Download ppt - Fundamentals of Taxation Reasons for tax evasion and tax avoidance There are various reasons for tax evasion and tax avoidance. In order to develop methods

Fundamentals of TaxationReasons for tax evasion and tax avoidance

There are various reasons for tax evasion and tax avoidance. In order todevelop methods and instruments for fighting tax evasion and avoidance, itis important to foremost establish a broad understanding of the differentreasons underlying these problems. These reasons can be filed in twocategories. The first category comprises factors that negatively affecttaxpayers’ compliance with tax legislation. These factors can be subsumedeither contributing to a low willingness to pay taxes (low tax morale) or tohigh costs to comply with tax laws.

The second category contains reasons for the low ability of taxadministration and fiscal courts to enforce tax liabilities. These factors canbe summarized as resulting from insufficiencies in the administration andcollection of taxes as well as weak capacity in auditing and monitoring taxpayments which limit the possibility to detect and prosecute violators.

Fundamentals of TaxationReasons for tax evasion and tax avoidanceLow tax morale

Taxpayers' willingness to pay taxes differs widely across theworld. It cannot be viewed as simply depending on the taxburden. Rather, empirical research indicates that taxpayersthroughout the world pay more taxes than can be explainedby even the highest feasible levels of auditing, penalties andrisk-aversion. These high levels of tax compliance resultfrom the tax morale of society that fosters self-enforcementof tax compliance. Tax morale is, however, not easy toestablish. Especially countries without a deep rooted'culture' and habit of paying taxes find it difficult to establishtax morale.

Fundamentals of Taxation Reasons for tax evasion and tax avoidanceLow tax morale Factors influencing tax morale

Low quality of the service in return for taxes :In general, citizens expect some kind of service or benefit in return for the taxes paid.If the government fails to provide basic public goods and services or provides theminsufficiently, citizens may not be willing to pay taxes and tax evasion and avoidancewill be the consequence.Tax system and perception of fairness : High tax rates foster evasion. The intuition is that high tax rates increase the taxburden and, hence, lower the disposable income of the taxpayer. However, the levelof the tax rate may not be the only factor influencing people's decision about payingtaxes. In fact, the structure of the overall tax system has an impact as well. If, forexample, the tax rate on corporate profits is relatively low, but individuals are facing ahigh tax rate on their personal income, they may perceive their personal tax burden asunfair and choose to declare only a part of their income. Similarly, large companiescan often more easily take advantage of tax loopholes, thereby contributing to theperceived unfairness of the system. Tax rates and the overall structure of the taxsystem, therefore, have a significant effect on the disposition to evade and avoidtaxes.

Fundamentals of TaxationReasons for tax evasion and tax avoidanceLow tax morale Factors influencing tax morale

Low transparency and accountability ofpublic institutions :Lack of transparency and accountability inthe use of public funds contributes topublic distrust both with respect to the taxsystem as well as the government. This, inturn, increases the willingness to evadeTaxes.

Fundamentals of TaxationReasons for tax evasion and tax avoidanceHigh level of corruption

If due to high levels of corruption, citizens cannotbe certain whether their paid taxes are used tofinance public goods and services their willingnessto pay suffers and it becomes more likely thatthey evade their tax liabilities. A tax payer mightconsider evading taxes if the cost of bribing a taxauditor is lower than the potential benefit fromtax evasion.

Fundamentals of TaxationReasons for tax evasion and tax avoidanceLack of rule of law and weak fiscal jurisdiction

Strong fiscal courts are essential to protect taxpayer's rightsand safeguard them from arbitrariness. If the legal systemdoes not operate in accordance with the rule of law, citizenshave to fear arbitrariness, discrimination, unequalattendance in court, etc. The lack of rule of law reducestransparency of public action and fosters distrust amongcitizens. As a result, citizens may not be willing to financethe state through taxes, and decide to evade theseliabilities.

