Terms Tax Planning, Tax Avoidance and Tax Evasion, all are methods of reducing the tax liability of a person or a corporate body or any assessee. Before explaining these concepts in detail, let us first look at their definitions.
Tax Planning refers to the practice of availing all available exemptions, deductions and rebates provided in the Act in order to reduce an assessee’s tax liability. Methods using which an assessee can reduce his/her tax burden are provided in the Income Tax Act itself. For example, allowable exemptions are provided under Section 10 of the Act; allowable deductions are provided under Sections 80C to 80U of the Act; and allowable rebates and reliefs are provided under Sections 87–89 of the Act.
Tax avoidance is an act of dodging tax without breaking the Law. When an assessee indulges in tax avoidance, he/she arranges his/ her financial activities in such a manner that takes advantages of loopholes present in the Tax Law without breaking any law or doing anything illegal. This is done for reducing an assessee’s overall tax liability.
Tax evasion refers to the use of any illegal methods that lead to the reduction of tax liability of an assessee. Tax evasion is achieved using dishonest means such as concealing income, claiming excessive expenditure, forging accounts, etc.
Let us now discuss these concepts in detail.
Tax planning refers to an act of lowering the tax liability of a person by using various provisions as stated in tax laws. The government and tax laws have provisions for deductions and exemptions, which can be used to lower the tax liability. A person or a corporate body must plan all his/its incomes and expenses in such a manner that they can lower their tax liability to a minimum by claiming maximum deductions and exemptions. For example, Section 80C of the Income Tax Act, 1961 provides that a person can claim a deduction of up to 1,50,000 by in- vesting in instruments such as Public Provident Fund (PPF) Account and Tax Saving Fixed Deposits. Remember, tax planning is done by using complete legal means; thus, all taxpayers are advised to engage in tax planning. According to section 3, previous year is the financial year immediately preceding the assessment year. Here, the financial year means where the year begins on 1st April and ends on 31st March.
Tax avoidance is another way through which the taxpayer may reduce his tax liability. There is a very minute difference between tax planning and tax avoidance. Tax planning and tax avoidance both are done 100% in accordance with the existing laws. In tax planning, the taxpayer does what the government tells him/her to do (by exhausting the provisions for deductions and exemptions). In contrast, in tax avoidance, the taxpayer cleverly takes advantage of the loopholes present in the tax law and does not go according to what has been mandated by the government, making it an acceptable way of reducing the tax liability. The government keeps introducing new amendments from time to time in the finance budgets to eliminate any loop- holes in the tax laws and to lower the incidences of tax avoidance.
Tax planning and tax avoidance are 100% legal ways of reducing tax li- abilities. On the contrary, tax evasion is an illegal practice. Tax evasion is the practice of reducing the tax liability by manipulating the expenses and income in such a way that the income is shown as being less and the expenses are shown as being high. Using this practice, persons or corporates are able to reduce their net taxable income. Taxpayers usually do not show some income and expense statements in order to evade tax. However, to avoid this practice, the income tax department keeps a close watch on all major financial activities of taxpayers or assessees. The department tallies the actual transactions done and the transactions mentioned by the taxpayer in his/her income statements. In case of any discrepancies, the department is authorized to take action (such as raids, arrests) in accordance with the law.