The Ethics of Tax Avoidance

The difference between legal tax avoidance and illegal evasion, and the debate over whether aggressive avoidance is morally wrong.

Paying taxes funds schools, hospitals, roads and courts. But individuals and companies naturally want to pay as little tax as possible. Where is the ethical line?

Avoidance versus evasion

Tax evasion is illegal: hiding income, falsifying records or not declaring earnings.
Tax avoidance is legal: using the rules to reduce tax, such as claiming allowances or investing in tax-favoured savings.

Between these lies aggressive tax avoidance: complex arrangements that follow the letter of the law but not its intent.

Profit shifting

Multinational companies can shift profits to countries with low tax rates, for example by locating valuable intellectual property in low-tax jurisdictions and charging subsidiaries high fees to use it. The OECD has estimated that such base erosion and profit shifting costs governments around the world 100 to 240 billion dollars a year in lost revenue.

The ethical debate

One view: companies and individuals have no duty to pay more than the law requires. If governments dislike avoidance, they should change the law. The famous British judge Lord Tomlin said in 1935 that everyone is entitled to arrange their affairs to reduce their tax.
Another view: aggressive avoidance undermines fairness, shifts the burden to ordinary taxpayers and exploits loopholes that were never intended. Companies that benefit from public services, educated workers and infrastructure have a moral duty to contribute fairly.

Responses

Governments have introduced general anti-avoidance rules, allowing tax authorities to reject arrangements whose main purpose is avoiding tax. India introduced such rules, known as GAAR, from 2017. Internationally, around 140 countries agreed in 2021 to a global minimum corporate tax of 15 percent to reduce the benefits of shifting profits to tax havens.

Two companies, same profits

Two companies each earn 1,000 crore rupees of profit in a country. One pays the full corporate tax. The other routes its brand rights through a low-tax country, pays large royalties to that subsidiary and reports little taxable profit locally. Both follow the law, but the second pays far less tax while using the same roads, courts and workers. Many people see this as unfair, even if legal.

Thinking legal always means ethical

Something can be legal but still raise ethical questions. The debate over tax avoidance is about whether following the letter of the law is enough, or whether companies should also respect its purpose.

Key takeaways

Tax evasion is illegal; tax avoidance is legal, but aggressive avoidance is controversial.
Profit shifting costs governments an estimated 100 to 240 billion dollars a year.
Some argue there is no duty beyond the law; others see a duty to contribute fairly.
Anti-avoidance rules and a 15 percent global minimum tax aim to limit avoidance.