Monday, August 02, 2010

AVOIDANCE AND EVASION-THE LINE IS RATHER THIN

BY

K.VIJAY KUMAR, M.A., B.L., B.Ed., M.B.A.

SUPERINTENDENT OF CENTRAL Excise


 


 

"Taxes are what we pay for a civilized society. I like to pay taxes. With them I buy civilization."

-Justice Holmes


 

    It is fashionable to think that anybody who can successfully avoid tax is a wise man. He is looked up with a lot of respect in society. In my office there is a clerk who is an expert in Income Tax matters (how to compute and how to avoid). During January to March every year he is in great demand and very senior officers take his help and so during this season he does not talk to lesser mortals like me. One of the topmost excise consultants in the county once told me with a proud smile aping at me, `I do not help any assessee evade tax; if it can be avoided, I will certainly make use of any flaw in the law.`


 

    Instead of troubling E.L.T. readers with my opinion on the subject, I would like to take the reader down memory lane with some of the greatest judges here and abroad. Actually I would suggest that every person connected with Tax should read Justice Chinnapa Reddy's order in McDowell & Co.Ltd.v.Commercial Tax Officer. At least, I wish that all my colleagues should read the masterly judgment from which I am quoting extensively in this article.


 

What is avoidance and what is Evasion?


 

    See what Justice Reddy says "The Shortest definition of tax avoidance that I have come across is ~the art of dodging tax without breaking the law`. Much legal sophistry and judicial exposition have gone into the attempt to differentiate the concepts of tax evasion and tax avoidance and to discover the invisible line supposed to exist, which distinguishes one from the other. Tax avoidance, it seems, is legal; tax evasion is illegal. Though initially the law was, and I suppose the law still is, ~there is not equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied.`


 


 

    Justice Reddy was fascinated by the great game of avoidance as he said ~the ingenious attempts to rationalise and legitimise tax avoidance have always fascinated and amused me and made me wonder how ready the minds are to adapt themselves and discover excuses to dip into the treasury`.


 

    Where did it all start? As all legal confusion, in England of course. Sometime in the early thirties, a theory gained widespread acceptance that it was perfectly open for persons to evade (avoid) taxes if they could do it legally. Avoidance gained respectability even from the Courts as a judge remarked ~the highest authorities have always recognised that the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so within the law, and that he may legitimately claim the advantage of any expressed terms or any omissions that he can find in his favour in taxing Acts. In so doing, he neither comes under liability nor incurs blame`.


 

    And the most quoted and misquoted, used and abused and the oracle for the avoiders came from Lord Tomlin in the case of IRC v. Duke of Westminster(1936)AC 1) ~Every man is entitled, if he can, to order his affairs, so that the tax attaching under the appropriate Acts, is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxgatherers may be of his ingenuity, he cannot be compelled to pay an increased tax."


 

But this was not a view that could survive eternally. Politics (better understanding and spread of democracy) and Economics (need for tax compliance in a Welfare state) had to influence and judges.


 

Avoidance often takes place because of a lacuna in law. Then can't it be rectified?


 

Lord Greene, M.R., dealing with the construction of an anti-avoidance section, said ~ For years a battle of manoeuvre has been waged between the legislature and those who are minded to throw the burden of taxation off their own shoulders on the those of their fellow subjects. In that battle, the Legislature has often been worsted by the skill determination and resourcefulness. It would not shock us in the least to find that the Legislature has determined to put an end to the struggled by imposing the severest of penalties. It scarcely lies in the mouth of the taxpayer who plays with fire to complain of burnt fingers.~


 

From respect to condemnation the fall was fast as Lord Simon Latilla V.IRC (1943) said ~ There is, of course, no doubt that they are within their legal rights, but that is no reason why their efforts, or those of the professional gentlemen, who assist them in the matter, should be regarded as a commendable exercise of ingenuity or as a discharge of the duties of good citizenship. On the contrary, one result of such methods, if they succeed, is, of course, to increase the load of tax on the shoulders of the great body of good citizens who do not desire, or do not know how, to adopt these manoeuvres.~


 

The anger continues ~.. There must be some limit to the devices which this Court ought to countenance in order to defeat the fiscal intentions of the legislature. In my judgement, these proposals overstep that limit.. I am not persuaded that this application represents more than a cheap exercise in tax avoidance which I ought not to sanction, as distinct from a legitimate avoidance of liability to taxation~.


