Tax Evasion

TAX EVASION TAX EVASION By Dr. Zaheer-ud-Din Babar Awan, Federal Minister for Law, Justice and Parliamentary Affairs, Pakistan CONTENTS Tax evasion, 2 Distinction in various jurisdictions, 2 Tax avoidance, 2 Illegal income and tax evasion, 3 Economics of tax evasion, 3 Evasion of customs duty, 3 Smuggling, 3 Evasion of value added tax (VAT) and sales taxes, 4 Control of evasion, 4 Corruption by tax officials, 5 Level of evasion and Punishment, 5 Privatization of tax enforcement, 5 Tax farming, 5 PSI Agencies, 6 Public opinion on tax avoidance, 6 Responses to tax avoidance, 6 Relevant Laws in Pakistan relating to tax evasion, 7 Pakistani judgments on tax evasion, 7 Statement of Chairman F.B.R.,10 Definition of tax evasion in the United States, 10 Judgment of Kerala High Court, 11 1. Tax evasion: By contract tax evasion is the general term for efforts by individuals, firms, trusts and other entities to evade taxes by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability, and includes, in particular, dishonest tax reporting (such as declaring less income, profits or gains than actually earned; or overstating deductions). 2. Distinction in various jurisdictions: The use of the terms tax avoidance and tax evasion can vary depending on the jurisdiction. In general, the term "evasion" applies to illegal actions and "avoidance" to actions within the law. The term "mitigation" is also used in some jurisdictions to further distinguish actions within the original purpose of the relevant provision from those actions that are within the letter of the law, but do not achieve its purpose. 3. Tax avoidance: 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. 4. Illegal income and tax evasion: In the United States, persons subject to the Internal Revenue Code who earn income by illegal means (gambling, theft, drug trafficking etc.) are required to report unlawful gains as income when filing annual tax returns, but they often do not do so. Suspected lawbreakers, most famously, have therefore been successfully prosecuted for tax evasion when there was insufficient evidence to try them for their non-tax related crimes. The United States Supreme Court has ruled that a simple declaration of income does not violate an individual's right to remain silent, although the privilege may apply to the source of the income if claimed. Those who attempt to report illegal income as coming from a legitimate source could be charged with money laundering. By contract, in the UK law enforcement agencies do not generally have access to tax returns and so illegal earnings can supposedly be safely declared, but in practice those carrying on criminal activities generally prefer not to do so, and so can sometimes be prosecuted for tax evasion rather than for other crimes. Soviet spy Aldrich Ames, who had earned more than $2 million cash for his espionage, was also charged with tax evasion as none of the Soviet money was reported on his tax returns. Ames attempted to have the tax evasion charge dismissed on the grounds his espionage profits were illegal, but the charges stood. 5. Economics of tax evasion: In 1968, Nobel laureate economist Gary Becker first theorized the economics of crime, on the basis of which Alligham and Sandmo produced in 1972 an economic model of tax evasion. It deals with the evasion of income tax, the main source of tax revenue in the developed countries. According to them, the level of evasion of income tax depends on the level of punishment provided by law. 6. Evasion of customs duty: Customs duties are an important source of revenue in the developing countries. The importers purport to evade customs duty by (a) under-invoicing and (b) misdeclaration of quantity and product-description. When there is ad valorem import duty, the tax base is reduced through under invoicing. Misdeclaration of quantity is more relevant for products with specific duty. Production description is changed match an H. S. Code commensurate with a lower rate of duty. 7. Smuggling: Smuggling is importation or exportation of foreign products through unauthorized route. Smuggling is resorted to for total evasion of leviable customs duties as well as for importation of contraband items. A smuggler does not have to pay any customs duty since the products are not routed through an authorized or notified Customs Port and therefore, not subjected to declaration and payment of duties and taxes. 8. Evasion of value added tax (VAT) and sales taxes: During the later half of the twentieth century, value added tax (VAT) has emerged as a modern form of consumption tax through the world, with the notable exception of the United States. Producers who collect VAT from the consumers may evade tax by under-reporting the amount of sales. The US has no broad-based consumption tax at the federal level, and no State currently collects VAT; the overwhelming majority of States instead collect sales tax. Canada uses both a VAT at the federal level (the Goods and Services Tax) and sales tax at the provincial level; some provinces have a single tax combining both forms. In addition, most jurisdictions which levy a VAT or sales tax also legally require their residents to report and pay the tax on items purchased in another jurisdiction. This means that those consumers who purchase something in a lower-taxed or untaxed jurisdiction with the intention of avoiding VAT or sales tax in their home jurisdiction are in fact breaking the law in most cases. Such evasion is especially prevalent in Federal States like the Nigeria, US and Canada where sub-national jurisdictions have the constitutional power to charge varying rates of VAT or sales tax. In Nigeria for example, some local States enforce VAT on each goods sold by trader. The price must be clearly stated and the VAT distinct from the price of the goods purchased. Any act by the trader contrary to this (like including VAT in the price of the goods) is punishable as attempting to siphoning the VAT. International borders in such countries usually lack customs offices or similar facilities that could effectively control the movement of any goods carried in private vehicles from one jurisdiction to another and most of the respective State and Provincial governments simply lack the manpower and resources to pursue and prosecute every case of State/Provincial sales tax evasion arising from purchases which do not cross State or provincial borders other than for major purchases such as cars. 9. Control of evasion: Level of evasion depends on a number of factors one of them being fiscal equation. People's tendency to evade income tax declines when the return for due payment of taxes is not obvious. Evasion also depends on the efficiency of the tax administration. Corruption by the tax officials often render control of evasion difficult. Tax administrations resort to various means for plugging in scope of evasion and increasing the level of enforcement. These include, among others, privatization of tax enforcement, tax farming, and institution of Pre-Shipment Inspection (PSI) agencies, 10. Corruption by tax officials: Corrupt tax officials cooperate with the tax payers who intend to evade taxes. When they detect an instance of evasion, they refrain from reporting in return for illegal gratification or bribe. Corruption by tax officials is a serious problem for the tax administration in a huge number of underdeveloped and southern European countries. 11. Level of evasion and Punishment: Tax evasion is a crime in almost all developed countries and subjects the guilty party to fines and/or imprisonment; in China the punishment can be as severe as the death penalty. In Switzerland, many acts that would amount to criminal tax evasion in other countries are treated as civil matters. Even dishonestly misreporting income in a tax return is not necessarily considered a crime. Such matters are dealt with in the Swiss tax courts, not the criminal courts. However, even in Switzerland, some fraudulent tax conducted is criminal, for example, deliberate falsification of records. Moreover, civil tax transgressions may give rise to penalties. So the difference between Switzerland and other countries, while significant, is limited. It is often considered that extent of evasion depends on the severity of punishment for evasion. Normally, the higher the evaded amount, the higher the degree of punishment. 12. Privatization of tax enforcement: Professor Christopher Hood first suggested privatization of tax enforcement for overcoming limitations of government tax administration in controlling tax evasion Some governments have resorted to privatization of tax enforcement to enhance efficiency of the tax system. The assumption is that leakage of revenue will lower under a privatized regime. In Bangladesh, part of customs administration was privatized in as early as 1991. Abuse by private tax collectors has led to revolutionary overthrow of governments which have outsourced tax administration. 