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Tax Evasion and Tax Avoidance: What are the Differences?

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20 Jun 20246 mins readBy MOFSL

Introduction

While the ultimate goal of tax evasion and tax avoidance is the same, they are two distinct concepts. The end goal of both is to minimise tax outgo or tax payment. That said, the former is illegal, while the latter is legal. Read on to learn more about them.

What is Tax Evasion and Its Ways?

Tax evasion is an intentional attempt to cheat tax authorities by hiding your taxable income. The various methods of tax evasion include:

  • Underreporting Income

This is one of the most typical ways of tax evasion. People resorting to this method don’t conceal all sources of income. In other words, they underreport their income to lower their actual income and evade taxes.

  • Inflating Deductions

The Income Tax Act 1961 has various provisions to claim deductions on your taxable income. If you inflate them to lower your tax liability, it qualifies as tax evasion. For instance, if you claim deductions for which you don’t qualify or claim deductions for investments you haven’t made, it qualifies for tax evasion.

  • Submitting Inaccurate Tax Returns

If you submit false tax returns, you are committing tax evasion. People often file returns with inaccurate information to reduce their tax outgo.

What is Tax Avoidance and Its Ways?

Tax avoidance is a legal route to bring down your tax liability. It incorporates strategies outlined under various sections of the Income Tax Act through which you can lower your tax outgo. Some ways of tax avoidance are:

  • Optimising and Maximising Deductions

This is the most common way to avoid taxes. You optimise the provisions under different sections of the Income Tax Act to lower your tax liability. For example, by investing in various instruments outlined under section 80C of the Income Tax Act, such as public provident fund (PPF), life insurance, National Pension System (NPS), equity-linked savings scheme (ELSS), you can bring down your tax outgo by up to Rs 1.5 lakhs in a fiscal. 

Similar to section 80C, there are other sections in the Income Tax Act through which you optimise deductions.

  • Seeking Advantage of Tax Credits

Certain credits, like education expenses, can help you lower your tax liability.

Major Differences Between Tax Evasion and Tax Avoidance

The table captures the critical differences between tax evasion and avoidance on various parameters:

Parameters
Tax Evasion Tax Avoidance
Intent The intention is to not pay taxes by using wrongful means. The intention is to lower tax outgo through proper tax optimising channels.
Transparency It is highly opaque and fraudulent.  It is transparent as the deductions and exemptions are within the legal framework
Approach Deploys deceptive practices to hide real income and assets Deploys legitimate methods to lower tax outgo
Legality Illegal and is subject to penalties as per relevant laws Considered acceptable and results in responsible planning of finances

Why Not to Practice Tax Evasion?

You shouldn’t indulge in tax evasion. Doing so can result in:

  • Stiff penalties

Section 276C of the Income Tax Act has provisions for those who attempt tax evasion. It outlines the penalties for those who indulge in it. The penalties could range from imprisonment to fines. The quantum depends on the amount of evaded taxes. It can result in legal implications under the Prevention of Money Laundering Act.

  • Earning a bad name

Tax evasion earns a bad name for you and your business. It can dent your image and make it difficult for you to obtain financing for different needs. It can erode investors’ confidence in your business and bring down revenues for your firm in a big way. â€‹â€‹â€‹â€‹â€‹â€‹â€‹

  • Unnecessary Stress

When you are indulging in something wrong, the same results in stress. This can harm you physically and emotionally. Therefore, it’s in your best interest to avoid taking this route.

In Conclusion

Today, tax authorities can quickly spot you if you try to evade taxes. Thanks to technology, it has become almost impossible to conceal your income. As every transaction is related to your PAN number, it’s next to impossible to dodge the taxman. Therefore, it’s in your best interest not to evade taxes but try bringing them down through legitimate means. Consult a tax professional to optimise your tax liability.


 

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Disclaimer: The stocks, companies, or financial instruments mentioned in this blog are for informational purposes only and should not be considered as investment recommendations. It is advised to consult with your financial advisor before making any investment decisions. Investment in securities markets are subject to market risks, read all the related documents carefully before investing. Investors are strongly encouraged to carefully read the risk disclosure documents prior to participating in market-related investments or trading activities. Due to the volatile nature of financial markets, no guarantees can be made regarding investment returns. Motilal Oswal Financial Services Ltd. does not offer any assured returns on market-linked securities. Please note that past performance of stocks or indices is not indicative of future results.
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