Tax Avoidance, 1; Tax Evasion, 0
As the American judge, Learned Hand (1872–1961), once stated; “No one owes any public duty to pay more tax than what the law demands”.
But on the other hand, many people who are in a financial position to do so spend considerable amounts of money to avoid paying much larger amounts of money in taxes. However, it appears that tax evasion is suffering from the “law of diminishing returns”—spending money to evade paying taxes is increasingly a poor investment. More and more, news reports indicate that increased legal oversight and improved enforcement are bringing the era of bank secrecy and tax evasion to an end.
Tax evasion is the general term for efforts by individuals, companies, trusts and other financial entities to evade taxes by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability and includes, in particular, dishonest minimizing or understating of taxable income, such as declaring less income, lower profits, or limited gains than are actually earned, or by overstating eligible deductions, both in the amount and the number of deductions to which one is entitled. For those practicing the illegal methods of tax evasion, concealment and confidentiality are of paramount importance and as the ability to conceal is being eroded, tax evasion becomes increasingly challenging and expensive.
Tax evasion is not the same as tax avoidance. Tax avoidance is the process of doing everything possible within the law to reduce one’s taxable income. Without changing country of residence or giving up one's citizenship, personal taxation may also legally be avoided by creating separate, legal entities to which one's property is donated. These separate legal entities are often companies, trusts, or foundations. Assets are transferred to the new legal entity so that profits and gains may be realized or income earned within the financial structure of this legal entity, rather than being earned by the original owner, which would be taxable.
The company, trust, or foundation may also be able to avoid or lower corporate taxation by using offshore financial centers, provided they are properly structured. Care must be exercised when selecting legal entities and offshore financial centers, also known as offshore structuring, because most countries have enacted anti-avoidance legislation designed to reduce or eliminate the effectiveness of offshore structures.
It is important to for the client of a financial advisor to know the difference between tax avoidance—the art of lowering one’s tax bill as much as possible without breaking the law—and tax evasion, which is illegal. Clients are wise to seek out reputable financial advisors who will not steer the client into tax evasion, a move motivated by the advisor’s own personal gain. For once a client collaborates with an advisor in practicing tax evasion, the client and the financial advisor have a different, more complicated relationship—having become “partners in crime.”
Traditionally many financial advisors who practice tax evasion have operated out countries that are designated as Offshore Financial Centers (OFCs) that have been characterized by low or no taxes, less onerous compliance requirements and secrecy. However, initiatives led by the Organization of Economic Cooperation and Development (OECD) against so-called “harmful” tax competition and efforts by the US-led Financial Action Task Force (FATF) against money laundering (particularly money from drug trafficking as part of the War on Drugs) have forced most OFCs to increase transparency and to be subjected to increased government regulation, permitting greater exchange of information for both criminal and fiscal matters. This means that under certain prescribed circumstances, the beneficial ownership of an offshore structure can and must be revealed on request by an inquiring tax authority. Not a problem for “tax avoiders” but it is a very big problem for “tax evaders!”
The latest press release of the Global Forum on Transparency and Exchange of Information, which contains information about the various peer review reports, indicates that the majority of the countries reviewed have changed or are in the process of changing their domestic legislation, following the recommendation received from supra-national organizations, such as the OECD and FATF.
Not only criminal financial advisors are under pressure; even renowned and respected banks are being pressured to be more transparent. Over the past number of years, due to increasingly intense pressure from primarily the United States, Switzerland, the bastion of bank secrecy, has issued new guidelines that reduce the traditionally high level of secrecy and confidentiality of tax evader clients. Various Swiss banks, including UBS and Wegelin, have been forced to provide information on accounts and pay huge fines; in fact, Wegelin was forced into bankruptcy due to the level of fines it had to pay. Although the guidelines still protect the identity of the tax-evading clients for now, they require Swiss banks to provide authorities with information on the accounts, the employees who worked on the accounts, and transfer of money to other banks, or pay huge fines. Currently only the Swiss banks are taking the big hit for being complicit in tax evasion but at any time it could be the clients themselves who risk financial ruin! Increasingly tax evaders using Swiss banks are moving their money to other jurisdictions, primarily in Asia, but as the saying goes, “they can run but they can’t hide (for long)!”
None of these developments means that legal offshore structures for tax avoidance are any less useful but it is absolutely critical to arrange the ownership and management of an offshore structure correctly if they are to be effective and safe for the client. By choosing the right type of financial advisor and using a blend of offshore companies, life insurance contacts, offshore trusts, and private foundations, one is able to create offshore structures that legitimately and legally defer and lower the tax bill in the taxpayer’s home country.