Tax avoidance facts for kids
Tax avoidance is when people or companies use legal ways to pay less tax. They follow the tax rules of a country to their own benefit. A tax shelter is one way to avoid taxes, and tax havens are places where taxes are very low. It's important not to confuse tax avoidance with tax evasion, which is against the law. Both are ways people try to pay less tax than the government expects.
Sometimes, people criticize tax avoidance, especially when big companies pay very little tax. This can lead to public anger. However, if someone uses tax laws exactly as the government intended, it's often called tax planning. Experts suggest that governments should try to stop aggressive tax avoidance. This helps make sure everyone contributes fairly to society.
Some ways of avoiding tax are called "aggressive tax avoidance." These often involve moving money between different countries, especially from places with high taxes to places with low taxes or tax havens. Since 1995, huge amounts of money have been moved this way.
Many countries have special laws called General Anti-Avoidance Rules (GAAR). These laws stop tax avoidance that might be technically legal but goes against the main idea of the tax rules. For example, if a business deal is only done to avoid tax and has no real business reason, these rules can stop it.
The US Supreme Court has said that people have a legal right to reduce their taxes using methods the law allows.
Tax evasion, on the other hand, is when people or companies try to avoid taxes using illegal methods. This is against the law.
According to an expert named Joseph Stiglitz, there are three main ideas behind tax avoidance:
- Delaying taxes: Paying taxes later means the money is worth less over time.
- Using different tax rates: People or companies try to use different tax rates that apply to different types of income or different people.
- Using different tax rules for income: Some types of income might be taxed differently, so people try to make their money fit into the lower-tax categories.
Stopping Tax Avoidance
Governments and courts have rules to stop tax avoidance. These rules prevent people from making deals just to reduce their taxes, especially if those deals don't make sense otherwise.
Rules from Laws and Courts
There are two main types of rules:
- General Anti-Avoidance Rules (GAAR): These are broad rules that apply to many different tax avoidance methods.
- Specific Anti-Avoidance Rules (SAAR): These rules target one specific way of avoiding tax.
Courts also play a big part. They often use two main ideas:
- Business Purpose Rule: A deal must have a real business reason, not just be for avoiding tax.
- Substance Over Form Rule: This means courts look at the real economic situation of a deal, not just how it's written on paper. They want to see the true purpose behind it.
EU Anti-Tax Avoidance Plan
The European Union (EU) has a plan called the Anti-Tax Avoidance Package. It started in 2016 to make company taxes fairer across EU countries. This plan includes rules to stop aggressive tax planning and make tax information more open.
The Anti-Tax Avoidance Directive (ATAD) is a key part of this plan. It has five main rules that EU countries must follow since 2019:
- Interest Deductibility: This stops companies from using fake debts to lower their taxes.
- Exit Taxation: This prevents companies from avoiding taxes when they move their assets to another country.
- GAAR: It includes the general anti-avoidance rule to ignore deals that aren't genuine.
- Controlled Foreign Company (CFC) Rule: This stops profits from being moved to countries with very low or no taxes.
- Switchover Rule: This helps prevent situations where income isn't taxed anywhere.
Stopping Avoidance in Different Countries
Australia
Australia has strong tax rules against avoidance. They have had a General Anti-Avoidance Rule since 1981. They also have a special law for multinational companies (MAAL). This law makes sure big international businesses pay their fair share of tax on profits made in Australia.
United States
The US has changed its tax laws many times. In the 1980s, some changes led to more tax loopholes, which are ways to legally avoid taxes. This caused a boom in the "tax shelter" industry. The 1986 tax reform tried hard to reduce tax avoidance. It lowered top tax rates and made it harder to use losses from one type of income to balance gains from another. Later reforms sometimes opened new ways for tax avoidance.
How Tax Avoidance Happens
Where a Company or Person Lives
Companies can avoid taxes by setting up their business in an offshore area or tax haven. Individuals can also move their official tax home to a tax haven, like Monaco. Some people even become "perpetual travelers," moving often to avoid being tied to one country's tax system.
However, a few countries, like the United States and Eritrea, tax their citizens on all their income, no matter where they live. So, for US citizens, just moving abroad doesn't always stop US taxes. Some US citizens even give up their citizenship to avoid this.
Double Taxation
Most countries tax income earned within their borders. To avoid taxing people twice (once where they earn money and again where they live), many countries have "double taxation treaties." But there are few such treaties with tax havens. So, just moving money to a tax haven usually isn't enough to avoid tax; a person often has to move there too.
Setting Up Legal Groups
People can also avoid personal taxes by creating a separate legal group, like a company, trust, or foundation. They transfer their property to this new group. This way, any profits or income are earned by the legal group, not the original owner. However, if the money is later transferred back to the person, taxes would apply.
