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UNDERSTANDING TAX SHELTER SCAMS AND STEPS TO CURB THEM - Tax Advisory by Aryan Consulting

Updated: Jul 21, 2023


Tax Advisory
Tax Advisory

Let's, talk about the effects of tax shelter scams, explains what tax shelters are, types of tax shelters, abusive and non-abusive tax shelters, role of unscrupulous accounting firms and initiatives taken by the various Government bodies around the world to curb aggressive tax planning and tax evasion


Tax shelters are any method of reducing taxable income resulting in a reduction of payment of tax to the Government. The methodology can vary depending on local and international tax laws.


TYPES OF TAX SHELTERS :-

1.Offshore investments -Different tax rates and legislation in each country and tax benefits can be exploited to reduce taxes. However, this is not the primary tax shelter

2.Financial arrangements


What is a tax haven?

Tax havens are countries with low or no taxes. Depending on perspective, the US is also considered by some to be a tax haven, especially if one is from any of the Scandinavian countries.


How People Use Tax Havens to Avoid Paying Taxes

By moving to the tax haven country and become a resident for the purpose of paying taxes. Another way is to incorporate your business in the tax haven country then move all the company’s assets to it. Any new income that’s created by the incorporated company (or trust) would then be subject to taxation in the tax haven country.


Are Offshore Tax Havens Legal for Indian Citizens?

According to Indian tax laws, it’s illegal for Indian citizens to take advantage of offshore tax havens. If you should ignore these laws, pursue an offshore tax haven and then get caught by the Income Tax Department, you will be prosecuted for tax evasion. Indian citizens are required to pay taxes no matter where their income comes from. The only way around that law is to renounce your citizenship and become a citizen of the offshore tax haven country.


Tax shelters are not always illegal, there may also be legal and legitimate, like Flow-through shares/limited partnerships or Pension/Retirement plan. These tax shelters are usually created by the government to promote a certain desirable behaviour, usually a long-term investment, to help the economy; in turn, this generates even more tax revenue. Alternatively, the shelters may be a means to promote social behaviours.


However, a few individuals find loopholes in the legal interpretation of the income tax laws. While these actions may be within the legally sound practices, these actions could be considered to be conducted in bad faith.


Tax havens are locations around the world known for having sloppy or non-existent tax laws that allow individuals or companies to reduce their tax liabilities by holding their assets offshore vastly. Whereas Tax shelters are mostly investment accounts, securities, investment, and tax-planning strategies that minimize tax liability within your own country's tax system.


While tax havens often seem mysterious, or for only to the rich and famous, tax shelters are commonly used by taxpayers of every strata. A tax shelter is simply a method of legally reducing your tax burden through the use of specific investment types or strategies.


Common Tax Shelters

Common tax shelters include retirement savings plans, where contributions made are eligible for tax deduction, and account holders simply pay income tax on funds upon withdrawal, resulting in lower tax incidence, because the account owner has retired, and his income is reduced.


JUDICIAL DOCTRINES


1) The Substance over form doctrine -if two transactions have the same economic result, they should have the same tax result.


2) The Step transaction doctrine - treats a series of formally separate steps as a single transaction to determine what really was going on with the transaction.


3) The Business Purpose Doctrine-Courts will invalidate a transaction for tax purposes under this doctrine when it appears that the taxpayer was motivated by no business purpose


4) The Sham Transaction Doctrine -looks for transactions where the economic activities giving rise to the tax benefits do not occur.


5) The Economic Substance Doctrine -courts will invalidate the tax transaction if the transaction lacks economic substance independent of the tax considerations.


Statutory Provisions and Initiatives

1. Provisions regarding dividend stripping

2. Transfer pricing provisions

3. Key-man insurance restrictions for Directors with high ownership interest

4. Minimum Alternate Tax structure

5. Taxation of Dividends and Dividend Distribution Tax

6. Organization for Economic Cooperation and Development (OECD). Now known as Harmful Tax Practices initiative.

7. Tax Information exchange between various countries like the USA

8. Updates to various DTAA (Double Taxation Avoidance Agreements)pacts with countries

9. FATCA

10. Rationalisation of tax on Long-Term Investments

11. Increased disclosures in Tax Return forms


ABUSIVE TAX SHELTERS

A tax shelter is an investment or a business through which a taxpayer reduces his or her tax liability. Many practices that fall within this definition are perfectly legitimate, for example investing in real estate trusts and pension plans. However, when a tax shelter is designed solely for tax avoidance, it may be deemed inappropriate, and the taxpayer who set up or used the shelter may face a penalty.

In the US, the IRS has published a non-exhaustive list of transaction types it considers abusive, which includes Guam Trusts, Debt Straddles, Lease-in/Lease-out transactions, S-Corp ESOP transactions, Off-shore deferred compensation agreements

Shelter Types are: COBRA, OPIS, DOS, BLIPS, FLIPS, SOS, CARDS


Tax shelter scams cannot be controlled only by litigation. Concerned parties need to be penalised and punished. Institution of reforms will motivate taxpayers to commence malpractice litigation against aggressive tax professionals who promote abusive tax shelters. For tax professionals, these reforms should prove sufficiently threatening to cause them to render less aggressive tax advice. Therefore, to curb abusive tax shelters, the Government should restrict tax professionals and their firms from insulating themselves financially through insurance companies from covering acts associated with the promotion of abusive tax shelters


The tax payers are already being penalised through litigation and imposition of penalties and imprisonment, it’s now time that the unscrupulous accounting firms be made to pay for their overtures


UNDERSTANDING TAX SHELTER SCAMS AND STEPS TO CURB THEM - Tax Advisory by Aryan Consulting

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