This article appears as the "Discussion of the month" topic in AML News and Updates Newsletter - October 2023 edition which can be found here.
Tax evasion is a serious crime due to its far-reaching consequences and the significant impact it has on society and governments.
The Australian Tax Office and the APG in September 2023 have prepared a “The Typology Report on Money Laundering Associated with Tax Crimes in the Asia Pacific” which provides typologies from the experiences of competent authorities in responding to money laundering associated with tax crimes.
The report has valuable information about how tax crimes take place highlighting the main methods employed.
Let’s start exploring some insights!
What is Tax Evasion and Tax Avoidance?
🧾 Tax Evasion: Tax evasion involves deliberate actions to underreport income or fraudulently misstate expenses to reduce tax liability. This includes not reporting cash income or inflating deductions, actions that are illegal and punishable by law.
🔣 Tax Avoidance: Tax avoidance, on the other hand, is the legal use of strategies to minimize tax liability. This can include taking advantage of tax deductions, credits, and loopholes provided by the tax code. Tax avoidance is within the bounds of the law, unlike tax evasion.
Is Tax Evasion a Predicate Offense for money laundering?
A predicate offense is a serious crime 👮 that generates illegal proceeds. While tax evasion itself may not directly result in the receipt of illicit funds, it can still be considered a predicate crime in the context of money laundering and proceeds of crime legislation.
👉🏻 Money laundering laws usually include tax evasion in their predicate offence lists.
Why People Engage in Tax Evasion
People may choose to evade taxes for various reasons:
➡️ Reducing Tax Liability: Some individuals aim to pay less in taxes to increase their disposable income.
➡️ Avoiding Penalties: Unpaid taxes can lead to penalties and interest charges, which some try to avoid through evasion.
➡️ Concealing Illegal Activities: Tax evasion can be used to hide income from illegal activities, such as drug trafficking or fraud.
➡️ Protesting Government Policies: In some cases, individuals may view tax evasion as a form of protest against government policies they disagree with.
When individuals or entities evade taxes, they shift the tax burden onto honest taxpayers, diminishing the resources available for essential public services such as education, healthcare, infrastructure, and social welfare programs.
It's important to note that tax evasion is illegal and can have severe consequences, including fines, imprisonment, and damage to one's reputation.
Methods Used for Tax Evasion
Tax evaders employ various methods to avoid paying their fair share of taxes. Here are some common methods:
🚩 Underreporting Income: Individuals may intentionally fail to report cash income or falsify expenses to lower their taxable income.
🚩 Paying expenses with cash: Instead of declaring all cash sales, some cash is used to pay expenses, diverting the funds from the business to third parties who use the funds for their personal expenses. This results in declaring less sales and as a result pay less tax.
🚩 Offshore Accounts and Shell Companies: Some use offshore bank accounts or establish shell companies in tax havens to hide income and assets from tax authorities.
🚩 Underreporting Self-Employment Income: Those in self-employment or freelancing may not report all their earnings or may falsely claim deductions to reduce taxable income.
🚩 False Documents: Tax evaders may create fake receipts or invoices to support false expenses or deductions.
🚩 Trusts: The use of professional trust accounts can hide beneficial ownership, making it challenging for authorities to trace income back to the true owner.
🚩 Nominees or Third Parties: Individuals can obscure the true ownership of assets and income by using third parties to hold assets or income on their behalf.
How to Prevent Tax Evasion
Tax evasion is difficult to spot. The reason is because it can be challenging to draw the line between tax evasion and tax avoidance. 😵
For example, it can be difficult to determine whether a taxpayer has intentionally concealed their income or simply taken advantage of legal methods to reduce their tax liability. ↘️
Compliance professionals should care about tax evasion because it is a serious crime leading to other crimes. It can also expose a business to significant reputational risks.
Here are some steps that compliance professionals can take to prevent tax evasion:
✅ Development of an AML program: These programs should include customer due diligence to identify beneficial owners of accounts, transaction monitoring for suspicious activity, and reporting of such activity to authorities.
✅ Staying Informed: Tax laws and regulations change over time. Compliance professionals should stay updated on these changes to ensure their AML programs remain effective in preventing tax evasion.
✅ Monitor transactions for suspicious activity: Compliance professionals should monitor transactions for suspicious activity that may indicate tax evasion. For example, compliance professionals should be on the lookout for large cash deposits, unusual wire transfers, and complex financial transactions.
✅ Report suspicious activity to the appropriate authorities: Compliance professionals must report suspicious activity to the appropriate authorities, such as tax authorities or law enforcement if the national law requires so.
✅ Education: Educating employees and customers about the risks of tax evasion and the importance of tax compliance can foster a culture of transparency and legal compliance.
✅ Identify the beneficial owner: Tax evaders aim to make it difficult, to identify the real persons who are controlling an entity or a group of entities. Ensure that you comply with your national law when identifying the beneficial owners of entities.
By taking these steps, compliance professionals can play a vital role in combating tax evasion.
As we conclude our exploration of tax evasion, it becomes evident that this issue is not one to be taken lightly.
In the effort to combat tax evasion, it is essential for compliance professionals to stay attentive and proactive.
They must not only understand the distinctions between tax evasion and tax avoidance but also recognize the interconnected nature of these practices with ultimate purpose to prevent and detect tax evasion.