TAX MATTERS – distinction between avoidance, mitigation and evasion

‘TAX avoidance’ has recently been demonised as an unsavoury practice adopted by taxpayers to avoid paying their due share of taxes. Most people will agree that governments cannot function without collecting taxes. We are constantly being reminded by the authorities that it is our moral duty as citizens of Malaysia to pay our share of taxes. Yes, most of us will not disagree.

Parliament creates tax laws

Tax laws formulated by the executive led by the prime minister are promulgated by Parliament. Whenever there are issues on interpretation or disputes, the courts step in and provide guidance and resolution.

The question of the moral duty to pay tax is not enshrined in the tax laws and till today, the views expressed by Justice Lee Hun Hoe in the Rakyat Berjaya Case in 1984 is still applicable; “No commercial person in his right sense is going to carry our commercial transactions except on the footing of paying the smallest amount of tax involved. There is nothing wrong at all for a company to organise their affairs in such a way to as to minimise tax”.

Taxpayers must comply with tax laws and pay the correct amount of tax. Any amount paid more than his dues, is a “gift to government”.

Why do disputes arise?

Although the taxpayer complies with the law, the tax authorities may take a different view on interpretation the law and may argue that sole purpose the transaction or series of transactions is to avoid taxes.

Borderline between tax avoidance, tax mitigation and tax evasion

Tax evasion is clear, it has a criminal aspect as it carried out with an intention to evade taxes by falsifying accounts, providing incorrect information, and simply not disclosing information or making fictitious expense claims.

The problem area is tax avoidance – which is “acceptable” and “unacceptable” tax avoidance. The basic requirement for any taxpayer is, comply with the letter of the law.

The issue of avoidance “pops its head” when the taxpayer structures his transaction in a way to reduce his tax liability by inserting intermediate steps which have no commercial rationale but to ensure the ultimate result of the whole scheme or arrangement results in a reduction of tax liability. If the intention of carrying out a transaction or a scheme is with the prime motive of avoiding taxes, that is unacceptable avoidance.

What is acceptable avoidance is now recognised as tax mitigation. Tax mitigation is invoked when the taxpayer has choice between two provisions of the law and if one route allows a more beneficial tax result, the taxpayer can opt for the reduced tax route.

Tax mitigation also requires a taxpayer to show that the primary intent of the transaction or an arrangement is commercially driven. The transaction involves the parties incurring costs, losses or sometimes a reduction of income and the tax benefit is merely incidental.

The “business purpose test” and the economic consequences to the transaction should be clearly visible in order to fall within the ambit of “acceptable avoidance” or tax mitigation.

Taxpayers, beware.

Whenever taxpayers are carrying out any transactions between third parties or related parties, the issue of avoidance must not be precluded since the tax authorities are constantly on the “lookout” for such misbehaviours.

Avoidance is a critical issue to be considered when transactions involve business restructuring, undertaking large transactions, using brought forward losses, changing transfer prices/business models, or if tax planning is done after a transaction has been initiated, etc.

This article was contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai.