Tax avoidance or tax evasion?

If you’re studying for R03 or AF1, it pays to remember K2. Not the mountain in the Himalayas, but the Guernsey based tax avoidance scheme that comedian Jimmy Carr (and also allegedly Gary Barlow) used to reduce his overall tax liability to a reported 1% of earnings.

Tax avoidance is not strictly illegal – the leading case of Duke of Westminster v IRC (1935) confirmed the principle that there is nothing wrong in arranging a taxpayer’s affairs legitimately so that they pay less tax than they might otherwise have paid. Broadly if there are a number of legitimate ways to arrange a transaction, it is acceptable to choose the method that results in the lowest amount of tax becoming payable. However, a transaction that is obviously a sham is always disregarded.

Tax evasion is another matter altogether – basically failing to provide full and accurate information and thus deliberately misleading HMRC –  is illegal. In the past many UK resident taxpayers have not declared income from abroad to the UK tax authorities – either because they assumed HMRC would ever find out, or the more generous view being that they didn’t think they needed to. In April 2007 HMRC declared an amnesty for taxpayers with undeclared offshore income ,with those owning up paying much lower penalties than should strictly have been the case if they were subsequently found out.

There were a number of leading tax cases in the 1980s which sought to clarify the line between acceptable tax avoidance and schemes which were shams.  The law is still evolving in this area but broadly if transactions with no commercial purpose are inserted into a series of transactions with the end result of avoiding, deferring or mitigating tax, then the courts have ruled that those steps can be disregarded.

HMRC fought back in the 2004 Finance Act – firms in the UK that market tax avoidance schemes must now register with the tax authorities, which gives each scheme a reference number which then needs to be shown on their tax return by users of the scheme. Registration covers most direct and indirect taxes. The Government has indicated that it will continue to change the law to counter what it sees as unacceptable tax avoidance, and to plug tax loopholes as soon as they are spotted.

So remember K2 – it’s a mighty big mountain, as Jimmy Carr discovered.