Avoidance and Morality – December 2012

Avoidance and Morality

While there has been – and no doubt will continue to be – a large amount of discussion as to what constitutes tax avoidance, a question that is less often raised is whether avoidance is moral.  In a recent paper[1] Zoe Prebble and Professor John Prebble argue that avoidance is, per se, immoral.

Daunting though it is to take on one Prebble, let alone two, this article considers that argument, and respectfully disagrees.

What is morality?

A fundamental question, of course, is what is meant by morality in this context.  The Prebbles adopt a deontological approach to examining the morality of tax avoidance.  A deontological approach to ethics judges the morality of an action based on the action’s adherence to a rule or rules, as opposed to consequentialist (or “teleological”) ethical theories which are concerned with outcomes or consequences.  However, if the rules in question are simply the relevant laws, then the analysis becomes unhelpfully circular; tax avoidance is immoral because it breaches the rules as to what is tax avoidance.  Instead, the Prebbles fall back on a wider set of rules; those which require obedience to law:[2]

“for the purposes of this article, it will be sufficient to proceed on the same assumption as that embraced by judges, that is, that there is a general moral obligation to obey the law”.

The problem with such an approach when applied to tax avoidance is that the law is not fixed and certain.  Take the well-known example of Messrs Penny and Hooper, the orthopaedic surgeons who put their businesses into trusts.  They were self-assessed as not being avoiders and reassessed as having avoided tax; that reassessment was overturned in the High Court, and reinstated on appeal.  Did the surgeons’ tax saving scheme change from immoral to moral and back again in the course of the litigation?  Of course not.  But if judged by the criterion of “obeying the law”, it would have.

Alternative suggestion

The Penny and Hooper example suggests that obedience to the law may not be a helpful criterion in determining the morality of avoidance.  Perhaps it is more appropriate to go back to first principles of morality, to moral concepts that are broadly held.  There seem to be two well-accepted and potentially relevant moral precepts, which most people hold to with only very limited and circumscribed exceptions:

·         It is wrong to lie;

·         It is wrong to steal. 

A less clear-cut question is the extent of moral obligations which, especially in modern societies, derive by extension or analogy from the prohibition against theft.  Is there a general moral obligation of fairness and equity?  People will have different views on that.  What perhaps can be said is that excessively disproportionate reward, or excessively disproportionate shouldering of a common burden, will often be seen as immoral.

The Prebbles’ approach

The Prebbles’ argument, however, essentially depends on two propositions:

·         Tax evasion is immoral. 

·         There is a very close factual similarity between avoidance and evasion.

The argument is expressed thus at page 149: “If tax avoidance is factually almost indistinguishable from tax evasion, and if despite being a legal construct tax evasion is in a deep sense immoral, then tax avoidance is similarly immoral”.

Most people would accept that tax evasion is immoral.  We can take that proposition as self-evident. 

The second proposition is a central thesis of the Prebbles’ article – only a “legal distinction” differentiates avoidance and evasion; there is no essential factual difference.  The thesis is expressed this way at page 139:

“An analytical framework that appears to have escaped earlier commentators is that tax avoidance and evasion, while legally distinct, are factually very similar.  That is, the difference between evasion and avoidance is essentially a matter of law not of relevant fact”.

And at page 134 of the article:

“Tax evasion and avoidance each seem to satisfy the culpability element.  Both share the same sorts of causes and motivations.  The tax avoiders and tax evaders alike seek to reduce or to avoid their tax liabilities.  If anything, tax avoidance might often comprise a more involved and substantial mental element”

And at page 136:

“Economically speaking, there is no distinction between tax avoidance and tax evasion.  They are motivated by the same desire to minimise tax liability and have the same economic consequences.”

This second proposition seems much more questionable to this writer.  To analyse it, this article now considers what is tax avoidance, what is tax evasion, what features make evasion immoral, and whether those features necessarily exist in tax avoidance as well.  

What is tax avoidance?

