‘Tax evasion’ is a broad term and it is not quite as simple as it might seem at first. In this article, I will unpack the meaning of the term and outline how the ATO decides which acts constitute tax evasion and which do not.
What we call ‘tax evasion’ are actually two separate but related Commonwealth offences under the Criminal Code Act.
The first is obtaining a financial advantage by deception, under Section 134.2(1) of the Act. This applies when someone obtains a financial advantage for themselves or another person, or induces a third party to do so. The deception that leads to the financial advantage must be reckless or deliberate, rather than due to a genuine mistake. A genuine mistake is when the taxpayer omits income or incorrectly claims a deduction by accident, but not in a manner that is reckless; meaning that they’ve considered the question of whether they have paid the correct amount of tax to the best of their knowledge.
The second offence is conspiracy to defraud, under Section 135.4 of the Act. This applies when two or more people work together to defraud the ATO.
You might be charged under the above sections if you knowingly and deceitfully misrepresent your tax obligations to the ATO, leading you to pay less tax than you are legally required to, or if you help someone else do so. The kinds of actions that might fall under the scope of tax evasion include, for example, hiding income through specific structures or offshore entities, and/or providing advice on how to understate income. This is different to merely accidentally overstating a deduction or forgetting to advise the ATO of interest. The threshold for fraud or evasion is quite high under the Criminal Code Act.
In cases of the deception being due to a genuine mistake, the ATO will impose a penalty amounting to 25% of the tax shortfall on the taxpayer rather than prosecuting them. Most cases fall into the category of genuine mistake. In fact, in my time as an ATO auditor, only one case was ever referred onto to the AFP for prosecution. This is because prosecution is expensive and it is not in the spirit of the ATO to prosecute all cases that break the rules.
Tax evasion is distinguished from tax planning and tax avoidance.
Tax planning is the normal preparation you would do with your accountant to figure out how to pay the correct amount of tax, all through entirely legal and appropriate means. Through tax planning, you ensure that you do not overpay and/or seek to minimise the amount of tax you pay through, for example, reductions or planning, but do so honestly and as intended by the law.
Tax avoidance differs from tax evasion in that it is not a criminal offence, but it is nevertheless frowned upon by the ATO. Tax avoidance generally amounts to exploitation of the tax system to minimise the amount of tax you pay – while it may all be within the limits of the law, it may not be in the spirit of that law. For example, one might find loopholes in the relevant laws that have not been corrected. The ATO is more likely to conduct audits of businesses and individuals that engage in such practices, and scrutinise them to ensure that their actions do not breach the thin line into tax evasion. Businesses and individuals that engage in tax avoidance are much less likely to pass ATO audits than those that do not attempt exploit the tax system.
One way of thinking about the difference between tax evasion and tax avoidance is that it is ultimately up to the ATO to decide whether an act is within or outside the law. It is a Schrödinger’s cat of sorts: you have simultaneously both broken the law (and are in trouble) and not broken the law (though you might still be in trouble if your actions lead to an audit, which is not a very pleasant experience), a paradox which resolves itself only when the ATO decides which one it is. It is thus no wonder that the terms ‘tax evasion’ and ‘tax avoidance’ are often used interchangeably, despite them technically being two distinct concepts.
To determine whether the law has been broken or not, the ATO might apply the ‘reasonable person’ test, which has two main components. Firstly, it will look at what a hypothetical reasonable person in the same circumstances as the taxpayer would have done if they were acting reasonably and honestly. Secondly, if the taxpayer’s actions differed from those of this reasonable person, the ATO will look at any reasons that they have provided for acting as they have. It will ask whether, in light of these reasons, the taxpayer’s wrongful acts or omissions should still be considered blameworthy. If its answer to this yes, the ATO may proceed to audit or prosecute the taxpayer.
Once the ATO decides to audit you, you are unlikely to be able to effectively hide evidence of any wrongdoing. The ATO is great at easily figuring out if your income is greater than what you are declaring, through comparing your businesses’ income to those of similar businesses, audits, and data matching. As technology develops, all of this is made easier for them, and, for those that are caught, there are some strict and severe penalties that they might face, from a 5% administrative penalty on the shortfall to up to 10 years’ imprisonment. So, the benefits of tax evasion are probably not worth the risk of getting caught and punished, and it is best to minimise the tax you pay in lawful ways through working with an accountant, rather than through fraud.
Michael Konarzewski CPA
Ex-ATO auditor in the High Wealth Individual Taskforce ($2m-$200m)