10 min read

Tax evasion v tax avoidance: essential information for start-ups

It was US Founding Father and polymath, Benjamin Franklin, who in 1789 once famously wrote: “The only thing certain in life is death and taxes.” Both are unavoidable.

If you’re starting your own business, you’ll have to pay tax, to a greater or lesser extent. This could include Income Tax, National Insurance contributions, Corporation Tax, VAT, tax on company share dividends or Capital Gains Tax (possibly business rates, too, if you take on premises). This article will explore the difference between tax evasion and tax avoidance.

Tax avoidance vs tax evasion – what’s the difference?

Tax evasion means concealing income or information from the HMRC and it’s illegal. Tax avoidance means exploiting the system to find ways to reduce how much tax you owe. It’s not always easy to see where one ends and the other begins.

HMRC takes a very dim view of both tax avoidance and tax evasion, but while one isn’t illegal – the other most certainly is.

Crucially, tax avoidance may be deliberate, but it’s not unlawful. Rules are often bent or ways to circumvent them used. Tax avoidance measures go against the spirit – rather than the letter – of the law.

Paying tax: what are my legal obligations?

Businesses and their owners are legally obliged to collect and pay any tax they owe to HM Revenue & Customs (HMRC). Failure to do so can lead to fines or more severe sanctions where illegal steps have been taken to avoid paying tax.

Naturally, owners want to keep their businesses as tax efficient as possible, which simply means working within the rules to minimise their tax liabilities and maximise their earnings. Effective tax planning can enable you to minimise your tax bills, while not breaking the law.

But some businesses and individuals go much further to minimise their tax liabilities, which can give rise to accusations of tax avoidance, if not blatant tax evasion. According to most recent official estimates, tax avoidance in the UK costs the Exchequer about £1.8bn a year, while tax evasion is believed to cost an eye-watering £5.3bn.  

What is tax avoidance?

According to government website GOV.UK: “Tax avoidance involves bending the rules of the tax system to gain a tax advantage that Parliament never intended. It often involves contrived, artificial transactions that serve little or no purpose other than to produce this advantage. It involves operating within the letter, but not the spirit, of the law.”

Furthermore, states GOV.UK: “Most tax avoidance schemes simply do not work, and those who use them may end up having to pay much more than the tax they tried to avoid, including penalties.”

Some years ago, many high-profile celebrities were exposed by the media as making significant tax savings by investing their money into “aggressive tax avoidance schemes”. Some schemes were later successfully challenged by HMRC. Many global heavyweight companies have also been accused of “avoiding tax by shifting revenue and profits through tax havens or low-tax countries”.  

Let’s take a look at some examples of tax avoidance… 

Disguised employment

Where workers are paid by their employer via an intermediary, to reduce the employer’s tax liability by masking the “contractor’s” de facto employee status. Some contractors are told to register as self-employed, when they are, in reality, employees. IR35 “off-payroll” legislation has been created to combat this.

Director’s loans

Director’s loans are perfectly legal and many are paid back. However, in some cases, limited company directors receive some of their income via company loans, but don’t repay them to the company, often they’re simply written off.

Contractor loan schemes

As explained on GOV.UK, a contractor is “paid in the form of a loan from a trust or company, sometimes referred to as a remuneration trust”, not directly from the company they’re working for, because “it’s diverted through a chain of companies, trusts or partnerships”. In reality, such income is taxable.

Offshore consultancy

Where a business or individual pays an offshore company for consultancy work, with the fees amounting to all or most of the profit made by the business or individual, who then receives the money back via loans or business expense payments.
Disguised employment

Where workers are paid by their employer via an intermediary, to reduce the employer’s tax liability by masking the “contractor’s” de facto employee status. Some contractors are told to register as self-employed, when they are, in reality, employees. IR35 “off-payroll” legislation has been created to combat this.

Director’s loans

Director’s loans are perfectly legal and many are paid back. However, in some cases, limited company directors receive some of their income via company loans, but don’t repay them to the company, often they’re simply written off.

Contractor loan schemes

As explained on GOV.UK, a contractor is “paid in the form of a loan from a trust or company, sometimes referred to as a remuneration trust”, not directly from the company they’re working for, because “it’s diverted through a chain of companies, trusts or partnerships”. In reality, such income is taxable.

Offshore consultancy

Where a business or individual pays an offshore company for consultancy work, with the fees amounting to all or most of the profit made by the business or individual, who then receives the money back via loans or business expense payments.

What is tax evasion?