As good a definition of tax avoidance as any can be found in the 1999 Australian Commonwealth  Review of Business Taxation paper [3]:

Tax avoidance may be characterised as a mis-use or abuse of the law rather than a disregard for it. It is often driven by the exploitation of structural loopholes in the law to achieve tax outcomes that were not intended by the Parliament but also includes manipulation of the law and a focus on form and legal effect rather than substance. The way things are done in order to take advantage of structural loopholes, or to dress up or characterise something to satisfy form but not substance can also stamp an arrangement as avoidance.

The difficulty has always lain in defining what constitutes abuse or mis-use, rather than simply a sophisticated and effective use, of the law.  The Prebbles recognise this in their paper at pages 128 – 129 where they describe a spectrum of tax reducing transactions from transactions like gifts to charity or the disposal of income producing assets, to avoidance schemes that “happen to succeed”, eg Peterson v Commissioner of Inland Revenue [2006] 3 NZLR 433 (PC), then avoidance that might succeed but does not because of a general anti-avoidance rule or equivalent judge-made doctrine, and finally tax avoidance that “will certainly not work if challenged”.  

What is evasion?

Evasion is not a defined term in the tax legislation.  From the facts alone that it is a serious revenue offence (Tax Administration Act 1994 (TAA), s 143B– maximum penalty five years’ imprisonment) and attracts the most severe civil penalty (150 per cent – TAA, s 141E) we can infer that it involves conscious wrongdoing.  It is often said[4] that tax evasion and defrauding the revenue are much the same thing; definitions of one may serve as definitions of the other.  While, as said, there is no definition of evasion in the tax legislation, it is clear that the Crimes Act fraud offence[5] has making a false representation with an intention to deceive as essential elements.

In short, evasion involves active or passive deception, intentional in either case, with the added intention that the Commissioner of Inland Revenue (CIR) will be led to believe that the taxpayer’s position is other than the taxpayer apprehends it to be. 

What features make evasion immoral?

There seem to be two norms at play in our judgment of evasion:

·         A person should not lie, especially when under a solemn obligation to tell the truth;

·         A person should pay his or her fair share of tax

Tax evasion violates both norms, and the first is the means by which the second norm is violated.  As noted above, the second moral judgment is a far less clear-cut and universally accepted proposition: the morality of fair distribution of benefits and burdens among members of society is a comparatively new moral concept (compared, say, to prohibitions against murder, theft and lying) and its application in many situations is something on which reasonable and moral people can reasonably differ.

However, it is hard for an evader to protest that despite the evasion, he or she has still paid the fair share of tax.  This is because the fact of the lie shows that the evader knows that, as a matter of fact, his or her tax should be higher than that disclosed.  Therefore, fuzzy though the second norm may be, we can usually be fairly satisfied that an evader has violated it.

Do these features exist in tax avoidance?

Tax avoidance, on the other hand, does not require deceit.  An avoider may well make full disclosure of all the facts in relation to the impugned arrangement: perhaps the clearest example is Westpac Banking Corporation obtaining a binding ruling on a structured finance transaction[6] which was said to be identical to those later found to be void tax avoidance arrangements.[7]

The Prebbles suggest at page 122 that the line between evasion and avoidance is “blurred” because some avoidance transactions depend on secrecy for their success.  They cite as an example a hypothetical taxpayer who repeats the paddock trust scheme which featured in Mangin v Commissioner of Inland Revenue[8], saying that:

[I]f a taxpayer were to repeat the Mangin scheme today and were challenged by the Commissioner of Inland Revenue, the courts would certainly hold the scheme to be void for tax purposes; Mangin itself is the direct authority for striking it down. The taxpayer’s only hope would be that the Commissioner would not become aware of the scheme. Secrecy would be a necessary condition for the scheme’s success.

However, it seems to this writer that this example is both factually debatable and, more importantly, somewhat beside the point.    

