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Ownership Structure And Tax Evasion

Ownership Structure:
"Ownership structure deals with the internal structure of a corporate entity as well as the rights and obligations of the people who have a legal or equitable stake in that corporation. Understanding the ownership structure of a particular business entity and what this means for the owner's rights is crucial for everyone who owns a business entity.

Tax Evasion:
"Tax evasion is the unlawful practise of trying to avoid paying taxes by people, businesses, trusts, and other entities. It includes dishonest tax reporting, declaring less income, profits, or gains than the amounts actually earned, overstating deductions, using bribes against authorities in nations with high levels of corruption, and hiding money in secret locations. Tax evasion frequently involves the deliberate misrepresentation of the taxpayer's affairs to the tax authorities in order to reduce the taxpayer's tax liability.

Now coming to topic, One of the key reasons why activities like tax evasion continue to occur despite rules is because that tax world is enormous and not simple to include. This section discusses tax evasion aspects and offers case examples to help the reader get a handle on the topic at hand. To reduce a company's taxable income, tax evasion strategies might be used.

Value is shifted from the government to the company's shareholders as a result of these actions. However, enforcing measures to prevent tax evasion is not necessarily debatable. Directing the company in such a way that taxes are kept to a minimum via the use of avoidance methods is a key responsibility of the board of directors.

Companies may get tax advice from the government thanks to several of the tax regulations. This is because there are a number of ways in which avoiding taxes may help a business. First, an improvement in taxable income means more money for shareholders to keep. Second, a company's worth might rise if the money it saves on taxes is reinvested in the business.

Generally speaking, a company's stockholders will make up the company's ownership structure. The voting and control rights attached to certain shares may not be present on other shares, whereas the rights attached to cash flows may be. In contrast to cash flow rights, which entitle their holders to a greater share of the firm's cash returns and direct stock, control rights only provide influence over the company's operations. As a result, the company's many shareholders may enjoy varying degrees of control. The identity and concentration of a company's owners are also key factors in determining the company's ownership structure.

Ownership Structure & Tax Evasion

  1. Effects Of Ownership Structure On Taxation

    There aren't many studies that take a direct look at the connection between tax evasion and business governance, or more precisely, ownership structure. There have been a few authors who have investigated whether or not various measures of corporate governance are associated with a variety of proxies that are intended to capture the level of tax evasion that firms engage in; however, they have found very little evidence that governance is associated with tax evasion.  The startling finding that companies with inadequate governance but high amounts of equity incentives for management engage in less tax is the end outcome of this study.

    They believe that this finding provides evidence that tax evasion and the extraction of management rent are complementary activities. If this is the case, then it follows that the degree to which a company is able to avoid paying taxes is proportional to the quality of its corporate governance. Companies in which managers are provided with strong risk-taking equity incentives are more likely to participate in tax avoidance practices.

    However, they could not discover any indication that governance systems, other than equitable incentives for CEOs, impact this relation.  This is a significant finding. In a separate but related work, the link between tax evasion and the financial expertise of audit committees was examined. They offer evidence that the financial knowledge of the audit committee is generally connected favorably with tax planning, but that this correlation is negative in situations when they consider tax planning to be dangerous (i.e., aggressive).

    A number of academics have investigated the relationship between ownership structure and the evasion of taxes, although there are still very few research on this topic. The vast majority of research in this field has been carried out in China, and the most of it focuses on how the presence of state ownership affects tax avoidance by companies. There is far less tax avoidance in state-owned enterprises (SOEs) compared to other types of businesses.

    It was discovered that state-owned firms make tax judgments that are advantageous to controlling owners but disadvantageous to minority shareholders. According to the findings of the study, there is a negative association between state ownership and the practise of evading taxes; furthermore, this association is more prominent in large enterprises than in small firms. It was also discovered that the negative association was significantly weaker among companies that had concentrated non-state ownership.
  2. An Empirical Study

    This research by Farooq and Zaher (2020) is based on an examination of the ownership and financial data of more than 1500 small and medium-sized businesses (SMEs) that operated in India between 2013 and 2014. The Enterprise Surveys (ES) that the World Bank conducted in the country of India in the years 2013 and 2014 provided the data used in this inquiry.
    A representative sample of a nation's private sector is surveyed at the business level as part of an enterprise survey (ES). Since the 1990s, a variety of World Bank departments have been responsible for carrying out their own firm-level surveys. The surveys make use of the same sampling approach in order to improve the data's dependability for the purposes of comparative analysis across the various economies of the world.