Fundamentals of TaxationReasons for tax evasion and tax avoidanceHigh compliance costs

High compliance costs, that are the costs the taxpayer has to bearto gather the necessary information, fill out tax forms etc, canbean additional reason for tax evasion and avoidance. Thissituation led businesses to worry more about the administrativeburden than about the actual tax burden. In such a situation it canbe assumed that compliance costs are very high and theprobability of the taxpayer complying with such a great variety oftaxes low. Particularly small and medium sized enterprises (SME) suffer fromhigh compliance costs. It is the paperwork that has to be masteredto comply with tax legislation which is deterring firms from payingtheir taxes appropriately. Under such situation, it is preffered tosimply try to avoid or evade taxation.

Fundamentals of TaxationReasons for tax evasion and tax avoidanceWeak enforcement of tax laws

While the preceding section discussed the sources for lowvoluntary com pliance and high regulatory costs of taxcompliance, the current section turns to challenges in theenforcement of tax laws. There exist several circumstancesthat restrain tax administrations from performing theirfunctions properly thereby increasing the possibility of taxevasion. Shortfalls in tax collection procedures as well asweak capacities of tax administrations to detect andprosecute tax violators are both factors that contribute to alow enforcement of tax legislation

Fundamentals of TaxationReasons for tax evasion and tax avoidanceWeak enforcement of tax laws Influencing factors

Insufficiencies in tax collectionRegarding tax collection, authorities face difficulties withrespect to important premises for a well functioning taxadministration, especially with respect to identifying andadministering those citizens and firms that are liable to taxpayments. Although there has been progress, taxadministrations' capacity to introduce and sustain e.g. wellfunctioning tax registers still pose severe difficulties .Problems of insufficient capacity may also occur due to theorganizational set up of the tax administration and itsrelationship to the ministry of finance.


Insufficiencies in tax collectionIt is important that tax administration and tax policy are intertwinedspheres. Tax policy directly affects the costs and the organization of the taxadministration. Additionally, the capacities of tax administration influencethe way tax policy is implemented. Thus, both areas tax policy as well astax administration have to be taken into consideration when designingsuccessful tax reforms.Otherwise, the proper functioning of the overall system is affected. For thisreason, the tax system should be aligned to the adminis trative and legalprerequisites of the respective country. Qualified, well trained and motivated tax officials are crucial for thecollection of taxes and the performance of tax administration bodies as awhole. In order to motivate tax officials to work in accordance with theinterests of the government and to reduce their vulnerability to corruption,attention has to be given to wages and other incentives


Insufficiencies in tax collectionFinally, insufficiencies in tax collection result from the fact that economiesof most developing countries are characterized by a large informal sector.Firms and individuals active in the informal sector usually do not pay directtaxes on personal or business income, and they do not charge consumptiontaxes or excises on their sales. The state loses these potential tax revenuesand, as a consequence, lacks necessary funds to provide goods and service.Often, the reasons to be active in the informal economy are not directlyrelated to attempts to avoid taxation but rather to limited options oexcessive adminis trative requirements to enter the formal economy orexcessive costs of labour regulations. However, there are also cases whereindividuals and companies choose to be active in the informal sector witthe intention to escape their tax liabilities. Nevertheless, tax evasion doesnot need to be the primary reason why firms remain or become informal.


Weak capacity in detecting and prosecuting inappropriatetax practicesA well-functioning body of tax investigation is essential forthe detection and prosecution of cases of tax fraud. The lackof sufficient capacities in tax administrations reduce theprobability of detection that again influences the decision ofa taxpayer as to whether evade or not. Additionally, thelegal frame work is an important prerequisite for anyenforcement activity. For example, the size and nature ofpenalties that are incurred after evasion has been detectedis directly connected to the level of tax compliance .


