In this article we take a look at what exactly is meant by the terms tax evasion and tax avoidance, the differences between the two, how one determines which is which, and factors to look out for that should immediately ring alarm bells.
The Westminster Doctrine
The Westminster Doctrine is a widely renowned principle that stems from Inland Revenue Commissioners v Duke of Westminster (1936) AC 1, and provides us with the following quote:
“Every man is entitled, if he can to order his affairs so as that the tax attaching under the appropriate acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax. This so-called doctrine of “the substance” seems to me to be nothing more than an attempt to make a man pay notwithstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable.”
The Westminster Doctrine, in short, allows a taxpayer to rearrange their affairs to minimise their tax liability, as long as such structuring of affairs is within the provisions of the law.
Tax avoidance through legislation
Tax avoidance stems from efficient tax planning and structuring one’s affairs in the most tax-friendly manner to reduce your tax burden by avoiding or paying less tax. There are correlations between the Westminster Doctrine and what is understood to be tax avoidance.
By making use of the advantages provided for in legislation, specifically the Income Tax Act 58 of 1962 (“Income Tax Act”), a taxpayer can legally minimise their tax liability using efficient tax planning by following the Act and provisions of law applicable.
Tax avoidance however has strict provisions governing such in South Africa. The General Anti- Avoidance Rules (“GAAR”) are general provisions under the Income Tax Act that address general tax avoidance which are deemed impermissible by the South African Revenue Service (‘SARS’).
Currently, the provisions of GAAR are found in Sections 80A to 80L of the Income Tax Act. Section 80A of the Income Tax Act provides us with the test to determine if there is an impermissible tax avoidance arrangement by considering the following elements:
(i) Entering into an ‘arrangement’ (which is defined as ‘any transaction, operation or scheme’).
(ii) An objective resulting in a tax benefit.
(iii) The ‘arrangement’ is solely to obtain a tax benefit.
(iv) The ‘arrangement’ did not take place for commercial purposes.
It should be noted that for an ‘arrangement’ to be deemed as an ‘impermissible avoidance arrangement’, it must satisfy each of the four elements set out above. However, the onus of proof lies on the taxpayer and Section 80G of the Act creates a presumption that any ‘arrangement’ concluded by a taxpayer is considered to have been specifically concluded as an ‘arrangement’ to obtain tax benefits and it remains the taxpayer’s responsibility to prove otherwise.
Consequences of impermissible transactions
Section 80B of the Income Tax Act sets out the consequences of impermissible transactions. The crux of the matter is that the taxpayer remains liable for any tax liability they may have benefited from. The taxpayer remains responsible for paying any tax still due as if the tax avoidance transaction never took place.
It should also be noted that numerous specific tax avoidance provisions in the Income Tax Act address specific anti-avoidance arrangements. These however fall outside the scope of this article.
Tax evasion, on the other hand, refers to illegally minimising or avoiding certain tax liabilities in their entirety. Tax evasion typically involves a person engaging in fraudulent activities, and such activities include providing information that is false and incorrect in an attempt to mislead SARS. Tax evasion is a criminal offence and is punishable by way of a fine or imprisonment.
Distinguishing tax evasion and tax avoidance
The crucial difference between tax evasion and tax avoidance is the legality of the transaction and the manner in which the transaction takes place. Tax evasion is a criminal offence, whereas tax avoidance is either deemed to be a permissible or impermissible method of tax avoidance. It is only where tax avoidance arrangements are considered to be impermissible that the taxpayer will be subject to the applicable tax in respect of that arrangement.
Although it may appear a fine line for the uninformed, there is a distinct difference between tax evasion and tax avoidance, with tax avoidance a legal method to avoid paying tax, and tax evasion involving illegal transactions aimed at avoiding tax. In both instances, the reduction of the tax burden is sought, but the manner in achieving this differs. As much as tax planning is appropriate and important, the complexity and dangers of incorrect planning should be clear from the above. Any tax planning must be within the legislative rules and done by a tax advisor who will ensure that tax planning is legitimate and permissible and remains in compliance with our tax laws.
Disclaimer: This article is the personal opinion/view of the author(s) and is not necessarily that of the firm. The content is provided for information only and should not be seen as an exact or complete exposition of the law. Accordingly, no reliance should be placed on the content for any reason whatsoever and no action should be taken on the basis thereof unless its application and accuracy have been confirmed by a legal advisor. The firm and author(s) cannot be held liable for any prejudice or damage resulting from action taken based on this content without further written confirmation by the author(s).