What’s the difference between tax evasion and tax avoidance?

by Ryan Ong

THE polite way to discuss tax avoidance is to say “tax efficient”. Or you could say “optimising your income,” or a dozen other euphemisms for “pay as little tax as possible without going to jail”. See, who says words people are not numbers people too?

But seriously, most of the  6,500 or so Singaporean entities mentioned in the Panama Papers are probably doing nothing wrong. Tax evasion tends to be quite rare in Singapore, because this is already a low tax environment. It’s so cheap that the penalties of lying to the Inland Revenue Authority of Singapore (IRAS) would far outweigh the cost of just paying them.

It’s far more likely that affluent individuals or corporations in China, Russia, the UK, etc, will be the ones evading taxes, and trying to hide it in Singapore (for which MAS has promised to perform checks to weed out).

But when does it all become illegal, and when is it just routine business?

Tax avoidance

Tax avoidance is actually quite routine, and most governments are aware that it happens. This is when individuals or corporations use legal means to minimise the taxes they pay, often by moving the money offshore. Tax avoidance is a natural consequence of the following:

• Lack of harmonisation in tax rates globally
• Lack of political will
• Corporate responsibility
• Legal vagueness

 

1. Lack of harmonisation in tax rates globally

The only way to put an end to tax avoidance, forever, is if every country in the world go together and decided to have the same tax rate on everything. This is as a probable as having laser eyes as a birth defect.

No two countries have the exact same tax scheme. In Singapore, which is a low tax environment, income tax tops out at 20 per cent. In Belgium, it tops out at 42.8 per cent. Singapore has a flat 17 per cent tax rate for businesses, as opposed to the United Arab Emirates’ insane 55 per cent corporate tax.

Conversely, income tax tops out at just 15 per cent in Hong Kong, and countries like the Bahamas have zero corporate tax.

Due to the wide disparity of tax systems, there will always be a place that’s cheaper to park your money. And rich people, along with corporations, will often try to minimise their taxes by moving to a cheaper place. The only thing that stops them is if they like being where they are – Singaporean companies don’t all rush to the Bahamas, for example, because they like the wider range of business prospects that come from our location and reputation.

But you get the main point – there will always be tax avoidance, because countries tax things at different rates. We can’t make it illegal for people or businesses to shift to a lower tax environment, because how would we even do that? Ban migration?

 

2. Lack of political will

Most governments are not unaware of tax avoidance schemes. Indonesia knows that their affluent citizens like to set up trust funds in Singapore, and the UK also knows some of its citizens avoid inheritance taxes by parking their money here.

The Cayman Islands, Switzerland, Hong Kong, Singapore, etc, have all been known as places that can make you more “tax efficient”, for many decades now.

The thing is, many governments don’t like to stop rich people from moving their money over here. Because if they do, it may cause the said rich people to move over here themselves. There’s a fear that, if the rich are pressured too much from taxes, they will uproot and move to a cheaper country (it’s not like they can’t afford it).

Most countries hate that, because of the theory that rich people create jobs and bring wealth.

That said, it’s political suicide to get on a podium and say “We’re going to tax rich people less, and poor people more”. So as a kind of subtle compromise, some countries have seemingly harsh tax regimes on the rich, but at the same time provide loopholes for the rich to retain their wealth.

I’m not going to be rude and point fingers, but let’s just say there’s a reason rich people continue to stay in countries with high tax rates of 40 per cent or more. Odds are, many of them are only paying taxes on the portion of their wealth that’s visible.

 

3. Corporate responsibility

This is where things get really sticky. Corporations have a duty to shareholders and stakeholders to minimise taxes. This often involves moving money to lower tax environments. In 2014, Burger King caused an uproar when it attempted a tax inversion – this is when a company legally “moves” to a lower tax environment, while maintaining its operations in a higher tax environment.

For example, a company in the United States could try to shift its legal domicile to the Bahamas, where it would pay no corporate taxes. But the majority of its outlets would still operate in the United States, where it enjoys access to the same large markets, and consumers with purchasing power.

There are thousands of ways corporations legally avoid taxes, and specialists are specifically paid to advise them on how to do it. The ethics of this is hard to sort out – on the one hand, it’s unfair to countries because companies take advantage of their infrastructure to make money, while returning very little to society. On the other, few shareholders or stakeholders would be happy with a company that pays taxes it could easily avoid.

But don’t worry, we have a good temporary solution: most companies promise not to steal from society and aggressively avoid taxes, unless they really want to.

 

4. Legal vagueness

This is rare, but it does happen. Sometimes the tax laws are loosely worded, and no one is entirely sure what they mean. The most common example of this is the difference between personal and corporate expenses, particularly in a sole proprietorship.

In the event that taxes fall into a “grey area”, tax authorities may have to wait until the rest of the government clarifies things.

 

Tax evasion

Tax evasion is straightforward. This is illegal, and involves lying to the tax authorities. Examples are under-declaring your income, or forging invoices to get Productivity and Innovation Credit (PIC) benefits.

Tax evasion is unusual in Singapore, as taxes are already low and penalties are hefty:

Section 96 of the Singapore Income Tax Act allows tax evaders to be penalised by up to 300 per cent of the tax undercharged, and/or $10,000 fine, and/or three years imprisonment. This is normally used for offences like not filing in tax forms properly, or shaving off a few dollars to fit into a lower tax bracket.

Section 96A of the Act, for serious tax evasion, deals with issues like forging sales receipts and invoices for a business. Penalties are up to 400 per cent of the tax undercharged, with a fine of up to $50,000 and/or imprisonment of up to five years.

If you want to make money off this, you can report tax evaders to IRAS. You’ll be rewarded 15 per cent of the tax reported, up to a limit of $100,000. Which seems a little low to me, because someone who makes that much money can probably afford an assassin.

The last major reported case was accountant Kung Seah Lim, who evaded over $45,500 in taxes back in 2015.

Tax evasion causes serious damage to a country’s overall economy. Remember Greece? Despite the frothing right-wing rants, it’s dubious to say that Greece was ruined solely by “socialist policies”. Greece was ruined by losing 23.3 per cent of its GDP in unreported revenue. Bloomberg figures that, if not for the tax evasion, Greece could have raked in US$22 billion in tax revenue, which would have paid off their debt in little over a decade, with no bailouts needed.

 

Regulation may not be the way forward

Today’s states are a schizophrenic mess: we hate the rich because of growing income inequality, but at the same time we really want them to stay. (Well okay, we want their money to stay, but unfortunately it comes attached to them.)

Going forward, the solution is likely to be social and not financial. It will no longer be about regulation and policy making, but about making the rich want to stay, despite higher taxes. What every country dreams of is a Warren Buffet type billionaire: someone who pays high taxes, but admits they made their fortune because of the opportunities their country provided, and stays grateful.

And that’s why Singapore needs to do more than provide a low tax environment, if we’re going to attract the rich. We need to maintain a stable environment, a strong sense of inclusion (especially for those who move here), and a vibrant cultural backdrop. That will take us further than another one or two per cent drop in taxes.

 

Featured Image by Sean Chong.

If you like this article, Like The Middle Ground‘s Facebook Page as well!

For breaking news, you can talk to us via email.

The post What’s the difference between tax evasion and tax avoidance? appeared first on The Middle Ground.

- Ryan Ong