Thanks to high profile reports by Global Integrity, Eurodad, the OECD, and the African High Level Panel spotlighting losses developing countries suffer from the manipulation of tax laws and other forms of illicit financial flows, questions about “tax fraud,” “tax evasion,” “tax avoidance,” and “tax abuse” are now on the development policy agenda. These terms and their equivalents in other languages are, with the exception of “tax fraud,” ambiguous — sometimes used to mean actions that are unlawful and sometimes used to refer to legal ones. Before the debate on how to ensure developing countries receive the tax revenues they are due goes any farther, it may be helpful to explain how the ambiguity arises.
About tax fraud there is no ambiguity. It refers to instances where an individual or entity has falsified records by willfully misstating income or deductions, and all OECD countries consider tax fraud a violation of law punishable by some combination of fines and prison.
Some equate “evasion,” “avoidance,” and “abuse” with acts that while not fraudulent are still illegal; others use one or more of these terms to mean legal ways to minimize the amount of taxes due by careful “tax planning” or steps to “mitigate” tax liability. Some use the terms pejoratively – to refer to situations where the tax payer has technically complied with the law but, at least to the speaker, the means of compliance are morally or ethically suspect.
Disputes over whether a transaction complies with the tax law, and even if it does whether it is “ethical,” arise from the interaction of a basic principle of tax law with the practicalities of writing tax statutes. The principle is one all countries recognize — taxpayers are free to plan their dealings in ways that minimize tax liability. In the oft quoted words of the American judge Learned Hand: “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. . . .[N]obody owes any public duty to pay more than the law demands.”
The rub comes because tax law drafters cannot write a tax statute that always makes what “the law demands” clear in advance. Tax law cannot be stated as a set of bright line rules like those setting a 40 kmh speed limit in residential areas and an 80kmh limit on highways. Countries that have tried to do so have watched as tax revenues failed to meet expectations because clever tax advisers structured transactions around the rules — creating complex corporate vehicles, off-setting transactions, and other elaborate devices to “shelter” income from taxation.
Accordingly, the laws of all OECD countries provide that the courts or tax tribunals or commissions can decide after the fact, on a case-by-case, basis whether a taxpayer is complying with “what the law demands.” Although the starting points differ across OECD countries, and sometimes between different agencies within a single country, in every evaluation the inquiry is the same: Does the challenged transaction represent a lawful “plan” to minimize tax liability? Or is it an unlawful “scheme”? OECD countries generally weigh two factors in answering these questions: i) whether the main purpose of the transaction was to obtain more favorable tax treatment and ii) whether the more favorable treatment was contrary to the object and purpose of the tax laws.
The application of these standards is subject to interpretation and thus to argument, and not surprisingly courts, tax agencies, professional advisers, and commentators frequently disagree on whether a particular transaction is legal or not. Disagreement is even greater when questions of fairness or ethics are introduced into the evaluation.
Understanding the source of ambiguity in the use of terms like evasion, avoidance, and abuse will not end debate about whether current tax laws treat developing states unfairly; it would be enough if it were to help keep the rhetoric from becoming overheated.