Tax planning, tax avoidance and tax evasion overview

This article is a private opinion based on private research and it shouldn’t be considered as advice.

Tax planning, tax avoidance and tax evasion overview
Photo: Natee Meepian, Bigstock

As an individual who lives in a country with rules, it is only natural to pay tax as one of the ways to abide the rules. It doesn’t matter who you are, how influential you are, and how much money you earn, you still have to pay tax.

However, if you are a small business owner, it could be a tough task to manage your income, as you will have to pay income tax. For that reason, business owners try several ways to relieve their income tax that include tax planning, tax avoidance, and tax evasion to reduce or minimise their small business tax.

However, as a business owner, you should also consider which one of these methods is the right one, because you might end up dealing with the law if you are not careful. Don’t worry; this article will help and guide you with the comparison between tax planning, tax avoidance and tax evasion so that you would get a better understanding about each of them and know what to do from there. Let’s get started!

Tax planning

Tax planning is the method that business owners use in order to reduce their tax liability without breaking the law by taking full advantages of deductions, exemptions, rebates and allowances that are deemed eligible by the government.

With this method, the government approve that all taxpayers have the right to arrange their financial matters in a way that can lessen their tax liability, as long as it is done within the law. This method is usually considered as “white” method, as it includes taking advantages of some exemption notifications, claiming eligible deductions from assessable value, transferring tax subject or object to some countries that are categorised as tax haven or some countries that give special taxation treatments to certain types of income, and many more.

Tax avoidance

Tax avoidance is the method of intentionally gaining advantages of paying tax as minimum as possible by arranging financial matters in such ways that are not anticipated by the government, so that it is not considered as illegal. This method includes twisting the rules of the tax system, taking advantages of the loophole in the provision of law.

Some common examples of tax avoidance practice are, contributing to a retirement account before tax deadline and after that claiming the deductions, being paid through private companies, setting charitable donations abroad to claim back tax, and many more. Tax avoidance can be considered as “grey” method, as technically, it is not breaking the law; however, it is an immoral act that can kill the spirit of the law or the tax system.

That being said, if you are not careful, this could backfire you someday, and the consequences could involve severe penalty by the law or jail terms.

Tax evasion

Tax evasion is the method of minimising tax liability as low as possible by avoiding tax illegally (breaking the law). This method includes concealment of facts (deflating income or inflating expenses), manipulation of records, fraud or collusion so that one can evade tax, as well as minimise tax liability while “hiding” from the law. This is not advisable, as it is strictly against the rules, and if you get caught, you would be penalised, either through fines, or sometimes prosecution.

Illustration of the difference between tax planning, tax evasion, and tax avoidance

In this part, we are going to share you some insights about the difference between tax planning, tax evasion and tax avoidance through a simple illustration. For example, the government grants exemption from excise duty for several years if your industry is set up around the specific area in Western Australia to promote industrialisation in these areas.

It can be considered as tax planning if you set up your manufacturing unit in Western Australia. However, it is called tax avoidance if you set up your manufacturing unit somewhere else and bring nearly ready products to Western Australia to implement small operations, such as testing, packing, etc. and sell from Western Australia. This clearly neglects the true purpose of the government to encourage industrialisation in Western Australia.

As for tax evasion, you can be considered as using tax evasion method if you manufacture and dispatch the products from somewhere else but then raise invoices of sale from Western Australia in order to “show” that your products have been manufactured and sold from Western Australia.

Hopefully, the illustration above can give you a clear picture of the difference between tax planning, tax avoidance and tax evasion. Basically, tax planning is legal, tax evasion is illegal, and tax avoidance is somewhere in between. Setting aside the tax evasion, both tax planning and tax avoidance are legal; however, while tax avoidance doesn’t break the law, it still neglects the true meaning and purpose of law making.

On the other hand, tax planning is highly advisable, as not only do you give transparency to the government, of which the government fully approve, but you can also deduct your tax liability in legal ways that would give you long-term benefits and relieve you from so much pressure in the future. Therefore, we recommend using tax planning methods to help you with legal tax deductions or exemptions that would make your business run smoothly and in peace.