Tax evasion vs. tax avoidance

Many people seem to get tax avoidance and tax evasion confused. One is illegal and the other is perfectly legal. Tax evasion is a case of an individual or corporation being dishonest, intentionally not paying taxes. Tax avoidance is a case of an individual or corporation leveraging the laws as they are written to pay as little tax as possible. In cases where legal tax avoidance occurs much of the blame is better placed on a failure of the tax system than a failure of the individual or corporation to pay taxes.

Let’s use a simple example. Let’s take our old example expat named Sven. Sven has long dreamed of buying an expensive $1000 digital camera. In doing so, he has a few options. He can actively evade taxes to pay no tax, avoid taxes by leveraging a knowledge of our tax laws or pay the maximum amount of taxes.  How?  Let’s take a look at 3 scenarios.

Full tax:

Sven takes a trip to New York to visit some friends.  While he’s there, he purchases a digital camera for $1000. When he arrives on island he fills out his paperwork, goes the “something to declare” line and pays his 25% tax, minus any reduction he gets.  Lets assume he purchases other items and uses the reduction on those so he pays the full $250 for the camera.

Tax evasion:

In this case, Sven makes the same trip but on arrival to the island he sneakily tries to hide the camera, makes no declaration and walks through the “nothing to declare” line hoping he doesn’t get caught. In this case, if successful, he pays no tax, if not, he’ll have to answer to customs. Let’s assume he manages $0 tax because he is willing to break the law and dishonestly evade his tax obligations.

Tax avoidance:

In this case, Sven purchases his camera but instead of bringing it back with him, he puts it into a box and ships it to the island. He knows that thanks to the custom’s tariff laws he would only pay 8.5% for both import via courier or import via an importer. In this case, he pays a tax of $85 so he effectively avoids paying the full rate in a perfectly legal way. He will have to pay for shipping, but overall it is likely he would come out having saved vs. paying the full amount at the airport.

So, here we have 3 cases. One is blatantly dishonest and illegal. The next is paying as much as possible and the last is leveraging an understanding of the tax laws to cut the rate. Here’s the question. Is Sven wrong or being dishonest in shipping in his camera? He’s following the law as stated so he’s certainly not breaking the law.

The problem with tax avoidance in the case of Bermuda’s duty tariff system isn’t expat Sven or Bermudian Johnny taking advantage. It is that the tax system is so complex that it creates a special kind of tax on the uninformed. Those who understand the system have an advantage over those who do not. Further, it creates bureaucracy and waste in terms of managing the complexity.

This is the problem with tax systems not just in Bermuda, but globally as well. Politicians and the corporations who lobby them create tax systems either to provide themselves an advantage or to íncentivize certain activities and discourage others. We see it in our local tax systems as well as in global tax systems.  Unfortunately tax systems are far from simple. In the case of Bermuda’s duty tariff system, much could be done to simplify it.  In the case of global taxation and Bermuda’s role in it, that is unfortunately a complicated matter with significant implications for global trade likely left for another article.