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The distinction in the United States

In the United States "tax evasion" is evading the assessment or payment of a tax that is already legally owed at the time of the criminal conduct.[18] Tax evasion is criminal, and has no effect on the amount of tax actually owed, although it may give rise to substantial monetary penalties.

By contrast, the term "tax avoidance" describes lawful conduct, the purpose of which is to avoid the creation of a tax liability in the first place. Whereas an evaded tax remains a tax legally owed, an avoided tax is a tax liability that has never existed.

For example, consider two businesses, each of which have a particular asset (in this case, a piece of real estate) that is worth far more than its purchase price.

* Business One sells the property and underreports its gain. In this instance, tax is legally due. Business One has engaged in tax evasion, which is criminal. * Business Two consults with a tax advisor and discovers that it can structure the sale as a "like kind exchange" (formally known as a 1031 exchange, named after the Code section) for other real estate that it can use. In this instance, no tax is due because (legally, under Section 1031) no sale took place. Business Two has engaged in tax avoidance (or tax mitigation), which is completely within the law.

In the above example, tax may eventually be due when the second property is sold. Whether and how much tax will be due will depend on circumstances and the state of the law at the time. This is true of many tax avoidance strategies. [edit] The distinction in the United Kingdom

The United Kingdom and jurisdictions following the UK approach (such as New Zealand) have recently adopted the evasion/avoidance terminology as used in the United States: evasion is a criminal attempt to avoid paying tax owed while avoidance is an attempt to use the law to reduce taxes owed. There is, however, a further distinction drawn between tax avoidance and tax mitigation. Tax avoidance is a course of action designed to conflict with or defeat the evident intention of Parliament: IRC v Willoughby.[19] Tax mitigation is conduct which reduces tax liabilities without “tax avoidance” (not contrary to the intention of Parliament), for instance, by gifts to charity or investments in certain assets which qualify for tax relief. This is important for tax provisions which apply in cases of “avoidance”: they are held not to apply in cases of mitigation.

The clear articulation of the concept of an avoidance/mitigation distinction goes back only to the 1970s. The concept originated from economists, not lawyers.[20] The use of the terminology avoidance/mitigation to express this distinction was an innovation in 1986: IRC v Challenge.[21]

In practice the distinction is sometimes clear, but often difficult to draw. Relevant factors to decide whether conduct is avoidance or mitigation include: whether there is a specific tax regime applicable; whether transactions have economic consequences; confidentiality; tax linked fees. Important indicia are familiarity and use. Once a tax avoidance arrangement becomes common, it is almost always stopped by legislation within a few years. If something commonly done is contrary to the intention of Parliament, it is only to be expected that Parliament will stop it. So that which is commonly done and not stopped is not likely to be contrary to the intention of Parliament. It follows that tax reduction arrangements which have been carried on for a long time are unlikely to constitute tax avoidance. Judges have a strong intuitive sense that that which everyone does, and has long done, should not be stigmatised with the pejorative term of “avoidance”. Thus UK courts refused to regard sales and repurchases (known as bed-and-breakfast transactions) or back-to-back loans as tax avoidance.

Other approaches in distinguishing tax avoidance and tax mitigation are to seek to identify “the spirit of the statute” or “misusing” a provision. But this is the same as the “evident intention of Parliament” properly understood. Another approach is to seek to identify “artificial” transactions. However, a transaction is not well described as ‘artificial’ if it has valid legal consequences, unless some standard can be set up to establish what is ‘natural’ for the same purpose. Such standards are not readily discernible. The same objection applies to the term ‘device’.

It may be that a concept of “tax avoidance” based on what is contrary to “the intention of Parliament” is not coherent. The object of construction of any statute is expressed as finding “the intention of Parliament”. In any successful tax avoidance scheme a Court must have concluded that the intention of Parliament was not to impose a tax charge in the circumstances which the tax avoiders had placed themselves. The answer is that the expression “intention of Parliament” is being used in two senses. It is perfectly consistent to say that a tax avoidance scheme escapes tax (there being no provision to impose a tax charge) and yet constitutes the avoidance of tax. One is seeking the intention of Parliament at a higher, more generalised level. A statute may fail to impose a tax charge, leaving a gap that a court cannot fill even by purposive construction, but nevertheless one can conclude that there would have been a tax charge had the point been considered. An example is the notorious UK case Ayrshire Employers Mutual Insurance Association v IRC,[22] where the House of Lords held that Parliament had “missed fire”. [edit] History of the distinction