    In order to protect the integrity of the data at every stage of the process, we made certain that the information remained strictly confidential. It is common practise to conduct between 1200 and 1800 interviews for bigger economies, 360 interviews for medium-sized economies, and 150 interviews for smaller-sized economies.

    The article stated that the degree to which a company's ownership is concentrated is a crucial factor in the tax-avoiding conduct of businesses. In order to determine whether or not this hypothesis is correct, we will estimate several different variants of the following logistic regression, in which TAX will serve as the dependent variable and OWNERSHIP will serve as the independent variable. We also take into account firm-level control variables such as size, age, LLC status, audit status, growth rate, location, and manufacturing, as was discussed earlier.

    According to the findings of their study, businesses with concentrated ownership structures had a lower probability of evading taxes. The findings show that all of the calculations produce a coefficient that is strongly negative, reflecting ownership. We argue that the outcomes we saw are a reflection of the fact that corporate risk-taking is associated with ownership concentration.

    Small and medium-sized businesses (SMEs) with more ownership concentration are quite likely to exhibit lower levels of tax evasion behaviour than other SMEs. To address this problem, we divided our sample into sub-samples based on the number of participants.. The firms that make up the small (big) firms sub-sample are those whose total employee count is lower (higher) than the average employee count of the firms that make up the full sample.
  3. Analysis
    It is crucial for governments and those who set policy to have a solid understanding of the factors that influence the tax non-compliance behaviour of SMEs. This is of utmost importance in emerging economies, where the prevalent belief is that businesses will do anything they can to avoid paying taxes. Countries are putting in place procedures to prevent tax evasion strategies. Concerned about the amount of income that has been lost due to taxes, policymakers are proposing new legislation to close tax loopholes and are working to reinforce policies around tax enforcement. 

    Nevertheless, the pressure is unquestionably greater for developing countries, as tax income is more essential in these nations than it is in developed nations, where tax revenue accounts for only 13% of GDP, whereas tax revenue in developing nations accounts for 35% of OECD GDP (UK International Development Committee, 2012). Developing countries with high fiscal deficits are the ones most likely to suffer the most from this predicament (in most cases dependent on the borrowings of public sector).

    The government deficit in China was 3.0% of its gross domestic product in 2002, whereas India's deficit was 4.7% of its GDP. When developing countries are unable to earn enough cash from taxes, the residents of those countries find themselves in desperate need of crucial services, which puts their most fundamental means of subsistence at risk (health care, clean water and sanitation, different infrastructures, and education facilities).

    When stock ownership and corporate decision-making are concentrated in just a small number of decision-makers, owner-managers will likely be more risk-averse, and as a result, they will be less eager to participate in hazardous ventures, as stated by. We made an effort to comprehend the complex nature of the connection that exists between committed investors, also known as the concentrated holding, and tax evasion technique.

    We contend that the concentration of ownership in the hands of a few has major ramifications for the performance of SMEs when it comes to tax avoidance by investigating the link between the ownership of SMEs in India and challenging their tax evasion behaviour. This was done to support our case. Our arguments are predicated on the notion that concentrated ownership promotes risk-averse behaviour among controlling shareholders, the great majority of whom are not diversified (in the case of SMEs).

    To draw a conclusion, businesses with very specified ownership structures are more  likely to avoid taking any action that could be interpreted as being hazardous. In addition, when we compared two small and medium-sized enterprises (SMEs) in India, we discovered that the Indian SME that operated in a setting with stronger institutions was more risk-averse than the other Indian SME.

    Stronger institutional environments put higher costs on small and medium-sized enterprises (SMEs) and their owners for any unlawful action because there is a larger possibility that the violators will be discovered by the enforcement agencies in these states and provinces. To put it another way, the dominant shareholders of small and medium-sized enterprises (SMEs) that have their headquarters in certain states or different provinces are basically more prone to act cautiously and may even be more risk-averse.

