Is Tax Avoidance legal? – Insights from a Tax Expert

By Faustin Mwinzi

 Layman’s definition of tax avoidance is reducing a tax payer’s liability without breaking the law. This is the most likely definition availed by search engines over the internet, you can try. Thus, tax avoidance sounds legal. Proponents of this argument quickly contrast tax avoidance with tax evasion by pointing out that tax evasion is illegal while tax avoidance is not. Whereas it is obvious that tax evasion is illegal, we need to be a little careful before we define tax avoidance as legal.

For starters, the words evasion and avoidance are not perfect opposites or antonyms. Outside taxation cycles, these words are used interchangeably as synonyms.   Borrowing from French, tax avoidance is évasion fiscale, closely translated to mean Fiscal evasion while tax evasion is fraude fiscale which means fiscal fraud. It therefore looks like tax avoidance and tax evasion are closely related.

Tax laws across the globe extend deductions, exemption of certain incomes and special tax incentives which essentially reduce the revenue of the state to the benefit of the taxpayer. These concessions are for the mutual benefit of the state and the payer for some specific reasons. As a result, taxpayers are encouraged to apply them.  It is obvious for a taxpayer to arrange his financial affairs in a manner that reduces the tax obligations because the law so permits. Organizing the financial conduct of a person in the most tax efficient way is known as tax planning, which is lawful.

Tax planning or tax sheltering introduces controversy in revenue administration and compliance. Whereas taxpayers are encouraged to apply the law for their benefit, they may twist it and end creating revenue leakages. If taxpayers are allowed to organize their financial affairs to minimize their fiscal obligations, then they can carefully devise transactions for the purpose of beating the law. Bearing in mind that the onus of declaring income for tax purposes rests with the taxpayer, a transaction might be altered to fit what is within the law with the intention of reducing the tax bill.

Tax avoiders keep mutating their tricks and wits, thus the lawmakers are ever catching up in sealing loopholes and creating anti-tax avoidance provisions. Bear in mind tax avoidance cuts across many jurisdictions where different laws apply. There is general tendency to apply the doctrine of substance over form which comes in handy in defeating these cunning practices.

Substance over form read in full means “the economic substance or reality of a transaction prevails over its legal form”. This concept which is also a general principle in accounting is applied by considering the economic sense of a transaction and not its mere legal interpretation. In taxation, the Doctrine allows the tax authorities to ignore the legal form of an arrangement and to look to its actual substance in order to prevent artificial structures form being used for tax avoidance purposes. The doctrine of substance over form was the basis of the ruling in the Gregory v. Helvering case (US) where Evelyn Gregory attempted to avoid taxes by transferring shares from a company to another under the guise of corporate reorganization. The transaction in a legal sense looked like tax-exempt corporate reorganization while the truth behind it was that she was avoiding taxes through a devious scheme.

 

Kenya like many other countries has in its tax laws the general anti-tax avoidance rule (GAAR) and specific anti avoidance rules (SAARs).  GAARs have the advantage of flexibility and give tax authorities an instrument which allows them to react fast to any new perceived tax avoidance scheme by disregarding arrangements that have been put in place mainly to obtain a tax benefit. However, as their critics rightly invoke, GAARs also confer great power and responsibility upon the tax adjudicators.  SAARs on the other hand are often more predictable in their application, and therefore provide more legal certainty. They are also easier to circumvent by taxpayers. When a new arrangement is designed by a taxpayer that is not yet in the scope of a SAAR, the taxpayer can benefit from this arrangement for a certain period of time until it is clamped down by a new SAAR adopted by the lawmakers.

Kenya’s General anti -tax avoidance rule (GAAR) is found in Section 23 of the Income Tax Act Cap 470. This rule empowers the Commissioner to collect taxes avoided if he is of the opinion that a certain transaction has been initiated with the very intention of reducing tax-payer’s tax liability. By invoking this rule, the Commissioner is empowered to reverse the effects of a dubious transaction by making appropriate adjustments and collecting the taxes thereof.  Besides this general provision, the income tax act has several specific tax anti-avoidance provisions (SAARs).

In summary and to answer our question is tax avoidance legal, the heaviest penalty in Kenyan tax is actually on tax avoidance.  The tax procedures act 2015 (TPA section 85) imposes 200% penalty on tax avoidance.

The author is a Tax Lecturer at KCA University