Legal terms like tax planning and tax evasion can mislead laypeople. You should be aware of a few terms when it comes to tax savings. Some of these include tax planning and tax evasion. Even though there is a significant distinction between them, they are frequently used interchangeably.
Tax Planning vs Tax Avoidance
Tax planning is defined as the structuring of financial activities so that the assessed can receive the maximum amount of tax benefits by utilizing all legal advantages, such as deductions, exemptions, etc. Contrarily, tax avoidance is a strategy for avoiding tax liability in legal and ethical ways, but it aims to subvert the primary goal of the government.
Difference between Tax Planning and Tax Avoidance (In Tabular Form)
|Tax planning is organizing one’s financial affairs so that the taxpayer is fully eligible for all legal deductions and exemptions.
|The practice of actively altering one's financial situation to avoid paying taxes is known as tax avoidance.
|moral and legal
|legal but unethical
|What is it?
|It is the tax savings.
|It involves evading taxes.
|to reduce tax obligations by following the rules and principles of the law.
|To reduce tax liability by strictly applying the law's rules.
|Permissible by law
|use the benefits of tax law.
|utilizes the flaws in tax law.
|in the long run, emerge.
Your annual income may be reduced by taxes. To combat this, tax planning is a reasonable way to reduce your tax liability each financial year. This allows you to make the most of the tax credits, deductions, and incentives offered by the government to ease the burden.
In a few terms, tax planning can be described. It looks at one's financial situation from a tax efficiency perspective.
A central part of financial planning is tax planning. This ensures tax savings while complying with the rules and regulations laid down in the Income Tax Act, of 1961. Saving money and reducing tax liability are the main objectives of tax planning.
Advantages of Tax Planning
- Minimizing legal action Dealing with municipal, federal, state, or foreign tax authorities to resolve tax disputes is known as litigation. Taxpayers and taxpayers are often at odds, as the former wants to collect as much money as possible, while the latter wants as little tax debt as possible. By minimizing litigation, the taxpayer avoids fulfilling its legal obligations.
- Lowering tax obligations Everyone who pays taxes wants to pay less in taxes and save money for the future. By planning your investment within the many incentives provided in the Income Tax Act, of 1961, you can reduce the tax payable. The law offers various investment schemes for tax planning that can significantly reduce your tax liability.
- To guarantee a stable economy: The nation's advancement is funded by tax dollars. Effective tax management and planning result in a smooth flow of white money that supports healthy economic growth. Citizens and the economy benefit from this.
- Increasing productivity Funding various income-generating strategies with money from taxable sources is one of the main goals of tax planning. This ensures the best possible use of money for profitable purposes.
Types of Tax Planning
Planning your taxes quickly
This approach involves thinking about and carrying out tax planning after the fiscal year. Investors turn to this planning to look for lawful ways to reduce their tax bill after the financial year. This approach avoids making long-term commitments. However, this can lead to significant tax savings.
A long-term tax strategy
This plan is established at the start of the fiscal year, and the taxpayer adheres to it all year long. While long-term tax planning may not offer you immediate tax benefits like short-term tax planning does, it can still be beneficial in the long run.
Allowing for tax planning
This approach involves making plans by various Indian tax law provisions. India has several tax planning measures including deductions, exemptions, taxes, and concessions. For instance, the Income Tax Act of 1961's Section 80C provides several different sorts of deductions on various tax-saving tools.
Intentional tax planning
Utilizing tax-saving tools with a particular goal in mind is a part of intentional tax planning. By doing this, you can be confident that your investment will yield the highest potential return. This entails carefully picking the right investments, coming up with a plan to replace assets as needed, and diversifying your business and income assets according to where you live.
How to Save Taxes
There are many ways for taxpayers to lower their tax obligations. Tax exclusions and deductions are available under various sections of Indian income tax legislation, with Section 80C being the most widely used method of tax avoidance. For instance, investments in ELSS plans, National Savings Certificates, Five Year Bank Deposits, and Public Provident Fund deposits.
The best and most efficient strategy to reduce taxes is to create a financial plan and stick to it whenever your income changes. Making tax-efficient investments before the start of the year is also a useful way to improve rather than making hasty and often poor investment decisions at the last minute.
Tax Saving Options Under Section 80C
Assuming the most often used sections of the Income Tax Act of 1961, Section 80C offers provisions to reduce annual tax payments by up to Rs46,800 (assuming the highest income tax slab, @30% plus education cess 4%). Investing in the Equity Linked Savings Scheme or ELSS as it is better known is one of the best ways to reduce taxes under Section 80C. Mutual funds that offer tax planning offer the opportunity for both capital appreciation and tax savings. Apart from ELSS funds, you can invest in government schemes such as Tax Savings Trusts, Public Pension Funds, and Government Savings Certificates. Cumulative investments in these securities can be eligible for deduction up to Rs 1.5 lakh.
Tax Saving Options Under Section 80D
Taxpayers can claim deductions from their health insurance premiums under this provision. The following amounts can be deducted under section 80D:
- You can get a maximum rebate of Rs 25,000 on the health insurance premium you pay for yourself, your children, or your spouse.
- If your parents are also covered by your health insurance plan, you can receive up to Rs50,000.
- A maximum deduction of Rs75,000 is permitted if one or both of your parents falls under the senior citizen category.