Causes Of Tax Evasion

Numerous factors influence whether or not a taxpayer will participate in tax avoidance. Taxpayers who engage in this behaviour may be prompted to do so by economic considerations. Sanctions on businesses, economic stagnation, and tax rates are all examples of economic issues that are taken into account. On the other side, what matters most are issues of law, society, demography, thought, and morality. Motives for tax evasion may stem from a variety of circumstances.
  1. Moral duty is one of the elements that might sway people away from tax avoidance. Taxpayers have the right and responsibility to support the tax authorities with a fair contribution without coercion from the government. Taxpayers have an innate incentive to do so.

    Poor tax payers are more likely to try to avoid paying any taxes at all and are less likely to pay their fair share of taxes. When tax authorities uphold their obligations with honesty and respect, taxpayer morale and integrity increase. Tax ethics may be influenced by socioeconomic background, family structure, and religious affiliation.

    Taxpayer participation is determined by individual choice. Individuals who are morally obligated to pay their fair share of taxes may be less tempted to cheat the system. It is generally accepted that taxes collected by the proper government body are moral. McGee contends that when it comes to the morality of tax evasion, there are three main schools of thought.

    Therefore, the decision to evade tax is an ethical dilemma that takes into account a number of factors, including (a) the idea that tax evasion is immoral and shouldn't be used by any payer; the idea that the government shouldn't be allowed to take anything from anybody; and the idea that tax evasion may be both moral and immoral depending on the circumstances.
  2. Taxpayers must be aware of both the causes and effects of tax avoidance. Taxpayers who are knowledgeable about tax evasion are less likely to engage in it, whereas less knowledgeable taxpayers are more likely to do so. The need of teaching people and authoritative tax experts on tax-related knowledge has to be emphasised more. Increasing tax compliance is one approach to contribute to higher government revenue.

    If the government provides various types of training to taxpayers on tax evasion and other tax-related problems, taxpayers will be less likely to participate in tax evasion. Tax knowledge influences the taxpayer's decision to participate in and maintain tax evasion operations. When taxpayers do normal duties without tax expertise, they may expose themselves to dangers that might lead to tax evasion.
  3. Another thing that makes taxpayers want to avoid paying taxes is how they feel about how other taxpayers act. Attitude is a way to figure out if something is good or bad, whether it's a person or a thing. Scholars have done a lot of research on the relationship between how people feel about paying taxes and whether or not they pay them. If a taxpayer doesn't like paying taxes, they won't pay what they owe to the government. On the other hand, if a taxpayer likes paying taxes, they will pay what they owe.

Consequences Of Tax Evasion

Since of tax evasion, the wealthy have become richer while the poor have suffered because the government has less money because it doesn't collect the full amount of tax that it's owed.
More damage is reportedly done to the vulnerable sector of the country as the government fails to eradicate this kind of misconduct. Because of a lack of wealth and sufficient cash, the government is forced to halt the development programmes it had initiated to do some good to individuals and communities as a whole via tax evasion.

By making the president's agenda for the public at large and the president's plan of action more difficult to implement, evasion disrupts the former and makes the latter's primary resources insufficient for the project.

Taxpayers who pay their fair share of taxes are unfairly burdened when others avoid paying their fair share, and this encourages them to do the same. In addition to being detrimental to national security, tax evasion and avoidance help individuals who would otherwise be dishonest in their pursuit of unlawful wealth by directing them toward tax havens and other such schemes. So many social wrongs happen on the small scale but only lead to avoidance in the long run. Forgery, accepting bribes, and other forms of corruption are all examples.

Penalty And Prosecution

In India, failing to pay your income taxes is a serious crime. Tax evasion is punishable by steep fines and interest on any additional tax owed under Chapter 12 of the Income Tax Act of 1961. Here are some of the situations when you might face fines or perhaps a prison sentence for breaking income tax laws that you should be aware of.
  1. The assessing officer may levy a fine of $5,000 or more against you if you fail to file your income tax returns by the deadline specified in subsection 1 of section 139 of the income tax act.
  2. If you don't provide your employee your PAN number when they start working for you, 20% TDS will be taken out of your pay rather than the usual 10%. If you then coated incorrectly, you might face a fine of 10,000 rupees.
  3. You should check the form 26AS's data several times because any discrepancy might result in harsh penalties. Mismatch in income expense and investment data will be punished similarly.
  4. According to section 140 (1) of the Income Tax Act, if a taxpayer does not pay any self-assessment tax or interest, whether in full or in part, they are considered defaulters. A defaulter may be assessed a penalty by the assessing officer in accordance with Section 221(1). However, if you give the assessing officer good cause for the tax payment delay, they may waive the penalty.
  5. According to Section 271(C) of the Income Tax Act, the penalty for failing to report all of your income or for hiding income tax is 100% to 300% of the tax avoided.
  6. In case a taxpayer fails to comply with notice issued by the income tax department under section 142 (1) or 143(2) then assessing officer can issue a notice either asking to file the return of income or to furnished in writing all the details of the asset and liabilities.