13. Tax farming: Tax farming is an old means of collection of revenue when it is difficult to determine the leviable amount taxes with certainty. Governments lease out the collection system to a private entity for a fixed amount who then collects the revenue and shoulders the risk of attempts at evasion by the taxpayers. It has been suggested that tax farming may be a solution to the problem of tax evasion seen in developing countries. Governments have historically turned to tax farming for quick cash. A "tax farmer" buys a "franchise" by making pre-payment to the government. The "tax-farmer," then invested with the authority of the government, goes into the "farm" and begins extracting "taxes" from citizens. This is a system destined to be abusive as the "tax-farmers" seek back their investment, plus profit, and are themselves unrestrained by "politics." Abuses by "tax farmers" (together with an unfair tax system that exempted the aristocracy) were a primary reason for the French Revolution that toppled Louis XVI. 14. PSI Agencies: Pre-shipment Agencies like SGS, Cotecna etc. are employed to prevent evasion of customs duty through under-through under-invoicing and mis declaration. However, in the recent times, allegations have been lodged that PSI agencies have actively cooperated with the importers in evading customs duties. Authority in Bangladesh has found Cotecna, a PSI agency of Swiss origin, guilty of complicity with the importers for evasion of customs duties on a huge scale. 15. 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 now a days they regard it with increasing hostility. 16. 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 Services 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, notably. Initiatives announced in 2010 suggest an increasing willingness on the part of HMRC to use retrospective action to counter avoidance schemes, even when no warning has been given. In 2008, the charity Christian Aid published a report, Death and taxes: the true toll of tax dodging, which criticized tax exiles and tax avoidance by some of the world's largest companies, linking it to the deaths of millions of children in developing countries. According to the Financial Times this is part of a growing trend for charities to priorities tax avoidance as a key campaigning issue, with policy makers across the world considering changes to make tax evasion more difficult. In 2010 tax avoidance became a big issue in the UK when UK Uncut started to encourage people to protest at local high street shops that were thought to be avoiding tax including Vodafone, Top Shop and the rest of the Arcadia Group. UK Uncut aims to highlight the fact that many big businesses and rich businesses men are avoiding paying tax whilst there are huge public sector cuts. It uses social networking websites to quickly organize protests in many different places around the country for days of mass action. 17. Relevant Laws (particular provisions) in Pakistan relating to tax evasion: Section 111 of Income Tax Ordinance 2001- Unexplained income or assets.---(1) Where.- (a) any amount is credited in a person's books of account; (b) a person has made any investment or is the owner of any money or valuable article; or (c) a person has incurred any expenditure, and the person offers no explanation about the nature and source of the amount credited or the investment, money, valuable article, or funds from which the expenditure was made or the explanation offered by the person is not, in the Commissioner's opinion, satisfactory, the amount credited, value of the investment, money, value of the article, or amount of expenditure shall be included in the person's income chargeable to tax under head "Income from [Other Sources"] to the extent it is not adequately explained. PART-IV Section 107 of the Income Tax Ordinance, 2001. 107. Agreements for the avoidance of double taxation and prevention of fiscal evasion.- CHAPTER-VIII, of the Income Tax Ordinance relating to ANTI-AVOIDANCE, Section 108a Transactions between associates.- Section 113. Minimum tax on the income of certain persons.- Section 184. Penalty for concealment of income.- Section 192A. Prosecution for concealment of income.- CHAPTER-XVIII of the Customs Act 1969 relating to PREVENTION OF SMUGGLING PLD 2007 Karachi 27 RAJA MUHAMMAD ZARAT KHAN v. THE STATE ---Four F.I.Rs. were lodged against accused/petitioner by Customs Authority, alleging therein that he being involved in claiming inadmissible customs rebate, and misuse of DTRE by way of phony and fraudulent export, caused loss to State exchequer; and that consignments/ containers intended for export when examined by Authority did not contain those export articles which accused had declared. 2008 PTD 1066 MUHAMMAD ARSHAD JAMAL v. ABDUL WAHID KHAN and another 3. However, it is alleged that subsequently the relevant record in the case was destroyed by the Customs officials with the help of Bank official's despite willingness of the accused persons in the case to deposit upto a sum of Rs.50,00,000,000. The alleged motive for spoiling the case was the involvement of senior Customs officials and a chain of Bank staff. 