 

Can not the laws be simple and clear so as to avoid avoidance? Easier said than done. Lord Reid, dealing with a scheme for tax avoidance by forward dividend stripping, observed ~ we seem to have travelled a long way from the general and salutary rule that the subject is not to be taxed except by plain words. But I must recognise that plain words are seldom adequate to anticipate and forestall the multiplicity of ingenious schemes which are constantly being devised to evade taxation. Parliament is very properly determined to prevent this kind of tax evasion and, if the Courts find it impossible to give very wide meanings to general phrases, the only alternative may be for Parliament to do as some other countries have done, and introduce legislation of a more sweeping character which will put the ordinary well-intentioned person at much greater risk than is created by a wide interpretation of such provisions as those which we are now considering.. I am inclined to think that the real explanation of these verbal difficulties may be that, in legislationof such extreme complexity as we have here, it is not humanly possible for a draftsman to preserve that consistency in the use of language which we generally look for. Indeed, I sometimes suspect that our normal mticulous methods of statutory construction tend to lead us astray by concentrating too much on verbal niceties and paying too little attention to the provisions read as a whole.~


 

As soon as a law is enacted people work overtime to look for loopholes and until those are rectified, should the Courts merrily allow avoidance as it is legal? A learned judge observed, ~While the techniques of tax avoidance progress and are technically improved, the Courts are not obliged to stand still. Such immobility must result either in loss of tax, to the prejudice of other tax payers, or to Parliamentary congestion or (most likely) to both.~


 

As judges began to frown on avoidance, new concepts of fiscal law interpretation emerged as another judge observed. ~(These words) that every man is entitled, if he can to order his affairs so as to diminish the burden of tax. The limits within which this principle is to operate remain to be probed and determined judicially. Difficult though the task may be for judges, it is one which is beyond the power of the blunt instrument of legislation. Whatever a statute may provide, it has to be interpreted and applied by the Courts: and ultimately, it will prove to be in this area of judge-made law that our elusive journey's end will be found.~


 

Westminster was discarded by Lord Roskil with the words. ~ When these ghosts of the past stand in the path of justice clanking their medieval chains, the proper course for the judge is to pass through them undeterred~.


 

So even in England where the concept of Tax avoidance was born, judges have ensured that tax dodgers do not enjoy at the cost of genuine tax payers. As Justice Reddy says, ~ the smile, cynical or even affectionate thought it might have been at one time, has now frozen into a deep frown. The Courts are now concerning themselves not merely with the genuineness of a transaction, but with the intended effect of it on fiscal purposes. No one can now get away with a tax avoidance project with the mere statement that there is nothing illegal about it~.


 

There was an opinion expressed in a newspaper that:


 

  1. The taxpayer is morally bound to obey the law, but is not bound beyond the law, for apart from the law, taxation would be black-mail or racketeering.
  2. There is not behind taxing laws, as there is behind laws against crim, an independent moral obligation. When, therefore, the taxpayer has obeyed the law, he had done all that morality requires.
  3. It is said that by avoiding a tax, he throws a load on to some other taxpayer. But this is not quite accurate, for the deficiency might be met by reducing expenditure.. is it not good thing that there should be this last lawful remedy against oppressive taxation by a majority, that human ingenuity can always find a way by which the minority, can escape from tyrranical imposts.~


 


 

To which the answer would be


 

~ Defence of tax avoidance is an ~ an amusing attempt to raise the art of tax avoidance to the moral level of political martyrdom. Nor, may we say, are our tax dodgers Gandhiji 's on the Dandi March to protest against the salt tax.~


 

Quite a few judges in India also subscribed to the Westminster school of thought and in several cases held that it was perfectly honourable to avoid within the framework of law.


