What is Tax Evasion? Meaning, Methods & Penalties

Income tax, goods and services tax, import-export tax, state border tax, etc., are mandatory taxes in India. However, some people try to evade paying taxes despite the rules and regulations surrounding these taxes. Tax evasion involves the deliberate act of underreporting income, inflating expenses, or engaging in false schemes to evade the rightful payment of taxes. It is a term that casts a dark shadow over finance.

Some causes of tax non compliance or evasion include higher tax rates, lack of integrity on the part of the citizens, the existence of tax havens, etc. However, tax evasion can lead to severe penalties. Let us understand this illegal way of tax exemption.

What Is Tax Evasion?

Tax evasion is the deliberate act of avoiding paying due tax liabilities by individuals or companies. It is an illegal activity and constitutes a serious offense under tax laws, often leading to severe tax evasion penalties. But what is tax evasion in broader terms? Tax evasion means intentionally using fraudulent methods to underpay or completely evade taxes that are owed to the government.

Methods of Tax Evasion

There are various tax evasion methods, including:

• Underreporting income: Declaring less income than earned to reduce tax liability
• Falsifying deductions: Claiming non-existent or inflated expenses
• Smuggling: Avoiding taxes by illegally transporting goods across borders
• Bribery: Paying officials to overlook discrepancies

Types of Tax Evasion

Different types of tax evasion occur across income tax and corporate filings, such as:

• Hiding cash transactions to avoid declaring taxable income
• Misclassifying personal expenses as business expenses
• Using offshore accounts to conceal wealth

Consequences of Tax Evasion

Engaging in tax evasion carries severe consequences:

• Fines: Tax evasion penalties often include hefty fines, sometimes exceeding the evaded tax amount
• Imprisonment: Severe cases may result in jail time
• Reputational Damage: Companies and individuals can face lasting harm to their credibility and public image

Tax Evasion vs Tax Avoidance

While tax evasion in income tax is illegal, tax avoidance is a lawful way to reduce liabilities. For example, investing in a Unit Linked Insurance Plan (ULIP) can legally lower taxable income under government-approved provisions. Tax avoidance encourages compliance through legitimate planning, contrasting sharply with unlawful methods of evasion.

How Does Tax Evasion Occur?

Evasion of tax occurs when individuals or organizations fail to report their true income on their tax returns, an illegal act punishable by law. While tax savings through legal investments are permissible, dishonest methods constitute a crime and lead to tax evasion penalties such as imprisonment or heavy monetary fines. Ways of tax noncompliance or evasion include the following:

Smuggling Instead of Paying State Border Tax, Import Tax, Etc.

Smuggling Instead of Paying State Border Tax, Import Tax, Etc.

Many people and businesses resort to smuggling to avoid paying state taxes, import-export taxes, and customs duties. Under Indian law, smuggling is punishable, and evasion of tax can result in greater penalties.

Filing Incorrect Income Tax Returns

Submitting incorrect information like understating your income, overstating deductions, or any other kind of false reporting is a popular income tax noncompliance or evasion strategy. However, this is illegal.

Maintaining Fake Financial Statements

Inaccurate financial documents like balance sheets and account books can give the impression of a low annual income. Some businesses also do not keep sale receipts to understate their income and reduce their tax due for the year.

Using Fake Documents for Tax Deductions

Another tactic is getting fake documents to prove that you are eligible for a tax deduction, such as a disability certificate, to claim tax deductions under Section 80U.

Not Showing Any Income

Many people resort to cash transactions to hide the trail of their earnings. Not having any income on paper implies you do not have to pay tax either. Businesses often do not produce invoices for their sales. Similarly, landlords may accept only cash payments instead of bank transfers or cheques for rent.

Keeping Money In International Bank Account

The Indian income tax authority has no jurisdiction over foreign bank accounts. Some individuals might keep a bank account outside of the nation to keep money. This is illegal under the law as this income cannot be determined while calculating taxes. If government officials get to know about the money in international accounts, one can be punished for committing this crime.