2005 PTD 78 PAKISTAN STATE OIL COMPANY LIMITED, KARACHI v. CUSTOMS, EXCISE AND SALES TAX, APPELLATE TRIBUNAL BENCH III, KARACHI and another ---Alleged evasion of customs duty was regarding the supplies made in the year 1997 to 2000 and wording employed in the show-cause notices were to the effect that the customs duty was evaded due to a wrong interpretation of S.106, Customs Act, 1969 by the appellant viz., that Pakistan Navy Ships proceeded to foreign territories which was factually incorrect and hence the benefit of S.106, Customs Act, 1969 could not be claimed by the appellant"--- PLD 2005 SC 461 = 2005 PTD 1654 COLLECTOR, CUSTOMS, CENTRAL EXCISE AND SALES TAX, QUETTA v. Messrs Haji AHMEDULLAH AND COMPANY, QUETTA and another ---Evasion of customs duty---Mis-declaration---Option to pay fine--- Principles---Committing fraud and forgery---Notice was served on importer by customs authorities for committing forgery and fraud to get the goods released---Authorities confiscated the goods and imposed 300% penalty upon the importer- 1999 CLC 1232 MUHAMMAD MUNIR v. COLLECTOR CUSTOMS and others ---Detention of vehicle-Car duly purchased by petitioner was taken into custody by Authority through detention memo. Issued under S.2(kk) of Customs Act, 1969 on ground that petitioner had evaded customs duty---Authority having failed to bring on record any material or definite proof to prove evasion of customs duty or smuggling against petitioner, his detention was illegal and uncalled for- 18. 1Statement of Chairman F.B.R. As the old adage goes, taxing income has created more criminals than any other single act of government. The disclosure by the Chairman of the Federal Board of Revenue (FBR) that the latter had detected 13,000 cases of tax evasion proves that the maxim applies as much to Pakistan as to any other country, in fact probably more. The Chairman said that only 60 per cent of the 2.7 million National Tax Number certificate holders had paid their taxes. Moreover, the recovery of taxes amounting to Rs. 300 billion to Rs. 400 billion is blocked due to the referral of courts and tribunals. These facts speak volumes for why our tax-to-GDP ratio is below 10 per cent, the lowest in the region. No government and society can exist without taxation. It is the price that each one of us who earns more than a certain amount of money must pay to enjoy the benefits of a developed, civilized society. At the same time, however, the tax policy and administration should not oppress the taxpayers. The government must ensure that taxation is equitable by doing away with all kinds of exemptions allowed to certain powerful lobbies and by reducing the-burden on taxpayers. If the government had not dithered on taxing agriculture and capital gains on real estate and stocks, it would not have to rely so heavily on bank borrowings which are inflationary in nature and that create serious distortions in the credit market. The exemptions to some provide others with an excuse to evade the payment of taxes. Moreover, the services sector, which comprises more than 50 per cent of the economy, should contribute a lot more to revenue-generation than it is doing at the moment (the government generates only 17 per cent of its total tax revenues from the services sector). An increase in the tax-to GDP ratio is crucial if the government is to ensure development and boost the economy. The dream of economic self-reliance cannot be realized until the government taxes everyone without discrimination, 1 http/news.dawn.com/wps/wcm/connect/dawn-content-liberary/dawn without regard to their source of income. On their part, the taxpayers should pay their taxes honestly. 19. Definition of tax evasion in the United States: The application of the U.S. tax evasion statute may be illustrated in brief as follows, as applied to tax protesters. The statute is Internal Revenue Code section 7201:-- Any person who wilfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution. The Kerala High Court in the case of Kerala State Coir Corporation Ltd. v. Union of India (1984) 21 ITR 121 observed that the object of section 143(1A) is prevention of tax evasion. It was observed thus (p.123):-- "Apart from that the object of section 143(1A) is prevention of tax evasion. Its purpose is to see that the assessee makes a true and correct disclosure of his income and expenditure. A true picture of the loss has to be made inasmuch as the loss is liable to be carried forward to the succeeding years. The provision for additional tax is thus, one intended to prevent evasion of tax, and such a legislation intended for