of tax evasion are:
Under-reporting business income to HMRC: By stating that less income has been earned, an individual or a company will be asked to pay less tax than they would have had to pay if HMRC had known how much they really did earn.
Hiding shares, assets or money offshore: Moving wealth offshore can mean that its owners have to pay less tax on it than if they had kept it in the UK (or wherever it was before it was moved). Such moving of money or items of value may be done secretively to ensure that no tax is paid on it anywhere as the authorities do not know of its existence or location.
Paying employees in cash: The practice of paying “cash in hand’’ for work enables people to receive money that HMRC is unaware of, meaning no income tax or National Insurance is paid on it.
Misreporting personal expenses as tax deductible business expenses: A person may use receipts (or other proofs of payment) for items that were bought for themselves or friends and family – such as a meal in a restaurant – and then claim that the payment was part of their business activities. Doing this means they can then claim the tax back on what they paid.
Using company property for personal use without a valid business reason: The use of company equipment by directors or staff has a range of tax implications, and the benefit of such use should be calculated for tax purposes. Many people, however, do not declare such use.
The penalties for tax evasion can vary. The penalty imposed will depend on the type of tax evasion, the amount of tax that was evaded and the length of time the tax evasion had gone on for.
The less serious cases of tax evasion can be heard in a magistrates court. If found guilty, a person can be fined up to £5000 or jailed for up to six months. The most serious cases will go to Crown Court, where the maximum sentence is seven years’ imprisonment and an unlimited fine. The courts can also order the tax to be paid, plus any interest that would have built up on that amount of money since the time it should have been paid as tax.
In the Spring Budget 2023, the government announced its intention to amend the maximum sentence that can be given to individuals convicted of serious tax offences (meaning tax fraud or tax evasion rather than tax avoidance) from seven to 14 years.
As we have outlined in this article, tax avoidance involves exploiting the system (bending the rules) in order to reduce the amount of tax you have to pay. But tax evasion means concealing income or information from the HMRC - and it is illegal. There is a fine line between avoidance and evasion. HMRC has closed down a number of tax avoidance schemes as it has taken the view that they amount to tax evasion.
Tax planning is the process of looking at a person or company’s financial situation in order to ensure they are making the most of the tax laws. It involves assessing income sources (the money being earned or coming in through other ways), investments and expenses in order to ensure that a person or company is minimising the amount of tax they should be paying legally and taking advantage of any benefits available to them under the tax laws.
Putting it simply, it is analysing a person or company’s tax situation to pay the lowest amount of tax that is allowed by law.
Tax planning is different to tax avoidance. While tax avoidance is an unethical bending of the rules to use loopholes to dodge tax payments, tax planning is the use of the existing tax law in a way that would not be considered “dodgy’’ by HMRC.
Tax fraud is a phrase that is used to describe a very wide range of illegal activity.
It includes activity such as:
HMRC will usually treat tax fraud as a civil matter, although it would consider criminal charges and prosecution if it believed the case merited this. If it is treated as a civil matter, the investigation will be resolved by the person or company under investigation paying what they owe and possibly a fine.
The cases that HMRC considers the most serious, however, will be the subject of a criminal investigation, which could lead to a large fine or even imprisonment.
Tax fraud is defined by HMRC as a deliberate concealment, misinterpretation or omission of information or the false presentation of circumstances or information to gain tax advantages. Tax evasion, however, is the dishonest and deliberate attempt to actually avoid paying the amount of tax that is owed.
Tax evasion is similar to tax fraud in that HMRC may try to deal with the matter by imposing fines and ordering payment of the tax that is owed, with prosecution being a possibility if that is not accepted and/or the evasion in question is particularly egregious.
HMRC makes it clear that it seeks to ensure the highest level of compliance with the law and regulations that relate to taxes. It views criminal investigation and prosecution as an important part of this.
If HMRC is investigating you, it will send you a letter explaining that it has started an official investigation. This letter will ask you for extra information. Until this point, there will be no formal notification that HMRC is looking into your tax affairs.
But in some situations, HMRC may begin its inquiries by asking for more information about your latest tax return or a particular transaction, such as the purchase of property.
HMRC may carry out:
HMRC’s options go far beyond deciding whether or not to prosecute. It can begin a COP 8 (Code of Practice 8) investigation to claim the tax that it believes it is owed. A COP 8 investigation can be carried out into individuals and businesses and can relate to any type of taxation.
Pension schemes, employee benefit trusts, inheritance tax schemes and share loss relief and enterprise investment schemes are also possible targets for a COP 8 investigation.
If a COP8 investigation finds that the correct amount of tax has not been paid then the tax due plus any penalties and interest must be paid. And if HMRC suspects the behaviour involves dishonesty or fraud, it can begin a COP 9 investigation or even a criminal investigation.
A COP9 investigation will only be started by HMRC when it suspects that serious tax fraud has been committed. The subject of this investigation can then either accept that they are in the wrong and make a full disclosure of their tax fraud or deny there has been any tax fraud.
If HMRC is satisfied that the subject has made a full and accurate disclosure, it will not begin a criminal investigation.
If you are notified that you or your business are under investigation by HMRC – or think you are about to be – seeking specialist legal advice is the first step to take. Obtaining advice from those with in-depth experience of HMRC investigations is essential so that you can use all available evidence to build a strong case, challenge any allegations and obtain the best possible outcome.
As a firm with in-depth experience of all aspects of HMRC investigations, Rahman Ravelli’s expert HMRC tax investigation layers are ideally placed to provide their expertise and advice.
Niall has a wealth of corporate crime expertise and an ability to coordinate global bribery and corruption cases. His achievements in such investigations have made him a logical choice for corporate clients.