Tax avoidance and evasion schemes - Assignment Example

? ……………………………………………………………………………xxxxx ………………………………………………………………………xxxx …………………………………………………………………………….xxxxx …………………………………………………………………………xxxx @2012 Accounting Introduction The number of reported cases by the media with regard to tax avoidance and tax evasion has been very high. For instance, a report from National Audit Office indicates that HRMC has a backlog of 41,000 cases including individuals and small businesses. The government has made tax evasion and avoidance one of its key priorities so as to reduce the deficit and boost the exchequer (Alan 2011). Tax evasion is illegal way of minimizing taxes thus stiff penalties are involved on individual or corporate bodies who evade taxes. Unintentional mathematical errors in tax returns are not considered to be tax evasion (McGee 2012). Tax avoidance is a legal way of minimizing tax liability, and it involves planning in advance an intended transaction so as to get a specific tax treatment. Individuals can minimize taxes through tax planning for example through schemes. Avoidance also involves disclosure. Tax avoidance and evasion schemes a) Defined contribution retirement plan Contributing money to a qualified employer sponsored retirement plan helps in reducing tax liability. A defined contribution retirement plan is an IRS approved retirement plan sponsored by an employer. Contributions made by the employees to these schemes are tax deductible, and as a result, the tax payable is reduced. For example, if an employee who is in a tax bracket of 25% contributes 2000, he will save 500 (McGee 2012). Another benefit with defined contribution retirement plan is that the contributions made by the employee to the scheme are invested to a mutual fund. These savings grow free of income taxes (McGee 2012). Income tax is only payable during retirement a time when the marginal tax rates are lower than one’s working years. b) Transport reimbursement plan With this scheme, the employer plan helps the employees save money using payroll deduction with pre-tax salary pay work related transportation costs. Such expenses include qualified parking, transit passes and van pool commuting. These savings made from the payroll are deductible for tax purposes thus tax payable is minimized (Alan 2011). c) Flexible spending account This account is also referred to as an expense reimbursement account designed for employees who pay for the child or parent care. FSA helps employees fund medical and dental expenses through salary deduction to out of pocket unreimbursed health care expenses limited by law to $2,500 annually and depended care up to a maximum of $5,000 annually (McGee 2012). Example includes prescriptions, over-the-counter drugs and annual deductibles. d) High income child benefit charge According to the Finance Act 2012 section 681B, a person is only legible to claim the high income child benefit charge if personal income for the year exceeds ?50,000 (Great Britain 2011). Also, when either a person or his partner are entitled to receive child benefit, or get contributions from someone else who claims Child Benefit for a child who lives with you..If you are liable to the tax charge and your income increases or drops, this can affect whether you continue to be liable or how much tax charge you have to pay. If your individual income drops to ?50,000 or less for a tax year you will not have to pay the tax charge (Karayan and Swenson 2007). e) Offshore business structures Investors make investments through non-resident companies especially ones with lower tax jurisdictions. Tax charged on rental receipts for overseas investments is 20% unlike 26% charged to residents. The tax is withheld by tenants or appointed agents from their rent. Alternatively, an approval from HMRC can be obtains for rents to be received at gross provided annual tax returns are filed and tax paid on due date (McGee 2012). The tax payer can plan to reduce net rents which are taxable by giving the company loan to purchase property. The interest on loan is allowable against taxable income. In order to obtain a maximum deduction, the loan should be secured on the property at an arm’s length in accordance with the UK legislation for transfer pricing. The interest paid should not be sourced in UK to avoid withholding taxes (Great Britain 2012).Offshore investments also eliminate exposure to UK inheritance tax (IHT). This tax is levied on all assets in UK on the death of the owner, regardless of whether he is residence or domicile in status. According to the finance Act 2012, the tax is charged at a rate of 40% above a threshold value of ?325,000. Any shares in the non-resident company are exempt from Inheritance tax on death of the owner (Great Britain 2011). Finally, offshore investments are exempt from the capital gains tax as long as one follows the special anti avoidance rules that apply for capital gains tax purposes. f) Enterprise Investment Schemes These schemes are specifically designed for wealthy people who are perceived to have a lot of disposable income. Therefore, when one invests in these schemes, he gets a tax relief on his income thus ends up paying fewer taxes. For example, investing into a pension scheme up to a certain limit. In most cases, the schemes have designed a limit on income that can be invested by people to get a tax relief there on. The tax reliefs available to the investor are as follows: 1. Income Tax Relief An investor can invest between ?500 and ?1 million in a tax year and have his tax reduced by 20% of the investment cost (Karayan and Swenson 2007).  