Tax Saving Options Under Section 80E
Section 80E allows for tax deductions for interest paid on student loan debt. From the date of repayment, you have eight years to claim these deductions. The deductible amount has no upper limit. This means that an assessee may deduct all the interest payments from their taxable income.
Claiming HRA Exemption
Taxpayers can deduct HRA from their housing expenses. The taxpayer must submit rent receipts from the landlord:
- Actual HRA received,
- The minimum deductible amounts are 50% of basic salary plus DA (salary allowance) for taxpayers in major cities and 40% (of basic salary plus DA) for taxpayers in other cities.
- Rent paid overall less 10% of base pay plus DA.
Other Exemptions and Deductions
You can reduce your tax liability in addition to the exemptions and deductions. Tax breaks are also available for contributions made to approved organizations and charities.
Individuals may choose to forego numerous deductions and exemptions to pay taxes at reduced rates and in accordance with newly defined income tax slabs under the new tax system made public with the release of the Union Budget 2020.
Income tax planning is completely legal and a wise move if done within the parameters established by the relevant authorities. However, if you use unscrupulous strategies to reduce your tax burden, you may find yourself in hot water. Every citizen has a duty and responsibility to conduct wise tax planning.
Using legal strategies to reduce an individual's or company’s tax liability is called tax evasion. Typically, this is done by utilizing all permitted deductions and credits. This can also be done by preferring tax-advantaged investments, such as tax-free municipal bonds. Tax avoidance based on unethical practices such as deductions and underreporting of income is not the same as tax evasion.
Many taxpayers may use tax evasion as a legal technique to avoid paying taxes or at least reduce their tax liability.
In fact, millions of people and organizations employ some type of tax evasion to reduce the amount they legally and properly owe to the Internal Revenue Service (IRS). In this context, tax evasion is also called a tax haven.
- By using the tax rules to one's advantage, one can legally avoid paying taxes.
- Using all available legal options Utilize certain elements of the country's law to avoid or decrease any tax obligations that would otherwise arise.
- A contract that is entered into exclusively or mostly to benefit from tax advantages.
Methods Used for Avoidance of Taxes
There are various ways to avoid paying taxes, but the large corporate houses in India use a variety of tactics, including many that heavily rely on tax havens and subsidiaries. The most desired and advantageous approach among India's large corporate houses is the movement of assets, shares, deals, and money from India to these tax havens through subsidiaries.
Is Tax Avoidance Legal?
Yes, this is the obvious response to this query. Tax evasion is a legitimate method of avoiding paying taxes. For instance, by taking advantage of tax credits, deductions, exclusions, and loopholes, you can avoid paying taxes. For instance, corporations frequently employ various legal techniques to evade paying taxes. Offshoring their income, employing accelerated depreciation, and deducting employee stock options are a few examples.
But when people actively disregard the tax regulations that apply to them, that is when tax evasion becomes unlawful. Fines, penalties, levies, and even legal action may be imposed for doing so.
Prevention of Tax Avoidance
The revenue of many governments, including India, suffers greatly because of the tax-dodging tactics utilized by large corporations worldwide. The only way to stop it is to close the gaps in the tax code. With the help of the Finance Act of 2015 and the Income Tax Act of 1961, the Indian government established several regulations and recommendations to control and prevent tax evasion.
Chapter X-A of the Income Tax Act of 1961 included the General Anti-Avoidance Rule (GAAR). With Section 96 of the Act's "Impermissible Avoidance Arrangement" clause, which states that agreements or deals made to receive a tax benefit are inadmissible, GAAR was only introduced with the intention of reducing tax avoidance techniques.
To replace a new corporate residency test that stated that if effective management was determined to be in India, a foreign business would be considered an Indian tax resident, 6(3) of the Financial Management Act of 2015 was amended.
Even though the government has taken many initiatives, tax avoidance continues to be a problem.
Main Differences Between Tax Planning and Tax Avoidance in Points
- Tax planning is a method for strategically organizing one's finances so that all legally permissible deductions, exemptions, and allowances can be taken advantage of. Tax avoidance is the deliberate arranging of one's financial affairs so that his or her tax liability is minimal or even nonexistent.
- Tax planning is both morally and legally acceptable, but tax evasion is both legally and morally wrong.
- Tax planning essentially entails tax savings. Tax hedging, on the other hand, is the avoidance of tax.
- Tax evasion is done with an ulterior aim. On the other hand, tax planning includes a genuine motive.
- Tax planning uses the letter and spirit of the law to reduce tax liabilities. Contrarily, tax avoidance merely follows the letter of the law and attempts to reduce the tax burden.
- Since tax planning entails abiding by the rules of tax, it is legal. Tax avoidance, on the other hand, is prohibited by law since it tries to exploit legal flaws.
- Tax planning makes use of the benefits that the law grants the assessee. Unlike tax avoidance, which makes use of legal loopholes.
- Long-term tax planning advantages can be observed. Contrarily, tax evasion only has short-term advantages.
Both tax avoidance and preparation require a thorough and current understanding of the tax rules. Tax avoidance used to be seen as acceptable, but as time has gone on, it has become just as wrong as tax evasion and can even result in punishment when it is uncovered. Contrarily, tax planning is fully legal because it does not involve exploiting any legal loopholes and is therefore acceptable.