CPA Daniel Kibona B4-Public Finance and Taxation Dar Es Salaam CPA Review

Centre (DCRC)

TAX AVOIDANCE, EVASION AND TAX PLANNING.

Tax avoidance means the legal exploitation of tax regions to one owns advantage to
attempt to reduce tax liability or not pay tax at all using means that are within the law
while making full disclosure of material information to the tax authorities.

It is a legal way of reducing tax liability which involves structuring Business affairs legal
(using loopholes in tax laws) so that to pay less or not paying at all.

Note that: Tax Planning is the process of arranging Business affairs again legal so that
to pay less tax or no tax at all.

Differences Tax avoidance and Tax Planning

a) Legality of Transaction

 Tax avoidance follows legal form and not substance i.e. the transaction arrangement
are legal accepted but lack of economic purposes rather than tax avoidance or tax
minimization.
For Example: opening a Branch in a tax haven which do not produce or distribute
anything just opened for tax arrangement, while:
 Tax planning; follows both legal and Economic reality of transaction substance of
transaction.

b) Acceptance by the Government

 In Tax Planning: A tax payer is doing something legal which the government want
him to do. Therefore Tax Planning is acceptable tax avoidance, while;
 In Tax Avoidance: A tax payer is doing something legal which the government did
not expect the tax payer to do. Therefore, Tax avoidance is unacceptable tax
planning as it lack economic purpose.

Tax evasion refers to illegal practices of the escaping paying tax. Occurs when a tax
payer uses illegal methods to minimize tax liability or not paying tax at all. Tax Evasion
is the resistance of tax payer to pay tax.
 CPA Daniel Kibona B4-Public Finance and Taxation Dar Es Salaam CPA Review
Centre (DCRC)

 It is an intentional and fraudulent attempt to escape payment of taxes in whole or

part
 Tax evasion usually entails taxpayers deliberately misrepresenting or concealing
the true state of their affairs to the tax authorities to reduce their tax liability, and
includes, in particular, dishonest tax reporting (such as under declaring income,
profits or gains; or overstating deductions).

METHODS OF TAX AVOIDANCE.

1. Transfer Price.

Transfer Price is a price of goods and services moving between related parties for the
purpose of minimizing taxes. The pricing is normally non-market Based price i.e. it can
be inflated or deflated depending on the objective and direction of the transaction.

Example:

If the items or goods services is transferred from lower jurisdiction to the lower tax
jurisdiction, then the price is HIGHER

If the goods or services is transferred from higher tax jurisdiction to the lower tax
jurisdiction then the price is LOWER.

2. Income Splitting

This involves splitting of income between more than one taxpayers so as to reduce the
marginal tax rate.

Example: In Tanzania if you can earn 2M per month you will fall into the 30% marginal
rate. If the income exceeds 1,000,000 per month

Tax Payable = 130,500 + 30% × (2,000,000-1,000,000) = 430,500

You can avoid tax by splitting the income into four individual. If you manage that each
will have 500,000 which will fall into 9% rate
 CPA Daniel Kibona B4-Public Finance and Taxation Dar Es Salaam CPA Review
Centre (DCRC)

Each individual will pay 9% × (500,000-270,000) = TZS 20,700 each individual

Therefore total tax payable by all individuals will be

=20,700×4 = TZS 82,800

3. Thin Capitalization.

These involves use of too much debts (excessive debt) instead of equity to finance
Business Operations Finance using Debt has tax advantage as interest on debt is tax
allowable whereas Dividend in equity is not allowable expenses.

Consider 2 companies:

Company A = All equity Coy

Company B = All debt Coy

Company
Details Company A B
Equity 10,000,000 -
10% Loan - . 10,000,000
10,000,000 10,000,000
PBIT 2,000,000 2,000,000
Interest - . 1,000,000
PBT 2,000,000 1,000,000
Assume: Tax 30% in TZ (600,000) (300,000)
Profit After Tax 1,400,000 700,000
Interest to Related Part - 1,000,000
Net Benefit 1,400,000 1,700,000
 CPA Daniel Kibona B4-Public Finance and Taxation Dar Es Salaam CPA Review
Centre (DCRC)

4. Change of Business Organization form.

For the purpose of reducing taxes a Business may change from sole proprietor to
partnership firm or from the company to a partnership firm. Under partnership income
will be shared among individual’s i.e. partner, hence less amount of tax will be paid as
individuals will fall under lower marginal tax rate [same as income splitting].

5. Use of Tax haven’s [sheltering of Income]

This is done whereby the income is received in the tax haven where rates are lower or
no tax at all.

Method of Tax Evasion.

a) The failure by the taxable person to notify the tax authority of his presence or
activities.
b) Failure to report full amount of taxable income [under declaration of income]
c) Claiming deduction for expenses that had not been incurred, i.e. for the case of
business income
d) Preparation/maintenance of false books of accounts. Involves non issuance of
receipt’s and destroying of accounting records
e) Smuggling i.e. importing or exporting without using unauthorized road’s
f) Claiming relief that are not entitled to.
g) Traders who collect VAT from the consumers may evade tax by under-reporting
the amount of turnover
h) The importers purport to evade customs duty by (a) under-invoicing and (b) mis-
declaration of quantity and product-description

Reasons for Tax avoidance and Evasion’s.

a) High marginal tax rate and frequent changes in tax rates

b) Multiplicity of taxes
 CPA Daniel Kibona B4-Public Finance and Taxation Dar Es Salaam CPA Review
Centre (DCRC)

Too much taxes are difficult to comply and Burden to tax payers which motivated tax
avoidance and evasions

c) Administrative inefficiency, collusion with tax Payer and bribery of tax officials.
d) Inadequate Training and experience of tax administrators. For example in
transfer price issues.
e) Low prospects of detection and punishment
f) Traditional and cultural tendency to hate and evade tax (low tax morality).
g) Low transparency and accountability of public institutions i.e. Tax Payer would
like to see clear/direct Benefit through improved social services. If not so tax
Payer will not pay tax.

Ways to minimize tax avoidance and Evasion.

a) Keep the marginal tax rate low.

b) Avoid multiplicities of taxes.
c) Technical training to staff e.g. in Tax laws, accountancy
d) Serious Punishment to evaders.
e) Judicious tax expenditure.
f) Tax Payer education to the importance of paying tax.

Statutory measures against tax Avoidance and Evasion

Tax laws has come up with the following measures

 Specific Provisions: The Income Tax Act, 2004 ss. 27 – 35 enact specific
provision that identify with precision the type of transactions to be dealt with and
prescribe against the tax consequences of such treatment.
 General Provisions: the enactment of general provisions to hit broad types of
avoidance practices in specific areas
 Arm’s Length Approach – the transactions between related parties should be
similar to transactions between independent parties. S. 33(1) of ITA.
 Administrative Approach – there possibility to control tax avoidance is left to the
discretion of the tax authority. S 33(2);34(1), 35(1)
 CPA Daniel Kibona B4-Public Finance and Taxation Dar Es Salaam CPA Review
Centre (DCRC)

Consequences of Tax Avoidance and Evasion

1) Revenue Loss

There will be non-realization of revenue goal to finance economic and social objectives.

2) Non-realization of non-revenue goal’s

Including; Reduction in income inequality, controlling of inflation etc.