I suggest that the example is debatable because in an article the author wrote in 2010[9] the view was given that the Penny and Hooper arrangement – a reasonably common modern structure – was difficult to distinguish factually from Mangin’s case.  And the Supreme Court[10] held that the Penny and Hooper arrangement was indistinguishable from that which the Privy Council had found to be tax avoidance in Peate v Commissioner of Taxation.[11]  Yet, far from being clapped in irons for blatant evasion, Penny and Hooper succeeded in the High Court and had a minority judgment in their favour in the Court of Appeal.  This shows that taxpayers and their advisers may legitimately take the view that earlier decisions on avoidance were wrongly decided and/or distinguishable on their facts.

I also suggest that the example is somewhat beside the point because if I know that on disclosure of the full facts, the CIR would assess differently from the way in which he would were I to conceal some facts, then any such concealment would amount to evasion.  That proposition is universal; it holds with equal validity if the facts which I conceal are relevant to any other tax issue, say, a capital/revenue issue.  So the Mangin example, of a taxpayer taking a hopeless avoidance stance, crosses the line from avoidance to evasion because of this concealment, not because of some feature inherent in tax avoidance.  As the Prebbles note at page 129 “Avoidance that can only succeed if not discovered is only contingently legal and is just short of tax evasion at the most serious end of the scale”; indeed the writer would question the need for the qualifying phrase “just short of”.  I evade tax if I take what I know to be a hopeless tax position (be it a depreciation deduction to which I am not entitled or the result of a discredited tax avoidance transaction) while concealing the facts which make it hopeless.

In summary, tax avoidance does not necessarily involve deception.  Indeed, if it does, then by that deception it will have become evasion.

Consequently, as tax avoidance does not necessarily have one of the features which enable us to say that evasion is immoral per se, we cannot argue by extension from the immorality of evasion to say that tax avoidance is therefore necessarily immoral per se as well.

Is avoidance immoral anyway?

While we cannot, therefore, say that tax avoidance is immoral because tax evasion is immoral, is it nevertheless possible to say that tax avoidance is immoral anyway?

Judicial Pronouncements

As has been said in another recent article by Mark and Kirsty Keating[12], being labelled as a tax avoider generates strong feelings, but “[t]he courts have repeatedly attempted to neutralise such passions by stating that tax avoidance does not carry any implication of immorality”.  The Keatings’ article summarises the most pertinent judicial pronouncements to such effect, and discusses the possible contra-indication suggested by the label “abusive” in the penalty for unacceptable tax positions which have a dominant purpose of tax avoidance. 

It may be that we are not very much helped by these judicial pronouncements as to the morality of tax avoidance, for some at least of the cases cited seem (on this point) simply to stand for the proposition, not that tax avoidance is or is not immoral, but that we should not let our notions of morality or propriety determine what is, at law, tax avoidance.  In other words, some of at least of these cases say that immorality does not imply avoidance, rather than that avoidance does or does not imply immorality.  The latter, of course, is the question with which this article is concerned.

First principles of morality

Tax avoidance is a means by which people attempt to pay less tax than they otherwise would.  Consequently it may well involve breaching the second of the two moral norms which tax evasion violates: a person should pay his or her fair share of tax.

This second norm, as I have already said, is a fuzzier one.  By and large, a lie is a lie.  But what a “fair share of tax” is, is a value judgment.  It is simplistic to say that the law stipulates what the tax is.  Of course, the rate of tax on income is stipulated.  But the ascertainment of taxable income, especially in the affairs of a large organisation, can be an enormously complicated exercise, on which clever and experienced people can differ.

