Tax Evasion & Avoidance in India

Taxes are levied on the citizens by the government for various purposes, including funding of projects it has planned across the country. It is imperative for all citizens to pay their taxes as per the tax slabs set by the Government of India. While tax avoidance may not be illegal, any form of tax evasion shall be deemed unethical and illegal and result in legal action against the defaulter.

Definitions

• Tax Evasion: Tax Evasion is an illegal activity where a person or corporate entity intentionally underpays or hides a certain part of their revenue to reduce their tax liability. Tax evasion is usually a result of individuals not paying taxes by failing to disclose their entire taxable income or by claiming unauthorized deductions.
• Tax Avoidance: There is no definition of Tax Avoidance as per the Income Tax Act, 1961. However, the term refers to instances where individuals reduce their tax liability by taking advantage of legislative ambiguities and loopholes. Tax avoidance is a legal approach to reduce the tax burden and is not prohibited under any law.

 

How do you know what is Tax Avoidance or Tax Evasion?

While both Tax Avoidance and Tax Evasion are activities carried out by individuals to reduce the tax burden on them, not both are legal. While tax avoidance is a legal activity, tax evasion is deemed an illegal way to avoid taxes.

Considering the severe repercussions you may have to face, it is imperative to understand whether an activity carried out by you falls under tax avoidance or tax evasion.

• Tax Avoidance: Any activity performed to avoid tax while complying with all tax laws and without any illegal intention shall fall under Tax Avoidance.
• Tax Evasion: Any activity performed to avoid tax while not complying with tax laws and with the intention of underreporting income, hiding total revenue, increasing the expenses, or making deductions shall fall under Tax Evasion.

Difference between Tax Evasion & Tax Avoidance

Tax Avoidance	Tax Evasion
Tax is avoided by leveraging legislative ambiguities & loopholes while complying with tax laws.	Tax is avoided through the usage of unethical & illegal means & fraud.
Tax is avoided by leveraging provisions stated under Tax Laws.	Unfair means used.
It is not carried out with unlawful intentions but by complying with the provisions stated under Tax Laws.	Tax evasion is performed through unethical way of paying tax dues & by not adhering to the provisions stated under the Tax Laws.
No punishment or penalty shall be levied. Although the applicant may be asked to properly present their case to higher authorities.	Applicants committing tax evasion may be both penalized & punished.
Income Tax Department may issue notices to clarify the meaning of Income Tax laws to avoid any loophole or amend the laws to eliminate any loophole.	No changes shall be made in the laws.

Some Examples of Tax Avoidance & Tax Evasion

• Foreign shareholders may lower their payable tax for income earned under interests, dividends, managerial services, and royalties through tax treaties between India and foreign countries. This is deemed as Tax Avoidance. However, not disclosing the income earned by foreign shareholders falls under Tax Evasion.
• If a company’s services are provided by a foreign subsidiary in Dubai and the revenue is reported as income of the foreign subsidiary in Dubai, it shall fall under Tax Avoidance. However, if the services are provided by a company in India but the revenue is reported as income of a foreign subsidiary, it shall be a form of Tax Evasion.
• While the income earned via a license of Technology and Transfer of Technology usually falls under the ambit of Royalty as per the Indian Income Tax Laws, in International Tax Treaties, income earned via such means is deemed as Capital Gain. The taxpayer may lower their payable tax by leveraging the provisions of the tax treaties between India and foreign countries and this shall fall under Tax Avoidance. However, failing to declare such income earned by foreign shareholders shall be deemed as Tax Evasion.

Tax Avoidance: Case Example

Hutchison Essar Limited is a company registered in India, whose 67% shares are held by ‘CGP Investments (Holdings) Limited’, which is a subsidiary of Hutchison Telecommunications International Limited (HTIL), a company registered in Hong Kong.

Vodafone International Holdings BV (‘Vodafone’), a company registered in Netherlands, acquired 100% shares of CGP Investments (Holdings) Limited for a whooping USD 1.1 billion. The share agreement was signed on 11 February 2007 and the capital gain tax of this deal was avoided on the transfer of Hutchison Essar Limited.