purposes ancillary to the correct assessment of the income or the loss and to prevent evasion of tax cannot be branded as arbitrary or struck down as-such. The section is invoked only when the return filed does not accord with the realities." CONCLUSION: The dream of economic self-reliance cannot be realized until the government taxes everyone without discrimination, without regard to their source of income. On their part, the taxpayers should pay their taxes honestly. The 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 by law. The government should take steps for control of evasion of income tax, customs duty and eradicate the corruption by tax officials, smuggling, should also consider for privatization of tax enforcement and tax farming etc. The policymakers set realistic targets for elimination the crime of tax evasion and introduce a statutory rules like General Anti-Avoidance Rule (GAAR) for this purpose like USA, Canada, Australia and New Zealand. LETTER FROM RATHORE AND COMPANY, LAHORE TO CHAIRMAN, FEDERAL BOARD OF REVENUE The Chairman, Federal Board of Revenue, Islamabad. GETTING SALES TAX REGISTRATION IS A FEAT DIFFICULT THAN SURMOUNTING EVEREST. Respected Sir, On the one hand Federal Board of Revenue (F.B.R.) is looking for ways and means to enhance tax collection but on the other those genuine business houses/units established have to wait for indefinite time due to whim and caprice of authorities. No unit can start business without being assigned the Sales Tax Registration Number. You must be aware that it takes four to six months to ultimately succeed and that also after hectic pursuit at various stages. We wish to bring to your kind notice the various stages through which it has to pass:- (1) Step one is to electronically make an application for registration with F.B.R. (2) If you are successful to do that then after phone calls to concerned officials in PARAL/FBR an acknowledgment e-mail is received calling for various documents. (3) Taxpayer sends all requisite documents through Courier for which no acknowledgment/e-mail is received. So again the Taxpayer has to stick to his telephone to get through if luck favours him and pray to the F.B.R. official for his documents to be attached with his application. (4) Thereafter indiscriminately one or the other Pseudo objection is raised. (5) After removal of objection the business house is again trying its luck on telephone time and again to attain attachment and update of the application. Many a time the same is not done by the official sitting behind the system in F.B.R. The business house has no alternative but to keep trying and requesting telephonically to do the needful. (6) If you are successful to get all the documents attached thereafter it goes mum at F.B.R. To further activate, the aspiring Sales Tax registree has to make phone calls once again. If he is lucky to get hold of some lesser evil he begs him to move his application further. They verbally inform that applicants' documents are approved and they have sent them to the concerned Regional Tax Office (RTO) for business verification. (7) Thereafter the applicant has to approach the Local Registration Office day in day out firstly to dig out the letter sent by F.B.R. and then to persuade them to send the same to the concerned RTO. The same has to be (8) Followed at all stages because it has to go through proper channel to reach the concerned reporting officer. (9) After the visit of the unit Inspector and before reporting then again there is a list of documents requisitioned by the Inspector as well. (10) If the report is prepared by the Inspector it comes back to Local Registration Office (LRO) once again through proper channel" (Addl. Commissioner/Commissioner). (11) Again the applicant has to approach the LRO to send the same to FBR for final action. (12) After insuring that report is sent to F.B.R. the applicant is once again faced with the hassle of contacting the Board officials to do the final action. It is crystal clear from above stated facts that at all these stages at all F.B.R. level and field authorities so many functionaries are involved time and again who in themselves claim to be the ultimate authority to do the needful all this process as stated above happens in minimum duration of four to six months if during all this time the applicant is on his toes. This time frame is for genuine gentleman businessman because it can be curtailed to days through slippery shortcuts. Kindly take cognizance of these facts and undue hurdles if we are serious about resolving problems because people involved at various stages are least pushed about business activity and generation of funds and revenue.