Up to half of this can be carried back to the prior tax year to a maximum of ?50,000 on condition that the investment is made before 6 October in the tax year. 2. Capital Gains Tax Exemption an investor who has received Income Tax relief on the cost of the shares, and thereafter shares are disposed of after being held for at least 3 years from the issuing date then any capital gain realized on the disposal of the EIS shares is exempt from capital gains tax. 3. Capital Gains Tax Deferral Capital gains realizable upon the sale of an asset can be deferred against investments in an EIS scheme. These gains crystallize when the EIS investment is disposed off. 4. Loss Relief Any loss realized on disposal of shares can be offset from any income tax relief in the year in which the shares were disposed of. g) Establishment of Charitable Trusts or Foundations Charitable trusts are established for the relief of poverty, advancement of education and religion and other purposes that would benefit the community. These foundations have several tax advantages. One, income from investment such as interest income to trustees are exempt for tax purposes provided the income is used for charitable purposes (McGee 2012). Two, any Grants accruing to beneficiaries are not been normally not recognized as income of the beneficiary for tax purposes. However, if the grants are given on a regular basis to the beneficiary, they are recognized as income to be taxed. Three, Individuals including sole proprietors offering gifts to charitable trusts can claim a tax relief on the difference between basic and higher income tax rate as long as they are in the higher tax bracket. The foundation can also claim back tax on donations from individuals (McGee 2012). Upon sale of assets, any realized capital gains are exempt as long as the proceeds are used for a charitable purpose. Therefore, the donor will not be charged any capital gain tax for assets donated. Finally, gifts and bequests made to trusts are exempt from the inheritance as long as they were for a charitable purpose. h) Employing your spouse One can avoid tax by employing their husband or wife. The couple divides their income tax bill thus end up paying less tax or no tax than if each of them was to be taxed individually. According to the finance bill Act 2012, this only applies in full to individuals with a taxable income of less than ?100,000000 (Great Britain 2012). Taxable income above this level is taxed. Tax relief for the Married Couple's Allowance currently is given at the rate of 10 per cent. Sharing ownership of the business may also lead to the couples paying less tax. Also they can avoid taxes by paying themselves dividends instead of salary (McGee 2012). i) Home working Anyone working from home is entitled for a home working allowance. HMRC offers this allowance to counter electricity, fuel, and water and telephone expenses. The allowance is also free from NICs. The employer contributes ?4 per week if working under the home-working agreement. However, if the employer is not contributing no claims can be made to the HMRC. The rate for employees working on a monthly basis is ?18 regardless of whether there are any records to show additional expenditure (Karayan and Swenson 2007). j) Artificial losses Artificial losses are becoming common among businesses. The main cause is creative accounting which involves making of unnecessary transactions so as to make losses. Actually, the loss is not in cash but the business owner benefits by paying less tax than usual. In most cases the loss is inflated by differing expenditure which is never incurred or using circular loans (Karayan and Swenson 2007). Changes in tax rates The government in contemplating to increase tax rates to collect more revenue since curbing tax avoidance and evasion has proves to be challenging (McGee 2012). For instance, let’s look how the tax payable will look like using 2012/13 rate for three individuals under different tax brackets. A B C   ? ? ? Basic Income 40,000.00 100,000.00 150,000.00 personal allowance (8,105) (8,105) 0.00 married couple allowance     -15,000.00   31,895.00 91,895.00 135,000.00 tax rate 6,379.00 36,758.00 67,500.00 Assumptions The limit of personal allowance is up to ?100,000 A & B are not married. Cis married thus he gets an allowance Conclusion Increasing tax rates by the government will lead to more government revenue. However, it might lead to an increase of tax avoidance and evasion rates. Therefore, the government should instead stiffen its anti-avoidance rules and impose heavy penalties to those who evade and avoid taxes. It should also educate the public on tax matters and on the importance of paying taxes. References Karayan, J.E and Swenson, C.W, 2007. Strategic Business Tax Planning. Wiley publishers Great Britain: H.M. Treasury, Great Britain H.M. Revenue & Customs, 2011. Tackling tax avoidance. The stationery office McGee, R.W, 2012.The Ethics of Tax Evasion: Perspectives in Theory and Practice. Springer Alan, M., 2011. Taxation: Finance Act 2012. Pearson Education, Limited. Great Britain, 2012. Finance Act 2012, Part 14. The stationery office Read More