Tax Avoidance

Learn about what is tax avoidance, types, strategies and how it is different from tax evasion.
OPEN FD
Tax Avoidance
OPEN FD
3 min
11-June-2025

Tax avoidance refers to the practice of using legal provisions to reduce one’s tax liability. It involves structuring financial activities in a way that takes advantage of gaps or loopholes in the tax system to lower the amount of tax payable. While it is technically legal, tax avoidance is generally discouraged, as it often involves manipulating the law for personal benefit. Although no tax rules are directly violated, such practices may border on unethical and, in certain cases, could even be treated as criminal behavior.

Key Takeaways

  • Tax avoidance involves using lawful strategies to reduce the amount of income tax payable.

  • Both individuals and businesses often engage in tax avoidance to lower their tax obligations.

  • Common methods include claiming tax deductions, credits, and excluding certain types of income.

  • The Internal Revenue Code (IRC) allows for legal tax benefits to promote activities like home ownership and retirement savings.

  • Tax evasion, unlike avoidance, involves illegal actions such as concealing income or falsifying records to evade taxes.

Pro tip

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Types of Tax Avoidance

1. Standard deduction

Taxpayers in India have the option to claim a standard deduction, a predetermined amount set by the government, to reduce their taxable income. By utilising the standard deduction, individuals can lower their overall tax burden, as it effectively reduces the portion of their income subject to taxation. This deduction is available regardless of whether they itemise deductions.

2. Retirement savings

Contributing to retirement accounts, such as the Public Provident Fund (PPF) or the National Pension Scheme (NPS), can be an effective tax avoidance strategy in India. These contributions are often tax-deductible under Section 80C of the Income Tax Act, meaning they reduce taxable income in the year they are made. Additionally, the investments within these accounts grow tax-deferred, allowing for greater accumulation over time compared to taxable accounts.

3. Workplace expenses

Certain work-related expenses may be eligible for tax deductions under Indian tax laws. For example, if you are self-employed or have unreimbursed business expenses, you may be able to deduct costs such as office rent, travel expenses, and professional fees. Salaried employees can also claim deductions for certain expenses like rent paid for accommodation and leave travel allowance.

Also read: What is Advance Tax

Difference between tax evasion and tax avoidance

A. Tax evasion

Tax evasion: Tax evasion is not just wrong, it is illegal. It involves deliberately hiding income, providing false information to lower your tax bill. Tax evasion might have serious consequences, such as hefty fines, possible imprisonment, and damage to your reputation.

Let us understand this with an example.

A salaried software developer earns Rs. 8,00,000 annually from his primary job. He also undertakes freelance projects on the side, earning Rs. 2,00,000. Some clients propose cash payments at a slightly reduced rate, and the developer agrees. However, he has never reported this additional income and pays taxes only on Rs. 8,00,000. This practice is known as tax evasion, which in this instance, entailed the intentional hiding of income.

B. Tax avoidance

Tax avoidance: Unlike tax evasion, which is illegal tax avoidance is legal and involves strategically using deductions, exemptions, investments, and business structures to minimise your taxes. For example:

A salaried individual with an annual income of Rs. 10,00,000 contributes Rs. 1,50,000 to their PPF and Rs. 50,000 to their NPS. They claim deductions under Section 80C and 80CCD(1B) of the Income Tax Act. And now they will pay tax on Rs, 8,00,000 instead of the original Rs. 10,00,000.

This is a perfect example of legal tax avoidance. Governments frequently incentivise such behaviors by providing tax-favored savings opportunities and deductions designed to support long-term investment and retirement preparation.

Common tax avoidance strategies in India

1. Using deductions

  • Section 80C: It offers deductions of up to Rs. 1.5 lakh p.a. for investments in avenues like:
    • Public Provident Fund (PPF)
    • Life Insurance Premiums
    • Equity Linked Savings Schemes (ELSS)
    • Employee Provident Fund (EPF)
  • Section 80D: Medical insurance premiums for yourself, your family, and your parents qualify for deductions under this section.
  • Section 80CCD(1B): Additional contributions you make towards the National Pension System (NPS) are eligible for deduction.
  • Home loan interest: You can claim a deduction for the interest paid on your home loan under Section 24(b)
  • Section 80G: Deductions on donations made to specified charitable trust or institution and certain approved funds.

