Tax Planning vs. Tax Evasion

Yash Shah

1. The word ‘tax planning’ connotes the exercise carried out by the taxpayer to meet his tax obligations in proper, systematic and orderly manner availing all permissible exemptions, deductions and reliefs available under the statute as may be applicable to his case.

2. To illustrate, assessee software company setting up assessee software technology park in assessee notified area to avail benefits of section 10A of the Act is assessee legally allowable course. Planning does not necessarily mean reduction in tax liability but is also aimed at avoiding controversies and consequential litigations. 3. Every taxpayer is expected to voluntarily make disclosures of his incomes and tax liabilities through legal compliance. When a tax payer deliberately or consciously do not furnish material particulars or furnishes inaccurate or false particulars or defrauds the State by violating any of the legal provisions, it shall be termed as ‘tax evasion’. It is also illegal, but also unethical and immoral.

4. Inflation of expenditure, suppuration of income, recording of fictitious transactions, claiming deductions wrongly are few examples.

5. Benjamin Franklin is credited with this classical statement: There are two certainties in this world – death and taxes. This makes all tax payers in general, and the companies in particular, realize the bitterness or hardship of taxes.

6. Three methods of saving taxes have been developed in most countries of the world in the past few decades: tax evasion, tax avoidance and tax planning. A great deal of confusion prevails in corporate sector about correct connotations of these terms. Hence, we shall attempt to explain these terms to show tax planning is absolutely legal.

7. The expression ‘Tax Evasion’ means illegally hiding income or concealing the particulars of income or concealing the particular source or sources of income or in manipulating the accounts so as to inflate the expenditure and other outgoings with a view to illegally reduce the burden of taxation.

8. Hence, tax evasion is illegal and unethical. It is uneconomical as well.

9. It deserves to be deprecated not only by the Government but by the companies as well. The next expression is ‘Tax avoidance’ which is assessee art of dodging taxes without breaking the law.

10. In my opinion, tax avoidance means traveling within framework of the law or acting as per language of the law only in form, but murdering the very spirit of the law and defeating the purpose of the particular legal enactment.

11. If, by adopting an artifice or device against the intension of the legislature but apparently on the face of it acting within the framework of the law, a company is able to dodge income tax, it would be a clear case of tax avoidance. In contrast, ‘Tax Planning’ takes maximum advantages of the exemptions, deductions, rebates, reliefs, and other tax concessions allowed by taxation statutes, leading to the reduction of the tax liability of the tax payer.

12. Tax planning has been contrasted with the expression tax avoidance and has the legal sanction of the Supreme Court as well. In recent years the sentiments in favour of tax avoidance have changed and the courts view tax avoidance with displeasure.

13. For example, Lord Summer in IRC vs. Fisher ’s Executors AC 395, 412 had earlier as per the ratio of Westminister ’s case said:

“My Lords, the highest authorities have always recognized that the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so with the law, and that he may legitimately claim the advantage of any express terms or any omissions that he could find in this favour in taxing Acts. In so doing, he neither comes under liability nor incurs blame.”

14. The significance of Ramsay as assessee turning point in the interpretation of tax laws in England and the departure from the principle of Westminister’s case were explained in TRC vs. Burmah Oil Co. Ltd., STC 30 where Lord Diplok said:

“It would be disingenuous to suggest and dangerous on the part of those who advise on elaborate tax-avoidance scheme to assume, that Ramsay ‘s case did not mark assessee significant change in the approach adopted by this House its judicial role to assessee pre-ordained series of transactions into which they were inserted steps that have no commercial purpose apart from the avoidance of tax liability, which in the absence of those particular steps would have been payable. The difference is in approach.”

15. Commenting on this judgment the Supreme Court of India in the McDowell Co. Ltd., Vs. CTO 154 ITR 148(SC) said:

“It is neither fair nor desirable to except the legislature to intervene and take care of every device and scheme to avoid taxation, it is up to the court to determine the nature of new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices for what they really are and to refuse to give judicial benediction.”

16. In the same judgment, Supreme Court Judges made a clear distinction between tax avoidance and tax planning. This is what the judges of the Supreme Court have said in the same case:

“Tax Planning may be legitimate provided it is within the framework of law. Colorable devises cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.”

17. Form the above it is very clear that tax planning by Assessee Company cannot be called a crime or an illegal activity or an immoral action as is wrongly considered by confused thinkers on the subject. What constitutes a crime is tax evasion and what is undesirable is tax avoidance but it is certainly desirable to engage in the exercise of tax planning.

18. In UK, wherefrom the principal coined in McDowell’s case was coined, the House of Lords expressly reaffirmed the basic principle, ‘A subject is entitled to arrange his affairs so as to reduce his liability to tax.

19. The fact that the motive for a transaction may be to avoid tax does not invalidate it unless a particular enactment so provides’.

20. The House of Lords expressly reaffirmed the cardinal principle of Duke of Westminister, ‘Given that a document or transaction is genuine, the Court cannot go behind it to some supposed underlying substance’.

21. They only ruled against the principle being overstated or overextended. Mukharji J, who in his prompt and lethal report in CWT vs. Arvind Narottam said: ‘…no amount of moral sermons would change people’s attitude towards tax avoidance’, and soon thereafter in UoI v Playworld Electronics stated: ‘one should avoid subverting the rule of law’.

22. As a matter of law, the Supreme Court in these two latter cases reiterated that where the true effect of a transaction is clear, the appeal to discourage tax avoidance is not a relevant consideration.

23. In any event, when the language of a deed of settlement is clear, an attempt to invoke McDowell would be futile even if the deed results in tax avoidance. as the Madras High Court held in Valliapan vs. ITO, McDowell does not hit tax planning.

24. The manner in which McDowell is to be dealt with was well summed up by the Gujarat High Court in Banyan and Berry vs. CIT thus:

The court (in McDowell) nowhere said that every action or inaction on the part of the taxpayer which results in reduction of the tax liability to which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act….

The principle enunciated in the above case has not affected the freedom of the citizen to the act in a manner according to his requirements, his wishes in the manner to do any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same falls in the category of colourable device.

The House concluded that steps which had no commercial purpose and had been artificially inserted for tax purposes into a composite transaction, should be disregarded; but that a transaction which came into statutory language could not be disregarded merely because it was entered into solely for tax purposes.

25. Therefore, while tax planning these principles emanating from court made law need to be kept in sight. Otherwise, planning looking good on paper may fail in practice.