Understanding taxes better

Paying Income Tax gives people heart burn over paying GST. If you calculate the total outflow of GST paid by a family, it will be more than the Income Tax outgo per year. Yet, the grouses are all against income tax.

Every tax payer wants to reduce their tax burden. There are three ways of reducing the tax outgo - tax planning, tax avoidance, and tax evasion.

All of them lead to the same end goal. But some are legal and acceptable, others are legal but not acceptable, the rest are outright illegal.

I have selected simple examples to convey the meaning so that we can relate to the situation. For example, Mr. Radhakrishna is drawing a salary of Rs 18,00,000. He wants to reduce his tax burden. Here are his options-

Tax Planning

He can avail 80C deductions by investing in eligible instruments up to Rs 1,50,000 a year.

Tax Evasion

He can evade taxes by showing rent receipts and take advantage of HRA exemption under section 10(13A) of the Income Tax Act.

Assume he is paying Rs 25,000 rent per month. But he fabricates the rent receipt and shows Rs 40,000 as rent per month. Is this legal? No, and it is called as Tax evasion.

Tax Avoidance

Here, he can obtain a rent receipt from a relative. If he pays rent to the relative, it is legal. The tax department cannot deny him tax benefits.

If the relative’s total taxable income is below Rs 5,00,000 he needn’t pay any taxes on rental income. Radhakrishna can take tax benefit on Rs 40,000, say, around Rs 10,000 per month. It is legal but it defeats the intention of the law.

This is taking advantage of the loopholes and the ambiguities in the tax laws. This is called tax avoidance, exploiting loopholes to one’s advantage.

The law does not bar people from claiming such benefits. In the past, a tribunal has ruled in favor of the person who claimed HRA for rent paid to his wife.

However, in the past, many tax officers have rejected the claims of taxpayers when they found the techniques of tax avoidance were resorted to. When the cases went to the Court, the Judges have pronounced on Tax Avoidance as “It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges”; “the art of dodging tax without breaking the law”; “colorful devices cannot be part of tax planning”

The legal framework

Tax Planning is a legal technique which won’t attract any penalty. Tax Avoidance is morally wrong, legally correct. Hence the Assessing Officer(A0) may reject the claim however, one can appeal against this order.

Tax Evasion is unacceptable and hence under-reporting or concealment of income, undisclosed income, fudging the books of accounts, etc., attract penalty ranging from 50% to 200% of the tax evaded, or punishable with an imprisonment of not less than 6 months to a maximum of 7 years or both. However, the may apply to the AO with an explanation as to why under-reporting or misreporting occurred. If satisfied, then the AO may either waive off or reduce the quantum of penalty.

(The writer is a Chartered Accountant, Registered Valuer, and partner at Balakrishna & Co in Bangalore)