In September 2007, Vodafone was issued a Show Cause Notice by the Indian Income Tax Department with respect to the above-mentioned transaction. The Tax Department claimed that the transaction between the two entities and transfer of shares in CGP had a significant impact of assets located in India.

Vodafone filed a writ petition in Bombay High Court, who, through their decision in 2010, held that the amount payable for transferring property such as telecom licenses, non-compete rights and use of their brand name are to be considered a transfer of Indian assets taxable in India.

In an appeal by Vodafone in Supreme Court, the Court negated and reversed the decision of the Bombay High Court. In its 2012 decision, the Court held that no part of the consideration paid by Vodafone to Hutchison is liable to taxation in India. Furthermore, it directed the Tax Department to reimburse the security amount deposited by Vodafone along with the interest.

Steps Taken by the Government to Reduce Tax Avoidance

• Transfer Pricing: As per the provisions under transfer pricing, the price of any international transaction or specified domestic transaction between two or more associated entities must be computed with respect to the arm’s length price to reduce any potential Tax Avoidance. This regulation was introduced to stop inter-group companies from shifting their profit from nations with high tax-rates to nations with low tax-rates.
• Place of Effective Management: Section 6(3) of the Finance Act, 2015 was amended to replace a new corporate residency test according to which if a foreign company’s place of effective management (POEM) is deemed to be in India, it would be a tax resident of India. Before this, a company that was not a resident of India was only considered a resident for tax reasons if it was controlled and managed in India.
• General Anti-Avoidance Rule (GAAR): It is mentioned in Chapter X-A of the Income Tax Act, 1961. Although GAAR was enacted into the Income Tax Act by the Finance Act, 2012, it came into effect in April 2017. The sole purpose of GAAR is to prevent tax avoidance through a provision under the Income Tax Act, known as, ‘Section 96, impermissible avoidance arrangement.’ Any arrangement or negotiation conducted with the aim of obtaining a tax benefit is restricted under the law.

Steps Taken by the Government to Reduce Tax Evasion

Provision	Penalty
Section 158FA – determination of undisclosed income for the block period, when a search is initiated under Section 132 or books of any account, other documents or any asset is requisitioned under section 132A in the case of any person.	Minimum - 100% of the tax leviable in respect of the undisclosed income. Maximum - 300% of the tax leviable in respect of the undisclosed income.
Section 221(1) – Default in payment of taxes.	Amount payable shall be as stated by the assessing officer. However, the amount shall not exceed the total tax amount in arrears.
Section 270A - Penalty for underreporting income. Penalty for underreporting on account of misreporting of income.	50% of the amount of tax payable on underreported income. 200% of the amount of tax payable on underreported income.
Section 271AA (1) - Penalty in respect of an international transaction / specified domestic transaction with regard to: - failure to keep & maintain any such information & document as required by Section 92D (1) or 92D (2). - failure to report such transaction which is required to be done. - Maintaining or furnishing incorrect information or document.	2% of the value of each international transaction or specified domestic transaction entered into.
Section 271AAD - Penalty for false entry, fake invoices, etc. in books of account.	If any assessing officer finds: a) A false entry, or b) An omission of any entry which is relevant for computation of total income of an assessee He may direct the assessee to pay a penalty of an amount equal to the sum of such false or omitted entries. The false entry here means the following: a) Forged or false document such as a fake invoice. b) Any invoice of supply or receipts of goods or services issued by any person without actual supply or receipt of goods or services. c) An invoice in respect of supply or receipt of goods or services or both to or from a person who does not exist.

Conclusion

Considering how important it is to pay your tax dues, many people pay their taxes after making certain deductions in order to reduce the total amount they must pay. While you may make certain deductions by leveraging provisions under different tax laws, it is imperative to make sure that such deductions fall under tax avoidance and not under tax evasion.