Not Paying Tax

A lot of people refuse to pay taxes. Then, despite the tax dues, the person does not make the necessary payments to the government, or people leave the country. The Income Tax Department keeps on reminding the dues regularly. After giving chances, there are provisions under which action is taken against the defaulter.

Offering Bribe to an Official

Offering bribes is one of India’s most common ways of committing tax crimes. Offering a bribe to an income tax official to change the amount of tax due is another way to evade tax. People turn to bribes to lower or eliminate any tax record due under their name. Both accepting and offering bribes are illegal. Strict actions are taken in case you are caught for the same.

Penalties for Tax Evasion

According to the Income Tax Act, evasion of tax is a punishable offense in India. This can result in severe penalties. The degree of the fraud perpetrated and the amount of the owed tax may affect the punishment for evasion of tax. Hence, it is recommended to take income tax compliance seriously to avoid any legal action by authorities. Here are some situations and the subsequent penalties levied in case of each:

Failing to File Your Income Tax Return Within the Due Time

As per subsection (1) of Section 139 of the Income Tax Act of 1961, all taxpayers must file their income tax returns during each financial year’s tax filing period. If anybody does not file their income tax return, they must pay a late fee. This late penalty fee was ₹10,000 till the financial year 2019-20. However, effective from 2020-21 till date, anybody filing a belated income tax return is charged ₹5,000 as a penalty. In some cases, the assessing officer can also decide the value of the penalty, which can be less or more than ₹5,000.

Providing an Incorrect PAN Card Number or Hiding the PAN Card Number

Failing accurate information while filing an ITR is also a punishable offense. Most employers ask for the employees’ PAN card numbers at the time of employment. This information is used while deducting TDS or the tax deducted at source from the employee’s salary. Here’s the penalty for two scenarios involving a PAN card:

• Hiding the PAN card number: In the absence of a PAN card number, the employer will deduct 20% TDS instead of 10% TDS.
• Providing an incorrect PAN card number: In case of an incorrect PAN card number, you will have to pay a penalty of ₹10,000.

The taxpayer may not provide accurate information in the Income Tax Return submitted to the authorities. In addition, the assessee may discover inaccuracies in the information provided after submitting it. However, it is possible that the assessment will not be able to be corrected within ten days of submission. Alternatively, the assessor may be aware of the error during submission but fail to notify the Income Tax Department. The penalty amount in such circumstances can be ₹50,000.

Concealing or Misreporting Your Income

As per Section 271(C) of the Income Tax Act of 1961, in case of hiding or understating your income, the penalty can be between 100% to 300% of the amount of tax that was due but not paid. Here’s how the percentage is decided:

• A penalty of 10% on the previous year’s hidden or understated income is levied if the taxpayer owns up to the undisclosed income and declares it. Interest may also be charged here.
• A penalty of 50% on the amount of hidden or understated income is levied if the reason behind the under-reporting was a bona fide mistake. This refers to a genuine mistake that is not committed to evade tax.
• A penalty of 300% on the amount of hidden or understated income is levied if the mistake was intentionally made to evade tax. This is also known as a mala fide mistake.

For businesses or employers who deduct and collect tax at source, having a Tax Deduction Account Number (TAN) is vital. Not having a TAN can result in a penalty of ₹10,000. Two kinds of fraud can be committed here:

• Not collecting tax at source: The penalty is the same as the tax not deducted at the source.
• Not filing a TDS return: Just like income tax returns, there is also a due date for filing TDS returns. If the TDS return is not filed within the stipulated time, the taxpayer has to pay tax every day after the due tax until the entire payment is made. In this case, the penalty can start from ₹10,000 and go up to ₹1,00,000. Taxpayers must file TDS returns before the prescribed due date to avoid paying this penalty.