An avoidance/evasion distinction along the lines of the present distinction has long been recognised but at first there was no terminology to express it. In 1860 Turner LJ suggested evasion/contravention (where evasion stood for the lawful side of the divide): Fisher v Brierly.[23] In 1900 the distinction was noted as two meanings of the word “evade”: Bullivant v AG.[24] The technical use of the words avoidance/evasion in the modern sense originated in the USA where it was well established by the 1920s.[25] It can be traced to Oliver Wendell Holmes in Bullen v Wisconsin.[26] It was slow to be accepted in the United Kingdom. By the 1950s, knowledgeable and careful writers in the UK had come to distinguish the term “tax evasion” from “avoidance”. However in the UK at least, “evasion” was regularly used (by modern standards, misused) in the sense of avoidance, in law reports and elsewhere, at least up to the 1970s. Now that the terminology has received official approval in the UK (Craven v White[27]) this usage should be regarded as erroneous. But even now it is often helpful to use the expressions “legal avoidance” and “illegal evasion”, to make the meaning clearer. [edit] Public opinion on tax avoidance

Tax avoidance may be considered to be the dodging of one's duties to society, or alternatively the right of every citizen to structure one's affairs in a manner allowed by law, to pay no more tax than what is required. Attitudes vary from approval through neutrality to outright hostility. Attitudes may vary depending on the steps taken in the avoidance scheme, or the perceived unfairness of the tax being avoided.

In the judiciary, different judges have taken different attitudes. As a generalization, for example, judges in the United Kingdom before the 1970s regarded tax avoidance with neutrality; but nowadays they regard it with increasing hostility. See the quotes below for examples. [edit] Responses to tax avoidance

Avoidance also reduces government revenue and brings the tax system into disrepute, so governments need to prevent tax avoidance or keep it within limits. The obvious way to do this is to frame tax rules so that there is no scope for avoidance. In practice this has not proved achievable and has led to an ongoing battle between governments amending legislation and tax advisors' finding new scope for tax avoidance in the amended rules.

To allow prompter response to tax avoidance schemes, the US Tax Disclosure Regulations (2003) require prompter and fuller disclosure than previously required, a tactic which was applied in the UK in 2004.

Some countries such as Canada, Australia and New Zealand have introduced a statutory General Anti-Avoidance Rule (GAAR). Canada also uses Foreign Accrual Property Income rules to obviate certain types of tax avoidance. In the United Kingdom, there is no GAAR, but many provisions of the tax legislation (known as "anti-avoidance" provisions) apply to prevent tax avoidance where the main object (or purpose), or one of the main objects (or purposes), of a transaction is to enable tax advantages to be obtained.

In the United States, the Internal Revenue Service distinguishes some schemes as "abusive" and therefore illegal.

In the UK, judicial doctrines to prevent tax avoidance began in IRC v Ramsay (1981) followed by Furniss v. Dawson (1984). This approach has been rejected in most commonwealth jurisdictions even in those where UK cases are generally regarded as persuasive. After two decades, there have been numerous decisions, with inconsistent approaches, and both the Revenue authorities and professional advisors remain quite unable to predict outcomes. For this reason this approach can be seen as a failure or at best only partly successful.

In the UK in 2004, the Labour government announced that it would use retrospective legislation to counteract some tax avoidance schemes, and it has subsequently done so on a few occasions. [edit] Tax protesters and tax resistance Main articles: Tax protester, Tax protester arguments, and Tax resistance

Some tax evaders believe that they have uncovered new interpretations of the law that show that they are not subject to being taxed (not liable): these individuals and groups are sometimes called tax protesters. Many protesters continue posing the same arguments that the Federal courts have rejected time and time again, ruling the arguments to be legally frivolous.

Tax resistance is the refusal to pay a tax for conscientious reasons (because the resister does not want to support the government or some of its activities). They typically do not take the position that the tax laws are themselves illegal or do not apply to them (as tax protesters do) and they are more concerned with not paying for what they oppose than they are motivated by the desire to keep more of their money (as tax evaders typically are).

In the UK case of Cheney v. Conn,[28] an individual objected to paying tax that, in part, would be used to procure nuclear arms in unlawful contravention, he contended, of the Geneva Convention. His claim was dismissed, the judge ruling that "What the [taxation] statute itself enacts cannot be unlawful, because what the statute says and provides is itself the law, and the highest form of law that is known to this country." [edit]