Tax evasion is where businesses, their owners, staff or advisers deliberately do illegal things to avoid paying tax. In other words, they willfully commit a criminal offence to get out of paying tax.  

Hiding income

Deliberately failing to report or under-reporting business income to HMRC, which can include doing jobs for cash, with no invoices or receipts given to customers (or VAT charged in some cases).

Offshore tax havens

Hiding money, shares or other assets in a bank account in an offshore tax haven, such as the Cayman Islands, Bahamas, British Virgin Islands or Panama, so that tax is not paid in the UK.

Expense abuse

This can include misreporting to HMRC personal expenses as tax-deductible business expenses (eg fuel costs or other vehicle-related expenses). In other cases, expenses may be invented or inflated to reduce tax bills.

Cash payments

Made to employees, for some or all work, to avoid having to pay Income Tax and National Insurance contributions (both employer and employees). Hospitality staff not declaring tips is another everyday example of tax evasion.   
Hiding income

Deliberately failing to report or under-reporting business income to HMRC, which can include doing jobs for cash, with no invoices or receipts given to customers (or VAT charged in some cases).

Offshore tax havens

Hiding money, shares or other assets in a bank account in an offshore tax haven, such as the Cayman Islands, Bahamas, British Virgin Islands or Panama, so that tax is not paid in the UK.

Expense abuse

This can include misreporting to HMRC personal expenses as tax-deductible business expenses (eg fuel costs or other vehicle-related expenses). In other cases, expenses may be invented or inflated to reduce tax bills.

Cash payments

Made to employees, for some or all work, to avoid having to pay Income Tax and National Insurance contributions (both employer and employees). Hospitality staff not declaring tips is another everyday example of tax evasion.   

What is “tax fraud”?

Tax fraud is a broad umbrella term used to describe a wide range of illegal activity, which includes:

  • not charging VAT when necessary
  • charging VAT or deducting PAYE tax from employee earnings but not paying it to HMRC
  • falsifying tax return information to reduce tax liability
  • failing to report to HMRC all sums paid to yourself or your staff.

Tax fraud is also committed when goods that are liable to excise duty, customs duty or VAT are smuggled into the UK. Not being registered for VAT when required is another example of tax fraud.

6:02

Video: Why Jimmy Carr hates tax loopholes

by BBC

Comedian Jimmy Carr was one of the high profile celebrities exposed for using ‘aggressive tax avoidance schemes’. In this video from BBC show Room 101 he points out some of the curiosities around tax laws. 

What action will HMRC take?

HMRC seeks to ensure the “highest level of compliance with the law and regulations governing direct and indirect taxes” and other regimes for which it is responsible. Criminal investigation, with a view to prosecution, is “an important part of HMRC’s overall enforcement strategy”.

HMRC deals with fraud by using “cost-effective civil fraud investigation procedures”, while criminal investigation is “reserved for cases where HMRC needs to send a strong deterrent message or where the conduct involved is such that only a criminal sanction is appropriate”.

Tax evasion can lead to severe sanctions from HMRC, including unlimited fines and up to seven years imprisonment, while also having to pay anything up to 200% of the total tax due.

And, when introduced, the Criminal Finances Act 2017 made it a criminal offence in the UK for a business to fail to prevent its employees or “associated persons” from facilitating tax evasion.

Determining which one applies

It is hugely important that we all contribute tax into the system. Tax avoidance is technically not illegal whilst tax evasion is – but, in essence, they both exist to achieve the same aim. When determining if what you’re doing is one or the other, consider if you should even be asking the question? If the tax-paying public were to find out about it, how would it reflect on your business? 

For the avoidance of doubt, any of the following could land you in trouble with the authorities for tax evasion:

  • Failing to report or under reporting your business income
  • Conducting business ‘off the books’ through cash payments
  • Hiding money, shares, or other assets in an offshore business bank account
  • Misreporting personal expenses as tax-deductible business expenses
  • Using company property for personal use without valid business reason

Where to get tax advice

A reputable accountant or specialist tax adviser will be able to tell you how to manage and plan your tax affairs to minimise your tax bills, while not breaking any tax rules.

Accountants who are members of professional associations, such as the Institute of Chartered Accountants in England and Wales and the Association of Accounting Technicians, are bound by codes of ethics and conduct, based on international standards, designed not only to maintain the highest standards of professional conduct, but also to take into consideration the public interest.

If you need help understanding your tax liabilities, use our directory to find an accountant or bookkeeper near you.