Changes in tax lawsTax laws changes rapidly, thus producing instability and low transparency of the tax code. As a result, complicated tax legislationand ongoing changes of the tax code confuse tax administrators andtaxpayers alike. This produces ample opportunity for tax avoidance .Furthermore, it results in tax evasion which is not intentional, butoccurs due to lack of knowledge . In extreme cases, tax evasion andavoidance even become inevitable when the tax system becomes toocomplex and/or contradictory to follow. The reasons for tax evasion and avoidance do not occur in isolationand some are mutually enforcing. Often, tax evasion and avoidanceare by-products of deficient political, economic and socialgovernance in a country.

Fundamentals of TaxationModes of tax evasion and avoidance

Misreporting and non-declaration of personal income orcorporate profits to circumvent direct income taxation or taxobligations resulting from sales of goods and services. Inthis context, holding offshore financial accounts to concealtaxable income from tax authorities in the country ofresidence allows tax evaders to benefit from low or zerotaxes abroad, exploiting bank secrecy and poor financialregulation abroad. Along these lines, trade mispricing through faked invoicesbetween colluding exporters and importers serves as acommonly used way to illegally transfer money abroadusually with the purpose to evade taxes .

Fundamentals of TaxationModes of tax evasion and avoidance

Bribery of tax officials: Countries thatsuffer from inefficiencies in theadministration and enforcement of taxesare exposed to bribing activities by the taxpayer both by the individual and corporateand companies

Fundamentals of TaxationModes of tax evasion and avoidanceModes are not mutually exclusive

The modes of tax evasion and avoidance arenot mutually exclusive but may also result asa consequence of one another. For instance,illicit financial flows that are directed tooffshore accounts may result from proceedsthat are realized through criminal activitiessuch as the smuggling of goods or fraudulentmanipulation of transaction records or bribery.

Fundamentals of TaxationTax avoidance strategies predominantly applied in practice

Profit shifting: Subsidiaries and holding companies are treated asseparate entities by tax authorities, i.e. they are liable to taxesseparately for their individual profit earned. Companies havingcomparatively low tax burden and can shift their outputs at a higherprice to the other member company having higher tax bracket. Suchpractice will show higher amount of profit for company with low taxbracket and lower amount of profit for companies under higher taxbracket . In case of cross border trade companies can engage in taxplanning activities to shift profits within the affiliated group from hightax to low tax countries. Profit shifting can be achieved bymanipulating transfer prices that is pricing of goods and servicestraded within the group, exploiting intra- group loans and deliberatelychoosing the allocation of profitable (intangible) assets

Fundamentals of TaxationTax avoidance strategies predominantly applied in practice

The deliberate choice of location for certain(intangible) assets offers interlaced companies anopportunity to optimize their overall tax liabilitywithin the legal framework. Intangible assets suchas patents, trademarks and copyrights that generatesubstantial profits out of license payments areassigned to subsidiaries located in low tax countrieswhereas cost intensive units such as R&D or centralservices are located in high tax countries to reducetaxable profits.

Fundamentals of TaxationMeasures to improve tax compliance

Taxpayer education and taxpayer serviceThe importance of taxes for the functioning of thestate is not always apparent to the taxpayer. Similarly,individual tax liabilities as well as requirements tocomply with the tax system such as filling out differenttax forms might be unknown or difficult to understand.By means of taxpayer education and taxpayer service,citizens can be informed and educated about the taxsystem and be assisted in their attempts to complywith the tax system.


Addressing tax compliance costs and administrative costs Apart from promoting voluntary tax compliance, governments in developingcountries as well as development partners should concentrate on measuresthat reduce taxpayers' costs of fulfilling their tax liabilities.In this regard, revenue authorities must be aware of the importance ofacting service oriented and should therefore monitor customer satisfaction.Many revenue authorities shift towards a customer service orientationwhich reflects the growing awareness of the need to offer a quality serviceto the taxpaying public and to be responsive to public concerns. Forinstance, measures to sim plify the taxpaying process and promotingservice oriented tax administration include a reduction of the number of taxforms and officers assisting clients in filling out documents or theintroduction of online services