Case Studies And Scams

R.K. Garg and Ors. vs Union of India (UOI) And Ors.

The government's action in this case-requiring people to come clean about their involvement with illegal funds-was contested. Tax evasion and other white-collar crimes are on the rise, and others have argued that this move is being done only to prevent such crimes and not to promote them.

This, they say, will help recover all the money that has been stolen and hidden by the individuals.

This was just an effort to expose the illegally acquired wealth that has been concealed via tax avoidance. Since the Indian government does not have a comprehensive set of effective guidelines, this was eventually seen as a positive approach since it aids in preventing such activities.

United States v. Stegman

Midwest Medical Aesthetics Center, Inc. is a Kansas business that Kathleen Stegman established in September 1997. A certificate of modification indicating a name change to Midwest Medical Aesthetics Center, P.A. was submitted in January 1998. (Midwest). Samson, LLC is one of the various LLCs that Stegman founded. Stegman utilised the LLCs to hide payments from clients in the Midwest.

She bought money orders using the LLCs, which she then used to buy stuff for her own use. Stegman bought $272,748 worth of money orders between 2007 and 2009, but she didn't declare any cash income on her federal income tax forms".

An IRS criminal investigation report issued in October 2010 stated that Midwest received large sums of cash but made no deposits in 2007 or 2008, and Stegman led a lavish lifestyle that included frequent travel and large asset purchases totaling approximately $2,000,000. Stegman also engaged in obstructive behavior while recording. Stegman was found guilty of tax evasion and other offences and sentenced to 51 months in prison.

Among the author's suggested measures to put an end to tax evasion and recover hidden wealth is revising the existing judicial and legislative framework to include expedited punishments for such offences. Information gathered by tax authorities that is connected to taxes and the economy should be double-checked to ensure there are no inconsistencies. There can be no tax avoidance without an effective link between state and federal governments.

Accurate records of all financial dealings need the presence of a reliable electronic system. The public at large has to be made more aware of the severity of such offences and the need of adhering to the law.

In order to prevent individuals from resorting to these types of crimes, we need a tax system that is both easy to understand and to pay for, regardless of socioeconomic status. Increase the severity of the penalties for these offences. There has to be a reform in the law to ensure that more tax cheats are punished and that the innocent no longer have to bear the brunt of their actions.

Entities Used To Assist Tax Evasion

  1. LLCs as a Shell
    Since LLCs may be owned and operated anonymously, they are vulnerable to exploitation. State-specific and international standards for ownership disclosure vary. When hired, members of LLCs get the same limited liability as is afforded to corporate investors.

    LLCs are essentially "shell" businesses that exist to keep, manage, or simply act as a point of transfer for funds moving from one account or corporation to another. Several other structures may be used, such as issuing additional shares to natural or legal people, or in registered or receiver from Bearer shares, which are illegal in the United States upon the transfer of ownership to shares to the real holder or possessor, are used to give rights.

    Although LLCs are easy to set up (in some states, in as little as two hours for about $100-$200), they provide a dilemma for forensic accountants, auditors, and tax investigators since they can be linked or layered across numerous jurisdictions. If the beneficial owners are established in a nation that does not respect ownership openness, it may be exceedingly difficult to identify them.
  2. Nominees or Nominee Directors uses in Shell Entities
    The shell director is another legal tool or method to maximise secrecy. A nominee is someone who possesses bare legal title in another person's name, is chosen to perform restricted functions on another person's behalf, or receives and disburses money on behalf of another. A nominee might be a close friend, family member, trusted business partner, or an individual with no connection to the real beneficial owner (s) nomination incorporation services or outside nominees who will serve as the shell company's management or director.  A general power of attorney is often signed by the nominee, giving the beneficial owner(s) total control over the shell entity.
  3. Trusts
    Trusts are yet another tool that tax evaders, scammers, and other criminals may abuse. A trust's distinguishing feature is that it separates legal ownership from beneficial ownership. A clause in the trust gives legal power to a tenant (also known as a creator or grantor) who maintains the trust asset(s) in accordance with the conditions of a trust agreement for the benefit of beneficiaries.