2. Structuring your salary

Here are a few key allowances to consider:

  • House rent allowance (HRA): If you are a salaried employee living in rented accommodation, you may be eligible for a partial or full tax exemption under Section 10(13A) of the Income Tax Act
  • Leave travel allowance (LTA): LTA offers exemptions for travel expenses incurred on domestic trips while on leave or after retirement.
  • Update: You cannot claim the leave travel allowance (LTA) tax exemption if you opt for the new tax regime.
  • Other allowances: Provisions like transport allowance, food coupons, and certain special allowances might enjoy certain tax benefits under Indian tax laws.

3. Business-specific tax avoidance strategies

  • Depreciation: Claiming depreciation on assets over their useful life is a legitimate way to reduce taxable profits.
  • Research and development (R&D): Businesses that invest in qualified R&D activities may avail of weighted deductions or other tax benefits.
  • Strategic business structuring: Different business structures (sole proprietorship, partnership, or company) come with different tax implications. To optimise your taxes, strategically choose the most favorable structure for your business.
  • Special economic zones (SEZs): Companies operating within SEZs may be eligible for tax holidays, exemptions, or special tax rates.

Tip: Apart from investing in tax-saving options, you can consider investing in fixed deposits to diversify your portfolio. FDs offer a reliable source of income with guaranteed returns, as they are not subject to market fluctuations. Bajaj Finance, India's leading NBFC, provides competitive interest rates on their Fixed Deposit, up to 7.30% p.a. for senior citizens and up to 6.95% p.a. for customers below the age of 60. Keep in mind that the interest earned on FDs is taxable as per your income tax slab.

Also read: What is Tax Planning

How to control tax avoidance?

Controlling tax avoidance involves a combination of legislative, administrative, and international measures. Governments can close legal loopholes by enacting comprehensive tax reforms and simplifying tax codes. Strengthening the enforcement of tax laws through rigorous audits and penalties can deter aggressive tax planning. Promoting international cooperation and transparency, such as through information-sharing agreements, helps address cross-border tax avoidance. Additionally, educating taxpayers about fair tax practices and the importance of compliance can foster a culture of voluntary adherence to tax laws.

Is tax avoidance legal?

Yes, tax avoidance is legal when done by following the provisions of the law. Individuals and businesses can reduce their tax liability by using legitimate means such as tax credits, deductions, and income exclusions. Corporations may also legally minimize taxes through strategies like offshoring profits, accelerated depreciation, and deducting employee stock options.

However, tax avoidance becomes illegal when taxpayers intentionally misuse these rules or ignore applicable tax laws. In such cases, it can lead to penalties, fines, and even prosecution.

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Conclusion

In this complex tax system, it is wise to explore legal ways to minimise your tax burden. Responsible tax planning isn't just about saving money –it is about being a good citizen. Paying your fair share ensures a healthy, thriving, and sustainable society.

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Frequently asked questions

What is a practical example of tax avoidance?

A practical example of tax avoidance is an individual investing in tax-free municipal bonds to earn interest that is exempt from federal income tax.

What is the difference between tax planning and tax avoidance?

Tax planning is the legal practice of organizing finances to maximize tax benefits within the law, while tax avoidance involves exploiting legal loopholes to reduce tax liability.

What are the effects of tax avoidance in India?

Tax avoidance in India can lead to reduced government revenue, increased tax burden on compliant taxpayers, and potential economic inequality.

Is tax avoidance a punishable crime?

No, tax avoidance is not a punishable crime as it involves legal strategies. However, it is often criticized for undermining the intent of tax laws.

What does tax avoidance mean?

Tax avoidance is the practice of using lawful methods to reduce the amount of income tax payable by an individual or business. This is typically done through allowable deductions, credits, and exemptions.

What is a common example of tax avoidance?

Tax avoidance involves minimizing tax liability while staying within legal limits. Examples include using advance deeds, claiming deductions, paying through loans, and leveraging available tax credits or exemptions.

What are the different types of tax avoidance?

Tax avoidance can take several forms, including claiming tax deductions, utilizing credits, and excluding certain types of income. These are legal strategies encouraged by the tax system, such as saving for retirement or purchasing a home. In contrast, tax evasion uses illegal means like hiding income.

What is the most widely used method of tax avoidance?

A commonly used strategy by companies involves paying directors through loans, which are later written off or left unpaid, helping reduce their declared income and, therefore, their tax liability.

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