Failure to Comply with a Demand Notice

The Income Tax (IT) department can issue a demand notice if inconsistencies are found in the income tax return. If this happens, the IT department issues a demand notice stating the amount of tax still owed. The taxpayer is offered 30 days from receiving the document to respond to the demand notice. Failure to respond and pay the tax due can result in a penalty.

Not Paying Tax as per Self-assessment

Taxpayers who fail to pay the entire or a part of their self-assessed tax or interest are considered defaulting taxpayers. Failure to pay tax as per self-assessment is considered to be tax fraud under Section 140A (1). In such a case, the assessing officer can levy a penalty up to the total tax owed to the government. However, the assessing officer may waive the penalty if there is a valid reason for not paying tax as per self-assessment.

Not Getting Audited

If an organization does not get itself audited or submit an audit report under Section 44AB, it must pay a penalty of ₹1.5 lakhs or 0.5% of its sales turnover, whichever is more. In addition, if the taxpayer does not provide an accountant’s report as mandated under Section 92E, it must pay a penalty of at least ₹1 lakh or more.

Common Methods of Tax Evasion in India

Tax evasion means illegally reducing or avoiding tax liabilities, often through deceptive practices. This not only harms the economy but also burdens honest taxpayers. Here are some common methods:

Underreporting Income

This is one of the most prevalent methods of tax evasion in income tax. Individuals or businesses deliberately declare lower earnings than they actually receive. For example, freelancers may not report all their cash payments, or businesses might understate revenue. This illegal act violates the law and invites strict tax evasion penalties.

Inflating Expenses

Many businesses try to reduce their tax liability by exaggerating operational expenses or claiming deductions for non-existent costs. For example, fake bills or exaggerated costs for utilities and salaries are often used to reduce taxable income. Such practices fall under the broader types of tax evasion.

Hiding Assets

Using offshore accounts, unlisted properties, or shell companies to hide wealth is another common tactic. This method avoids disclosing taxable assets, leading to significant losses for the government.

Smuggling

Goods are transported illegally to avoid customs duties and taxes. Smuggled items, such as electronics or luxury goods, deprive the government of significant revenue.

Exploiting Legal Loopholes

Some exploit complexities in tax laws to claim deductions or exemptions they do not qualify for. For instance, misusing Unit Linked Insurance Plan (ULIP) benefits without legitimate investment purposes can lead to tax evasion penalties if detected.

What is a Tax Evasion Notice?

Any individual or organization suspected of tax noncompliance or evasion is given a legal notice by the government, which is called a tax evasion notice. It is a notification that your actions are under scrutiny. It contains information about the issues authorities have with your tax filings. The notice will also explain what steps you should take to address the situation.

How Tax Evasion Affects the Economy?

Evasion of tax harms the economy in several ways by disrupting the flow of government revenue and impacting various sectors:

Revenue Loss for Government

It leads to significant revenue loss for the government, reducing funds available for public services and infrastructure development.

Increased Tax Burden on Compliant Taxpayers

When tax evasion occurs, compliant taxpayers may face higher taxes to compensate for the shortfall, creating an unfair financial burden.

Economic Inequality

It exacerbates economic inequality by allowing evaders to retain more wealth while law-abiding citizens bear the financial load.

Erodes Public Trust

Widespread evasion of tax undermines public trust in the tax system and governmental institutions, potentially leading to decreased compliance.

Budget Deficits

Persistent evasion can contribute to budget deficits, forcing governments to cut spending or increase borrowing, both of which can negatively impact the economy.

Difference Between Tax Evasion, Tax Avoidance and Tax Planning

Tax evasion is illegal and unethical. However, tax avoidance and tax planning are legal strategies to reduce tax liability. They differ significantly in legality, methods, and ethical considerations. Here’s how:

Conclusion

Tax evasion is a serious crime in India and should be avoided at all costs. Repeated attempts to evade tax can result in severe punishments. This is why it is extremely important to pay attention to your income tax details, file your returns on time, and ensure that you follow all the rules and regulations laid down by the income tax department and the Government of India.

FAQs on Tax Evasion