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 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?

Not paying the full due taxes or deliberately underreporting income is tax evasion. This includes hiding or fabricating income and claiming unsubstantiated deductions. Another example is failing to declare cash transactions.

Various tactics are employed to evade taxes, such as filing fraudulent returns, smuggling, falsifying documents, and bribery.

How does Tax Evasion Occur?

Tax evasion 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 evasion include the following:

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 tax evasion 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 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 tax evasion 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, tax evasion 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 tax evasion. 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.

Tools and Technologies for Detecting Tax Evasion

The digital age has brought new tools and technologies that are helping tax authorities fight tax evasion more effectively. Let us take a look at those:

AI in Tax Compliance

AI algorithms can analyze vast amounts of tax data to identify unusual patterns that might indicate tax evasion. It can also assess the risk of tax evasion for individual taxpayers or businesses based on various factors.

Data Analytics for Audit and Compliance

Tax authorities can integrate data from various sources, such as bank statements, property records, and third-party reporting, to create a more complete picture of taxpayers’ financial situation.

Impact on Common Methods of Tax Evasion

By matching income reported with third-party data, AI can identify discrepancies that might indicate unreported income.

Enhancing Income Tax Act 1961 Compliance

AI tools can improve compliance with the Income Tax Act. They can automate many manual tasks involved in tax audits, freeing up resources for more complex investigations.

Role in Detecting Money Laundering

Tax evasion is often linked to money laundering activities. By identifying suspicious financial transactions and patterns, these tools can also assist in uncovering money laundering schemes.

Whistleblower Assistance

By analyzing data from different accounting software, AI systems can sniff out inconsistencies in whistleblower reports on tax evasion. This strengthens the validity of these reports and streamlines the process of ensuring everyone pays their fair share.

What is a Tax Evasion Notice?

Any individual or organization suspected of tax 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?

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

Revenue Loss for Government

Tax evasion 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

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

Erodes Public Trust

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

Budget Deficits

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

Where to Report Tax Evasion?

To report tax evasion, one can use the online complaint portal of the Income Tax Department. This is the quickest and most convenient method. You just have to visit the official website of the Income Tax Department of India and look for the link titled “File Complaints on Tax Evasion/Violation of Tax Laws” or a similar option. The website allows anonymous reporting, but including your contact information can aid the department’s investigation if they need further clarification.

Also, if you prefer a non-digital approach, you can submit a written complaint to your nearest Income Tax Office. The complaint should include all relevant details about the suspected tax evasion, such as the name of the individual or business you’re reporting, and any evidence you might have to support your claims.

Role of Audits and Compliance

Audits and compliance play crucial roles in maintaining the integrity and transparency of financial reporting and tax systems.

Audits

Generally, audits are independent examinations of an organization’s financial records and practices. They assess accuracy, adherence to regulations, and identify areas for improvement.

Compliance with Financial Regulations

Organizations must follow specific rules and standards regarding their finances. This includes accounting standards and industry-specific regulations.

Section 139 and Income Tax Returns

Section 139 pertains to the filing of income tax returns in India. It is important to file an ITR so that the government can monitor the source of your income. Taxpayers can avoid legal issues and contribute to the transparent and efficient functioning of the tax system.

Whistleblower Programs

These programs highlight the importance of mechanisms that allow employees to report financial wrongdoing within an organization. Strong whistleblower programs are crucial for uncovering financial misconduct.

Detecting Illicit Financial Flows

It is important to address methods to identify illegal money movements, such as money laundering or terrorist financing. Audits can be used to detect such activities.

Monitoring Tax Deductible Claims

Audits play a role in ensuring the legitimacy of tax deductions claimed by organizations and individuals.

Addressing Financial Secrecy

Financial secrecy helps hide illegal activities. Regular audits and regulations must aim to combat such secrecy.

Evasion Tactics

Illegal methods are used by individuals or businesses to avoid paying taxes. Audits can help pinpoint those tactics that undermine the tax system and lead to significant revenue losses for governments.

Income Declaration

Taxpayers file income declarations to report their earnings to tax authorities. It helps authorities monitor the source of income and ensure transparency and compliance within the tax system.

Tax Shelters and Fiscal Fraud

Tax shelters are legal loopholes to reduce tax burdens, while fiscal fraud involves misrepresenting financial information. Audits can help identify both.

Key Takeaways

• Taxpayers who fail to pay the entire or a part of their self-assessed tax or interest are considered defaulting taxpayers.
• Tax exemption can reduce your taxable income.
• Having a Tax Deduction Account Number (TAN) is vital for businesses or employers that deduct and collect tax at source.
• Unlawful activities to evade tax can make you a defaulter and penalized under the law.
• The degree of the fraud perpetrated and the amount of the owed tax may affect the punishment for tax evasion.

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