Tax planning, avoidance and evasion are all ways of reducing the amount of tax you pay. Only the first one is legal, though the second can get pretty grey.

Tax planning is what financial planners and accountants are supposed to do. It involves using all the perfectly legitimate ways provided in legislation for investing money and achieving the optimal results after tax has been paid out. Sometimes this means paying little or no tax, sometimes it means taking advantage of an incentive to invest that may well end up leading you to pay more tax, but only because you make more money. This will be discussed in the next couple of articles.

Tax avoidance is where structures are set up to route money through low tax routes, or attempting to take advantage of unintended benefits that are quite legal, yet not part of the original aims of the legislators. This can be legal, it is often illegal, the practice is often pretty devious but goes unpunished by a tax office that knows that a loophole probably does exist. Tax avoidance works very well, provided that the Australian Tax Office does not decide to make an example of you. One of the ways that a court decides if a practice is tax avoidance or just benign tax planning is to examine the transaction to see if it makes commercial sense, as opposed to merely being primarily driven by tax considerations.

An example of a practice that would be examined in such a way would be to place your money in an overseas bank or fund where tax is not payable, despite this promising much lower investment returns than would be common in local investments. In this case it would probably be considered a primarily tax driven decision that makes no investment sense. It would probably be considered tax avoidance.

Another example, rather questionable legally, yet hard to prove and quite common among big corporations is to run various holding companies around the world, including in tax haven countries. Rupert Murdoch's Newscorp is quite commonly accused of doing this. The practice is to shuffle money and assets around your large multinational corporation, declaring huge profits for your small office stationed in the Cayman Islands yet announcing staggering losses in first world countries where companies pay tax. Undoubtedly it is tax avoidance, but once a company does become truly global in scope, it becomes quite hard to prove the practice, and hard to know who has the jurisdiction to prosecute.

You don't have to be Rupert Murdoch to try to pull of this kind of stunt. Lots of people set up complicated companies and trusts, claim deductions and credits when they probably shouldn't, move assets overseas and otherwise try to throw up plenty of smoke to confuse the tax man. It is always tax avoidance, often illegal, but only sometimes punished. It remains the domain of highly intelligent and slightly morally ambiguous accountants and lawyers to research and perfect these schemes.

The third level of tax reduction is tax evasion. This is always absolutely illegal and ruthlessly crushed by the tax office whenever it is suspected. Tax evasion basically involves the deliberate falsification of accounts and misreporting of profits. Hiding assets, illegally transferring ownership overseas, controlling assets and investments through third parties so as not to be seen to have a link with them and keeping two (or more) sets of books are all examples of tax evasion. If detected you will serve a long prison term.

The difference between evasion and avoidance is not always clear, but the difference is this. Avoidance is creative accounting, the attempt to exploit loopholes in law and to throw up a whole bunch of red herrings and complicated, somewhat opaque corporate structures so as to perhaps minimise tax by sleight of hand, or exploiting gaps in accounting rules. Evasion is straight out fraud.