For someone setting up a trust to avoid tax, there might be rules. For example, the person who creates the trust might not be allowed to control the money or benefit from it.
Unclear Rules
Tax rules can sometimes be unclear. For example, it can be hard to tell the difference between "business expenses" and "personal expenses." This unclear language can sometimes be used to avoid taxes.
Tax Shelters
Tax shelters are investments that aim to reduce how much income tax you have to pay. Things like owning a home or having a pension plan can be seen as tax shelters because money in them isn't taxed right away.
In the US, the tax agency (IRS) and the Department of Justice have been working to stop "abusive" tax shelters. These are schemes that push the limits of the law.
Transfer Mispricing
Transfer mispricing is when related companies trade with each other at unfair prices. This is often done to move profits from a country with high taxes to one with low taxes.
For example, a company in Africa might sell its product to its own branch in a tax haven at a very low price. This makes the African company look like it made little profit, so it pays low taxes. Then, the branch in the tax haven sells the product to another branch in a high-tax country (like the US) at a very high price. This makes the US branch look like it made little profit, so it also pays low taxes.
Experts say that a lot of money is moved from Africa to tax havens this way.
Who Avoids Taxes?
Studies show that a large part of the profits of big international companies are moved to tax havens. This means less tax is paid in the countries where the companies actually do business.
United Kingdom
The UK tax agency (HMRC) estimated that tax avoidance cost the UK about £1.7 billion in 2016-17. This is money that should have been collected but wasn't due to avoidance.
Big Companies Accused of Tax Avoidance
Many large companies have been accused of tax avoidance. For example, Tesco was reported to use offshore companies to reduce its tax bill.
In 2011, a report found that many of the UK's biggest companies used tax havens. By 2016, some of the top companies were reported to pay no company tax at all.
Tax avoidance by companies became a big issue in 2012. Companies like Google, Amazon.com, and Starbucks were criticized for moving profits to tax havens. This led to public anger and even boycotts. Starbucks later promised to pay more tax in the UK. However, Amazon and Google said their actions were legal.
Other big companies like Apple, Microsoft, PayPal, Facebook, and Uber have also been linked to tax avoidance schemes.
General Anti-Avoidance Rule
The UK introduced a General Anti-Avoidance Rule (GAAR) in 2013. This rule stops tax reduction from legal deals that are only made to avoid tax and have no other good reason.
Old Ways of Avoiding Tax
Window Tax
A historical example of tax avoidance was the window tax in England. It started in 1696. The more windows a house had, the more tax its owner paid. People disliked this tax, calling it a "tax on light." To avoid it, many property owners blocked up their windows. The tax was finally removed in 1851.
Destroying Roofs
Another old way to avoid property taxes in Scotland was to deliberately destroy roofs. For example, the roof of New Slains Castle was removed in 1925, and the building fell apart. Owners of Fetteresso Castle also destroyed their roof after World War II to protest new taxes.
United States
In the US, tax avoidance means legally reducing the amount of income tax you owe. This can be done by using all the allowed deductions and credits, or by investing in ways that have tax benefits.
Reports have shown that some very rich individuals and large companies in the US have paid very little or no federal income tax in certain years. For example, General Electric was widely noted for this in 2011.
A study found that from 1998 to 2005, more than half of US companies paid no federal income taxes in at least one year. Another review found that many profitable Fortune 500 companies paid a very low average tax rate.
In 2012, Hewlett-Packard lost a lawsuit over a tax scheme. Also, it was reported that rich individuals had trillions of dollars hidden in offshore tax havens. Banks like HSBC and Citigroup were said to help clients avoid taxes.
The US government has tried to fight tax sheltering. In 2010, a law was passed that made the "economic substance" rule stronger.
A group called the US Public Interest Research Group said in 2014 that the US government loses about $184 billion each year. This is because companies like Pfizer, Microsoft, and Citigroup use offshore tax havens to avoid US taxes.
An investigation in 2021 showed how some billionaires avoid taxes. Instead of taking a salary (which is taxed highly), they take stock. They also use a "buy, borrow, die" method:
- They buy assets like stocks and never sell them, because assets aren't taxed until sold.
- They borrow money using these assets as collateral. Loans aren't taxed as income.
- They hold assets until they die. Then, the value of the assets is reset for their heirs, so no capital gains tax is paid.
They also avoid estate tax by moving money into trusts or charities before they die.
While tax avoidance is legal, there are penalties if taxpayers don't follow the rules correctly. These can include penalties for:
- Not filing or paying taxes on time.
- Not paying enough estimated taxes throughout the year.
- Being careless or making big mistakes on tax returns.
However, sometimes these penalties can be avoided if there's a good reason, like a natural disaster, serious illness, or other unavoidable problems.
Images for kids
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People avoided the window tax in England by blocking up windows.