Moreover, it seems that the result (not paying a perceived “fair” level of tax) rather than the means by which that result is achieved is the determining factor in popular views of tax morality.  In the week of writing this article, the American Starbucks coffee empire was in the news.  It seems that its United Kingdom (UK) arm had paid no corporation tax in the UK at all over the last three years despite £389 million of sales in that period.  Obviously this was in the newspapers because the editors thought, or thought their readers would think, that this was A Bad Thing.  Noteworthy in most of the coverage that the writer has seen was the absence of indication as to how Starbucks achieved this result.  It may have involved what could be categorised in New Zealand as tax avoidance; it may well not have: beyond some indication that fees payable to its overseas parent had a part, we simply do not know what Starbucks did.  This, in the writer’s view, highlights that it is the result (no tax paid) and not the means (whether they involve avoidance, narrow profit margins, interest costs, management fees, royalties or any other factor) which is considered immoral.

To take another example, if one company used lawfully unassailable means to reduce its effective tax rate to five per cent whereas another used a tax avoidance arrangement to reduce its effective tax rate to 25 per cent, then many would regard the tax avoider as the less immoral of the two.

In the writer’s view the degree and existence of immorality of tax avoidance is no greater than or conceptually different from that involved in breaching several other areas of law – employment law, competition law, and environmental law spring to mind.  These areas of law govern spheres of activity where people’s actions may minimise costs and/or maximise revenue, but in a way which is so injurious to the common good as to be proscribed by the criminal and/or civil law (payment of wages below a minimum level, using or creating a monopoly position to extract excessive profits, polluting waterways).  The most that can be said is that in very general terms, the limits set by the law are roughly those that most people would consider moral.  For example, many businesses pay the minimum wage, and most people would not consider that, in and of itself, to be immoral behaviour.  If a business paid a fraction below the minimum wage, that might be illegal, but would it necessarily be immoral?  On the other hand, if the proprietor of a business paid such excessive salaries to staff that the business ceased to be profitable and failed, leading to the unemployment of all staff and the loss of shareholder wealth, then that would be judged unwise and quite possibly immoral.  Of course, exploitation of employees, extracting high levels of monopoly profits and excessive pollution will often be considered – and rightly so – as immoral.  But not always.

So too, in the writer’s view, with tax avoidance.   A person running a business has conflicting obligations – to reduce costs and so maximise return to the business and ensure its future and the return to stakeholders, and to comply with the Income Tax obligations.  A responsible taxpayer will not needlessly diminish profits by paying unnecessary tax, but if taken to an excessive level, so that a clearly disproportionately low amount of tax is paid, then that will be considered immoral.   


In conclusion, the writer’s view is that it cannot be said that tax avoidance is immoral per se.  It can be said that attempting to reduce the amount of tax paid beyond a certain limit will be immoral.  Tax avoidance is a common means by which people attempt to reduce the amount of tax they pay.  But that does not mean that tax avoidance is itself any more immoral than any other means to that end. 

1.   John Prebble and Zoe Prebble “The Morality of Tax Avoidance” (2010) 20 Creighton Law Review 101.

2.   At 144, section VI Introduction.

3.   John Ralph, Rick Allert and Bob Joss Review of Business Taxation – A Tax System Redesigned (Commonwealth of Australia, July 1999) at 243.

4.   John Prebble “Criminal Law, Tax Evasion, Shams, and Tax Avoidance: Part 1 — Tax Evasion and General Doctrines of Criminal Law” (1996) 2 NZJTLP 3.

5.   Crimes Act 1961, s 240.

6.   The “First Data” transaction.

7.   Westpac Banking Corporation v Commissioner of Inland Revenue (2009) 24 NZTC 23,834 (HC).

8.   Mangin v Commissioner of Inland Revenue [1971] AC 739, [1971] 2 NZLR. 591 (PC)

9.   Mike Lennard “Orthopods’ Arrangements: Orthodoxy or Avoidance?” (2010) 30 Taxation Today 42.

10.     Penny v Commissioner of Inland Revenue [2011] NZSC 95, [2012] 1 NZLR 433.

11.     Peate v Commissioner of Taxation of Commonwealth of Australia [1967] 1 AC 308 (PC).

12.     [12] Tax Avoidance in New Zealand: The Camel’s Back that Refuses to Break!  (2011) Vol 17:1 NZJTLP 115

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