 

But in the landmark case, which is the subject of this article, justice Reddy emphatically said, ~ We think that the time has come for us to depart from the Westminster principle as emphatically as the British Courts have done and to dissociate ourselves from the observations of Shah J. and similar observations made elsewhere.. but, surely, it is high time for the judiciary in India too to part its ways from the principle of Westminster and the alluring logic of tax avoidance. We now live in a welfare State whose financial needs, if backed by the law, have to be respected and met. We must recognise that there is behind taxation laws as much moral sanction as behind any other welfare legislation and it is pretence to say that avoidance of taxation is not unethical and that it stands on no less a moral plane than honest payment of taxation. In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord it approval to it. A hint of this approach is to be found in the judgement of Desai J.in wood polymer Ltd., In re and Bengal Hotels Limited, in re {1977} 47 Comp Cas 597 (Guj), where the learned judge refused to accord sanction to the amalgamation of companies as it would lead to avoidance of tax. It is neither fair nor desirable to expect the legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the Court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of ~emerging~ techniques of interpretation to expose the devices for what they really are and to refuse to give judicial benediction.


 

In Calcutta Chromotype Ltd. v.Collector of C.Ex., Calcutta – 1998 (99) E.L.T 202(S.C>), the Hon'ble Supreme Court observed ~ This Court stressed upon the need to make a departure from the Westminster principle based upon the observations of Lord Tomlin in the case of IRC v.Duke of Westminster [(1936) AC 1] that every assessee is entitled to arrange his affairs as to not attract taxes. The Court said that tax planning may be legitimate provided it is within the framework of law. Colourable devices, however, cannot be part of tax planning. Dubious methods resorting to artifice or subterfuge to avoid payment of taxes on what really is income can today no longer be applauded and legitimised as a splendid work by a wise man but has to be condemned and punished with severest of penalties~.


 

In Union of India v. Playworld Electronics Pvt.Ltd – 1989 (41) E.L.T368 (S.C), the Court declared, it is true that tax planning may be legitimate provided it is within the framework of the law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. It is also true that in order to create the atmosphere of tax compliance, taxes must be reasonably collected and when collected, should be utilised in proper expenditure and not wasted. [See the observation in Commissioner of Wealth Tax v.Arvind Narottam – 1988 4 SCC 113]. It is not necessary, in the facts of this case to notice the change in the trend of judicial approach in England: [ Sherdely v. Sherdely (1987) 2 AER 54]. While it is true, as observed by Chinnappa Reddy, J. in MC dowell and Co.Ltd v. Commercial Tax Officer (Supra) too much to expect the legislature to intervene and take care of every device and scheme to avoid taxation and it is up to the Court sometimes to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and to expose the devices for what they really are and to refuse to give judicial benediction, it is necessary to remember as observed by Lord Reid in Greenberg v.IRC [1971 (47) TC 240 (HL) that one must find out the true nature of the transaction. It is unsafe to make bad laws out of hard facts and one should avoid subverting the rule of law.


 

The Hon'ble High Court of AP in VBC Industries Ltd. v. UOI – 1999 (114) E.L.T 378 (A.P) observed, ~legal ingenuity knows no bounds. It baffles an ordinary person whether the pleas such as those put forward in the present case would be available at all. The petitioners having got the refund pursuant to the judgement of this Court, which was later reversed by the Supreme Court tries to resist the move of the Excise Department to recover back the amount refunded~.


 

Finally what are the consequences of avoidance? Over to Justice Reddy again, The evil consequences of tax avoidance are manifold.


 

  1. First, there is a substantial loss of much needed public revenue, particularly in a welfare state like ours.
  2. Next, there is the serious disturbance caused to the economy of the country by the piling up of mountains of black money, directly causing inflation.
  3. Then there is ~ the large hidden loss~ to the community by some of the best brains in the country being involved in the perpetual war waged between the tax-avoided and his expert team of advisers, lawyers and accountants on the one side and the tax-gatherer and his perhaps not no skilful advisers on the other side.
  4. Then again there is the ~ sense of injustice and inequality which tax avoidance arouses in the breasts of those who are unwilling or unable to profit by it ~.
  5. Last, but not the least is the ethics (to be precise, the lack of it) of transferring the burden of tax liability to the shoulders of the guideless, good citizens from those of the "artful dodgers".


 

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