There is nothing which hurts more than payment of taxes. One question that goes through every tax payer’s mind is “how can I reduce my tax liability?” Reducing tax liability is not always a bad or illegal exercise. There are legitimate ways to reduce taxes through proper tax planning and such methods are always encouraged. But unfortunately, there is also a tendency to reduce tax through illegal methods. They are not accepted practice and can invite problems.
There are three methods which are commonly used by the taxpayers to reduce their tax liabilities
- Tax Evasion,
- Tax Avoidance and
- Tax Planning
Dishonest taxpayers try to reduce their taxes by concealing income, inflation of expenses, falsification of accounts and willful violation of the provisions of the Income-tax Act. Such unethical practices often create problems for the tax evaders. Tax department not only imposes huge penalties but also initiate prosecution in such cases.
Tax avoidance is minimizing the incidence of tax by adjusting the affairs in such a manner that although it is within the four corners of the laws, it is done with a purpose to defraud the revenue. It is the act of dodging without directly breaking the law. For example if A gives gift to his wife, the income from the asset gifted will be clubbed in the hand of A. But to avoid this clubbing provision “A” decides to give gift to B’s wife and B reciprocates it by giving gift to A’s wife. This is not tax planning but tax avoidance. Such practices are not acceptable. In the words of Justice Rangnath Misra of Supreme Court in the case of McDowell & Co Limited v CTO  154 TR 148,
“tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid payment of tax by resorting to dubious methods.”
Tax planning is arrangement of financial activities in such a way that maximum tax benefits, as provided in the income-tax act are availed of. It envisages use of certain exemption, deductions, rebates and reliefs provided in the act.