Tax Evasion: Impact and Incidence

Tax evasion is illegal action by which an individual or company to avoid paying tax liability and also includes hiding or false income, without proof of inflating deductions, not reporting cash transaction etc.

Tax evasion occurs when intentional efforts are made by individuals, Firm’s Trusts and various other entities to avoid paying taxes by illegal and unfair means. The tax evasion usually takes place when taxpayers intentionally hide their incomes from the tax authorities in order to reduce their tax liability.

Tax evasion, however, is illegal and Chapter XXII of the Income Tax Act, 1961, is clear about penalties. A few examples of tax evasion are, an individual, a firm, or a company intentionally avoiding payments of tax liability, misreporting of income, and wilful attempts to evade tax are cases of tax evasion.

Tax avoidance is the practice of taking advantage of the gaps and mismatches in the tax rules to prevent or lower tax liability. It is not illegal as it is not well-defined in tax laws. For example, many companies channel their funds through offshore branches to avoid paying taxes in their home country.

History of Tax Evasion

Tax farming is an historical means of collection of revenue. Governments received a lump sum in advance from a private entity, which then collects and retains the revenue and bears the risk of evasion by the taxpayers. It has been suggested that tax farming may reduce tax evasion in less developed countries

In 1968, Nobel laureate economist Gary Becker theorized the economics of crime for the first time on the basis of which authors M.G. Allingham and A. Sandmo produced, in 1972, an economic model of tax evasion. The model deals with the evasion of income tax, the main source of tax revenue in developed countries.

According to the authors, the level of evasion of income tax depends on the detection probability and the level of punishment provided by law. Later studies, however, pointed limitations of the model, highlighting that individuals are also more likely to comply with taxes when they believe that tax money is appropriately used and when they can take part on public decisions.

India’s income tax was instituted in 1922 by the British, their tax history explains their high degree of tax delinquency today. With effect from 1 April 2017, the Income-tax Act, 1961 has introduced the General Anti-avoidance Rules. The intent of the bringing the said rules is to curb the ill-practices of the tax payers & tax practitioners assisting the tax payers in avoiding the tax where the tax impact of the arrangement or the transactions is more than INR Three Crores in a particular Financial Year.

Provisions relating to Tax Evasion in India

Section 276C of the Income Tax Act is the primary provision addressing tax evasion in India. This section specifies the penalties for individuals intentionally trying to evade taxes, which can range from imprisonment to fines. The magnitude of the penalty is determined by the amount of tax evaded. Additionally, tax evasion can result in legal complications under the Prevention of Money Laundering Act (PMLA), especially, when income concealment occurs through illicit methods.

• Non auditing of accounts: Section 44AB of the Income Tax Act mandates that a taxpayer get the account audited or furnish a report of the audit. In case of failure to do so, the penalty will be 0.5% of total sales, turnover of the gross receipts, or Rs 1,50,000, whichever is more. If the taxpayer fails to present a report from an accountant, as required under Section 92E, the penalty imposed is Rs 1,00,000 or more.

• Penalty for underreporting of income (Section 270A): On underreporting of income, a penalty of 50% of the tax payable will be imposed and when income is misreported, the penalty can be levied up to 200% of the tax due.
• Penalty for concealment of income (Section 271(1)(c)): if there is a concealment of income or the taxpayer has provided inaccurate details, a penalty can be levied between 100% to 300% of the tax attempted to evade. In severe cases, such as willful tax evasion, imprisonment may also be imposed.
• Penalty for failure to furnish income tax return (Section 271F): Failure to submit income tax return by the due date can result in a penalty of INR 5,000 and when the total income is under INR 500,000, the penalty is capped at INR 1,000.
• Penalty for failure to comply with the notice under Section 115WD(2) or 115WE(2): On failure to comply with the notice required to furnish information within a specified time, a penalty of INR 100 for each day of the default period will be levied.
• Penalty for failure to deduct Tax at Source (TDS) (Section 271C): On failure to deduct or pay any part of the tax at source as required, a penalty equal to the amount of tax that was not deducted or paid will be imposed.
• Penalty for failure to collect Tax at Source (TCS) (Section 271CA): On failure to collect or pay any part of the tax required under section 206C(1), a penalty equivalent to the amount of tax that should have been collected and paid will be levied.