Administrative reformTax administration reforms are a crucial part of any effectivestrategy to strengthen enforcement of at the national level.Measures in this area include different approaches of organisationalreform such like the creation of semi-autonomous revenueauthorities, setting-up of Large Taxpayer Units (already practicedin Bangladesh) as well as capacity development such as trainingsand courses on selected topics, e.g. specialized courses in the areaof detecting illegitimate profit shifting activities or tax fraud, butalso restructuring of the wage schedule to offer sufficientincentives in order to attract and recruit capable staff and tominimize the risk of corruptive behavior


Law enforcementReforms referring to the organization of the administrationare a sensible step to enhance law enforcement. Often, theorganizational setup of the tax admin istration is a reasonfor the extent and prevalence of Inefficiencies. Therefore, publicadministration reforms should aim at simplifying theorganizational body of tax administrations and its workingstructure. Between and within different authorities, competences needto be divided and different departments within the institutionsneed to be mandated explicitly. Especially when it comes toexchanging information within the institution, simplification ofthe administrative organization might be a useful contribution


Reduction of administrative costStrategies to strengthen tax administration should also focuson reducing administrative costs inside the taxadministration. For this purpose introducing unique taxpayeridentification numbers are considered a useful instrument asthey facilitate cross-checking of information betweendifferent types of taxes such as VAT and income tax. Inaddition, monitoring and auditing of tax payments and taxarrears are easier if a unique taxpayer identification number

exist.


Jurisdiction of LTUExpanding the jurisdiction of the large taxpayerunit (LTU) allows for specialization of taxauditors and thus increases efficiency.Additionally, LTUs help tax administrationconcentrate all available capacities to those firmsthat contribute considerable amounts to domesticrevenues .


Simplification of tax lawComplex and often changing tax laws cause confusion anduncertainty among tax officials and taxpayers. Addressingdeficiencies in the tax system is there fore probably as importantas process orientated reform actions that enhance the userfriendliness and transparency of the taxation procedure.Particularly small and medium size enterprises (SME) with onlylimited administrative capacities and private households do notonly suffer from the bureaucratic burden of complicated taxprocedures but also from the complexity of the tax system itself.Simplifying the (corporate) income tax structure by reducing thenumber of tax brackets and high statutory tax rates lowers the taxburden and may support voluntary compliance


Availability of quality dataFurthermore, the possibility to detect and prosecute tax violators dependscrucially on data availability and data quality. Hence, actions taken againsttax evasion and avoidance relate to an improvement of the data qualityavailable to tax officers. The inter institutional exchange of high qualityinformation requires different steps. On the one hand, it is important toensure the collec tion of adequate data. Therefore, one needs to ensure asufficient endowment with technical equipment and the establishment ofgood performing statistic divisions with competent staff members to collectdata and keep records. On the other hand, good technical equipment andtechnically educated staff are also a prerequisite for a well functioninginformation exchange. Along these lines, automation of tax collectionprocedures e.g. through online tax assess ment, payment and monitoringopportunities may serve as an efficient way to reduce the scope for taxevasion and avoidance


Strengthening of rule of lawTax fraud and avoidance are also a result of a weak judiciary.Addressing revenue shortfalls needs to go hand in hand withlegislative reforms strengthening the rule of law. This includesinsufficient punishment and prosecution of violators which can onlybe tackled when detected tax criminals face stricter penalties thatare effectively executed by courts. Higher penalties act as adeterrent and help to improve tax compliance. To achieve this goalauthorities have to strengthen the rule of law and developcapacities of investigation authorities. Moreover, investigators aswell as courts and judges should receive greater support bypoliticians in order to emphasize the importance of this issue.


Transparency in financial reportingConsolidation of financial accounts of companiescontributes to a lack of transparency andinformation asymmetry. Thereby imposing anadditional challenge on detecting harmful taxpractices this can be addressed through increasedtransparency in bookkeeping e. g .by ensuring thestrict compliance of financial accountingstandards that require disclosure of disaggregatedand unconsolidated accounts.