Ever asked the question “what’s the difference between tax evasion and tax avoidance?” Many people can tell you that one is legal and the other is illegal, but they often get mixed up as to which one is which. Good accountants will definitely know the difference and will be able to help their clients walk the thin line between being tax efficient and falling foul of the law.

If you didn’t know already tax avoidance is definitely the legal one of the 2 choices. It is described as bending the tax rules in a way that parliament never intended in order to reduce your tax bill and could be considered by many to be fair play. Let’s look at an example.

Mr F runs a successful building business which makes a profit of over £80k per year, normally he would be required to pay the higher rate of tax however he has decided to hire his daughter to take care of the administration side of things. He pays her a salary equivalent to any other professional in her role and that salary reduces his profit and he escapes the higher rate band of tax. His daughter is a basic rate payer and doesn’t have to pay higher rate tax either so as a family they have reduced their tax rate.

Many people out there would argue that this is perfectly legitimate but maybe some questions need to be asked before we decide.

  • Would Mr F have hired anyone at all if his daughter wasn’t available to do the job?
  • Is his daughter the best person available for the role?

If the answer to both is yes then this isn’t tax avoidance or evasion and Mr F’s business is as healthy as it should be. If on the other hand Mr F made a less than optimum hiring decision in order to reduce his tax bill then this is a perfect example of avoidance.

Taking it one step further what if Mr F did any of the following:

  • Didn’t actually hire his daughter but claimed on his accounts he did.

  • That he hired her under the arrangement that she would pass some of her earnings back to him in cash.

  •  Paid her significantly over anything that could be considered competitive for her profession or skills.

Then this would certainly be a prime example of tax evasion.

Okay he’s committed tax evasion, how is he going to be caught? Indeed many building businesses do have admin staff even though he didn’t need any and this might go unnoticed as HMRC inspectors would consider it the norm for his type of business.

He would of course need to put his daughters pay through the payroll system so as to not trigger any cross referencing inconsistencies and due to HMRC staffing reductions random inspections are very rare these days. He might even take the time to manufacture fake time sheets and a job role as well as create a fake e-mail account in his daughters name to send a few work related e-mails. This would be great protection in the event of an enquiry.

So actually this would appear to be the perfect crime and that’s why this and similar activities cost the treasury over £5bn a year in lost revenues, although from a holistic point of view the money he doesn’t pay in tax he will still probably spend within local businesses and create a measure of local growth that way.

Well if Mr F’s business does somehow trigger a tax investigation then HMRC will probably want to see some evidence that his daughter has received and spent the money, this means that she definitely couldn’t be claiming jobseekers allowance or other income related benefits and she might be asked to account for her money coming in and going out with an explanation of the balance. It’s also unlikely that MR F will be able to find a good accountant to work for him unless he lies to them as well, this could cause other losses in terms of tax efficiency as he will have a poor advisor.

The reality is that the average Joe doesn’t have the tax knowledge and insight to safely break the tax laws, they will always trip up somehow and then be left with hefty fines, a criminal record, a custodial sentence and asking the question “was it worth destroying a business I spent my life building for a couple of grand a year?”

Northants Accounting help businesses in and around Northampton save tax using legitimate methods and our experience in small business tax can often mean that clients will save far more using legal methods than illegal ones. The peace of mind on top of that is priceless. Please contact us to discuss any of these issues further.

Nishi Patel