Tax fraud may involve simple non-declaration of income or it may take place on an international scale involving a complex web of legal entities and cross-border transfers. International tax fraud can only be prevented by international cooperation between tax authorities.
Domestic tax fraud
Although taxpayers may make full use of the tax allowances and reliefs made available to them by the government, tax fraud is illegal. Taxpayers may evade tax by simply failing to declare their income, especially if they receive that income in the form of cash and there are no records of its receipt. These people are sometimes referred to by tax authorities as “ghosts” because they do not exist for tax purposes. People who have a regular employment but also earn income in their spare time, which is not declared on the tax return, are called “moonlighters”. Tax investigations may include random selection of taxpayers for further examination and this can lead to the collection of amounts of tax lost through non-declaration or under-declaration. Data matching tools may be employed, allowing under-reported income to be traced through declarations made by third parties. The data from third parties is matched to the reported income of tax evaders and the amount of under-reported income may be calculated.
International tax fraud
People who are mobile internationally may evade tax by setting up complex legal structures including offshore entities which are difficult for tax authorities to unravel. They may set up companies, partnerships or trusts in jurisdictions where tax and accounting regulations are not very strict, and shift funds between entities to make use of low tax jurisdictions. Some individuals have made use of secret bank accounts to keep funds out of the reach of tax authorities. In recent years, countries have concluded bilateral treaties on the exchange of tax information. The “Multilateral Convention for Assistance on Tax Matters” drawn up by the Organization for Economic Cooperation and Development (OECD) and the Council of Europe has been extended to non-member countries. Bilateral tax treaties and European Union directives also provide for information exchange. Some agreements provide for the automatic exchange of some types of information such as dividends, interest, royalties, salaries or pensions. They may provide for spontaneous exchange of information where one tax authority suspects the taxpayer has not reported income or is using an artificial tax avoidance scheme. Information could also be exchanged on request where one tax authority needs specific details and explains to the other authority the reasons why they are needed. Tax authorities may jointly analyse transactions of the taxpayer and unravel the tangle of legal entities to arrive at the amount of income and tax liability attributable to each jurisdiction.