Stocks and Tax Management: The Curious Logic of Tax ‘Avoidance’ vs. ‘Evasion’

NEW YORK (TheStreet) — Bank of America (BAC) has just been accused of using U.S. government-insured depositor money to finance trades facilitating “dividend tax arbitrage.” This is the practice of moving stocks around to different jurisdictions so that the ultimate client beneficial owner of the stock minimizes the tax he must pay on his dividend. BofA takes a slice of the saved tax bill for effecting this tax trick, also known as “tax aviodance.”

Tax avoidance is understood as the lawful avoidance of tax by using tax management to minimize an individual’s or a corporation’s tax bill. It differs from “tax evasion,” which is simply the breaching of legal tax codes.

The criticism of BofA comes off the back of a heated debate in the U.K. where HSBC (HSBC) appears to have been parking large amounts of its client’s money in Swiss bank accounts in a practice that some see as plain tax “evasion.” But if BofA’s practice was just “avoidance,” what has it do with the HSBC scheme or the concept of “evasion” at all? More importantly, what exactly is the meaning of claims in the U.K. (and periodically in the U.S. also) that all tax “avoidance” should be treated as tax “evasion”?

The Difference Between ‘Tax Avoidance’ and ‘Tax Evasion’

It is true the line between “avoidance” and “evasion” is not necessarily black and white (although it is not as grey as many think either). As far back as 25 years ago there was English case law saying that if an “aggressive” tax avoidance scheme clearly went contrary to the “spirit” of certain tax rules than that “avoidance” should be deemed “evasion.” That judgment, back then, made plenty of sense. Judges are supposed to look at the commonsensical purpose of a rule and, if a particular practice undermines entirely the purpose of said rule, then there is a problem with that practice.

But that is absolutely not what is going on with the BofA case or with HSBC or with the current U.K. fiasco involving the attempt to conflate tax “avoidance” with tax “evasion.” If you believe a particular practice is contrary to the spirit of a tax code, then a Government should by all means formally outlaw this practice. At which point, for a person or company to continue with the practice would simply be breaking the law — all very clear. But to try to ban all “tax avoidance” is quite another matter and shows a fundamental misunderstanding of the very logic of all legal (including tax) rules themselves.

The Letter vs. the Spirit of the Law

Here’s a brief thought experiment: imagine that you have two boxes (Box A and Box B). The Government creates a law saying no one is allowed to open Box A. So being a law abiding citizen you do not open Box A. However, the law clearly didn’t prevent you from opening Box B, did it? So (as a free agent) you decide to open Box B. But having done so, the Government suddenly turns and abruptly says, “hang on you really cannot open Box B either for we (the Government) meant to ban all box opening.” Oh and of course it turns out the Government is particularly exercised about this point because you just so happen to have found a whole pile of cash in Box B.

We can see that the logic in the Government’s position above just won’t do. It won’t do because the whole point of the rule of law (tax laws or any laws) is to define the limits of our freedom — at least in a democratic system. Plenty of things are legitimately prohibited in society for the general good or to maintain moral order, but if a certain act is not prohibited, then de facto one is allowed to do that act.

Making ‘Avoidance’ ‘Evasion’

This is the crux of the profound logical confusion in trying to ban all forms of tax avoidance: It is just meaningless. If the courts or the Government feel a practice is contrary to the spirit of the tax code, then simply outlaw it, that’s all.

How then is that this muddle could have even arisen when it comes to the conflation of tax “avoidance” with “evasion”? Well the answer is (as usual), mass human psychology and morality. The politics of envy is at play here — big time. Yes, there are gross wealth inequalities in our society (no news there) and these inequalities need managing and mitigating. Yes, wealthy people who manage their affairs well can minimize their tax bills through avoidance. Those tax avoidance options are complex for the more wealthy as an inevitable consequence of richer individuals having more assets and more variable forms of income and gains. But remember also that everyone can minimize their tax bills via avoidance — for example, just make sure all your relevant costs and allowances are included in your tax form and you will have reduced your tax bill.

But the mass politics around wealth inequality is now so rampant that those who feel socially alienated have no problem just profoundly confusing the very logic of the concepts of avoidance and evasion. You see, unfortunately, legal rules are open to interpretation. And when people do feel aggrieved they will use whatever tools (including the crudest argumentation) to twist the meaning of rules. This is also very prevalent when two parties get in to a dispute over a contract and both sides try desperately to re-interpret the terms of a contested deal.

Banning tax avoidance per se is just logical nonsense. It’s a bit like banning the rules of mathematics! Outlawing practices that you feel are contrary to the spirit of a tax code does, by contrast, make fine sense. Once done, those practices are plainly illegal and to flaunt them is evasion. But if it is not evasion, it is not illegal. And let’s please remember — what’s not illegal defines the very essence of our human freedoms.

Jeremy Josse is the author of Dinosaur Derivatives and Other Trades, an alternative take on financial philosophy and theory (published by Wiley & Co).

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.