    Courts in several jurisdictions, including the majority of U.S. states, have a clear rule that any self-settled trust (one in which the creator or grantor is also a beneficiary) cannot be a spendthrift trust, regardless of whether it contains a fiscally irresponsible clause.
  4. The scenario of Limited Partnerships (LPs) and Family Limited Partnerships (FLPs)
    LPs and FLPs are excellent vehicles for tax avoidance and asset concealment. The tax evader (general partner) gives reliable friends, family members, or associates income-producing assets to invest in an LP in a typical scheme involving an LP. Personal legal liability for the business's debts, including tax liabilities, and inability to play an active role in the business's management.

Another LP-related technique involves transferring income-producing assets to an LP where the tax cheat is the sole limited partner before transferring the partnership interest to a trust where the tax cheat is the sole trustee and beneficiary (usually done on an offshore basis).

Impact Of Foreign Ownership On Tax Evasion

According to the agency hypothesis, several articles have shown a negative correlation between foreign ownership and tax evasion. More foreign ownership, as discovered by Yoo, leads to less tax dodging on the part of businesses. Hasan also discovered an inverse correlation between foreign ownership and tax evasion by corporations in 43 different nations. Some earlier research has shown a positive and statistically significant relationship between a company's percentage of foreign ownership and its ability to evade taxes.

They argued that the capacity of foreign investors to scrutinize management via voting rights on a company's financial and taxation policies had a detrimental impact on tax evasion practices. According to Salihu's research, foreign ownership is associated with corporate tax evasion among Malaysian enterprises that are traded on public exchanges. Also, the foreign ownership structure facilitates tax evasion.

Results from Shi show a correlation between high levels of foreign ownership of board seats and tax evasion. It is clear from this discussion that the literature study found conflicting evidence about the link between overseas investment and evasion of taxes.

It is crucial for governments and those who set policy to have a solid understanding of the factors that influence the tax non-compliance behaviour of SMEs. This is of utmost importance in emerging economies, where the prevalent belief is that businesses will do anything they can to avoid paying taxes.

Countries are putting in place procedures to prevent tax avoidance strategies. Concerned about the amount of income that has been lost due to taxes, policymakers are proposing new regulations to close tax loopholes and are working to bolster tax enforcement procedures.

White-collar criminals use a variety of shell companies to commit massive tax evasion. These criminals can choose from a variety of legal structures. LLCs, shelf corporations, LLPs, FLPs, IBCs, asset protection trusts, private interest foundations, and company foundations are among the various structures available.

However, the pressure is most certainly heavier for developing countries, as tax income is more essential in these nations than it is in developed nations, where tax revenue accounts for only 13% of GDP, whereas tax revenue in developing nations accounts for 35% of OECD GDP. Developing countries with high fiscal deficits are the ones most likely to suffer the most from this predicament (largely dependent on public sector borrowings). The government deficit in China was 3.0% of its gross domestic product in 2002, whereas India's deficit was 4.7% of its GDP.

When developing countries are unable to earn enough cash from taxes, the residents of those countries find themselves in desperate need of crucial services, which puts their most fundamental means of subsistence at risk (health care, clean water and sanitation, infrastructures, and education).

Building on previous research, we investigated the ownership structures of small and medium-sized enterprises (SMEs) in India, which are widely recognised as an essential feature of businesses located in developing markets. The agency theory serves as the foundation for our research.

A variety of issues complicate the use of ownership registries, including privacy violations, excessive burdens on financial institutions, infringing on national sovereignty, bank secrecy, breach of contractual relationships, and others. Global efforts to improve tax-related information exchange and transparency of entity ownership are moving slowly.

Written By: Divyansh Singh Sisodiya, BBA LLB - Symbiosis law School Nagpur

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