Panama Papers: Why some of this is perfectly legal

What is the difference between tax avoidance and tax evasion?

Tax Avoidance
As the Panama Papers shine a spotlight on tax avoidance, we examine the differences between evading tax and avoiding tax [Thomas Trutschel/Photothek via Getty Images]

Before the North Atlantic financial crisis that triggered the Great Recession of 2008 there was very little focus on tax havens. In fact, there was a race among nations to see who could offer the cheapest tax regime for corporations.

But as tax revenues slumped, the banks were bailed out and austerity was imposed – mostly on the weakest in society, the inner workings of tax systems and the way in which rich people and corporations use them has come under scrutiny.

Amazon’s UK business, for example, racked up sales of more than $4.7bn in 2011 – but paid no corporation tax on that income. The online retailer had transferred the ownership of its UK business to a company in Luxembourg in 2006. The UK business was then designated as an “order fulfillment” business, while the Luxembourg company processed the payments. All this is legal. It’s called tax avoidance.

Tax avoidance vs. tax evasion 

It is estimated that corporations are saving themselves as much as $260bn a year by setting up businesses in lower tax regimes. A favourite method to avoid paying tax is to ask companies in high tax regimes to pay royalties for the use of a brand name – or simply to make a loan and ask for repayment. In other words, one part of a company makes a loan or pays for services to another. Again, this is legal.

But to deliberately seek to evade tax is considered illegal. This is when corporations and individuals underreport how much they earn or make bigger deductions than they are entitled to.   

There is no suggestion in the stash of files leaked to the International Consortium of Investigative Journalists that anything illegal has taken place. The so-called Panama Papers highlight how easy it is for the wealthy, political elite and their families to set up shell companies in tax havens to conceal their wealth.

According to financial transparency campaign group Tax Justice Network, as much as $32 trillion was hidden in offshore accounts by rich individuals. It can cost as little as $1,500 to set up an offshore structure to hide your wealth.

It has been known for some individuals to avoid tax by setting up offshore shell companies, in which they deposit their earnings before making loans to themselves. That way they avoid future tax liabilities.

Mossack Fonseca, the Panama-based law firm from which the documents have been leaked, has said it “does not foster or promote illegal acts”. And that’s the key: wealthy clients who may wish to hide money from their spouses, children and public scrutiny employ law firms to make sure they don’t fall foul of the law.

While such offshore structures are legal they are increasingly seen as odious in the realm of public opinion.

Source: Al Jazeera