Estimation of Tax Evasion

The difference between actual revenue collection and an estimation of potential collection is the tax gap. It is an estimate of total leakage, comprising the effects of tax avoidance, tax evasion and corruption. Typically, however, the tax gap is referred to as estimated tax evasion. Estimating tax evasion can be direct or indirect. The indirect method links tax evasion to the underground economy since the latter could be thought of as the size of economic activity that would be taxed if reported in tax returns. A more direct method of estimating the tax gap, in particular for VAT, is to obtain potential VAT revenue from the country’s input-output matrix and to compare it with VAT revenue collection.

Common methods of Tax Evasion in India

Non filing of income tax returns is the most common method of tax evasion in India. Inflating deductions or creating fake ones is another common tactic which could involve overstating business expenses, fabricating travel claims, or claiming dependents who don’t exist. These manipulations decrease the taxable income reported to authorities.

The taxes that are payable by an individual or an organisation may be decided on the financial dealing that have taken place during the assessment year. If false financial documents or accounts books are submitted, ones that show incomes less than what was actually earned, the tax may come down. Offshore accounts in countries with strict banking secrecy laws can be used to hide income and assets. By storing wealth outside their home country, evaders can avoid taxes and make it difficult for authorities to track their financial activities.

Another reason for taxpayers to evade taxes is the personal benefits that come with it, thus the individual problems that lead to that decision. Customs duties are an important source of revenue in developing countries and importers attempt to evade customs duty by (a) under-invoicing and (b) misdeclaration of quantity and product-description.

Effects of Tax Evasion

Distortion of economic efficiency is the prime effect of tax evasion and revenue loss is the significant effect on the society.

Tax evasion undermines public trust in the government’s ability to ensure a fair and equitable system. When a significant segment of the population feels they are not playing by the same rules, it breeds cynicism and weakens the social contract. Lost tax revenue due to evasion limits the government’s ability to invest in education, infrastructure, and research – all essential ingredients for long-term economic growth.

As inequity and inefficiency lead to lower revenue intake for government, its functional capacity, efficiency and effectiveness suffer because of tax evasion. Capacity suffers due to lower availability of resources. The result could very well be an increase in tax rates, or the imposition of distortive taxes, thereby initiating a vicious cycle of inequity and inefficiency.

Black money has resulted in transfer of funds from India to foreign countries through clandestine channels which decrease country’s reputation globally. Tax evasion leads to poor standards of living of the rural masses and the people BPL as the government cannot undertake welfare measures at the national level. Due to tax evasion, the government may be forced to increase the rates of tax every assessment year for increasing its revenue which results in increased tax burden of those who pay taxes promptly.

The Way Forward

There is utmost need for complete re-orientation in the department’s approach to its methods of intelligence as investigation. The machinery for intelligence and investigation at the command of the department should also be thoroughly overhauled and streamlined to tackle adequately the menace of tax evasion.

Governments must develop robust tax laws and regulations to eliminate legal loopholes and combat tax evasion effectively. Reviews of tax legislation are essential to ensure that the laws remain updated and aligned with evolving financial practices and emerging tax evasion schemes. Strengthening penalties for tax evasion can be an effective method. Increased fines, potential imprisonment, and stricter enforcement measures can deter individuals and businesses from attempting to evade taxes.

There is a need to keep political institutions free of corruption. Removal of the ban on donations by companies to political parties is, therefore, not favoured. Reasonable grants-in-aid should be given by the Government to national political parties and suitable criteria should be evolved for recognising such parties and determining the extent of grant-in-aid to each of them.

The absence of a uniform system of indexing all taxpayers in the country on a permanent basis can be held responsible for the difficulties experiences by the department in tackling tax evasion. Introduction of additional code ‘Records Locator Code’, can help locate the records of a taxpayer when the case is transferred from one circle to another after the permanent account number has been allotted. To avoid confusion with the permanent numeric code, this records locator code may be short alphabetic code.

Conclusion

Tax evasion is the outcome of individual taxpayer behaviour and social norms on the supply side, and shortcomings in tax administration on the demand side. To begin with, the tax structure has to perceive as equitable across various groups of taxpayers.

Every drop of water makes an ocean, it can also be said that our small contribution makes a huge difference in the growth of the economy. Instead of expecting for change to happen and be the torchbearers to fight against tax evasion.

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