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Tax Avoidance vs Tax Evasion

By Euney Marie Mata-Perez on November 18, 2021

Tax avoidance and tax evasion are the two most common ways used by taxpayers to not pay taxes or pay reduced taxes. Tax avoidance is the use of tax-saving devices within the means sanctioned by law and where the taxpayer acts in good faith and at arm’s length. Tax evasion, on the other hand, involves schemes outside those lawful means that, when resorted to by taxpayers, usually subjects them to civil or criminal liabilities in addition to penalties and interest on the unpaid tax liabilities. In the case of the Commissioner of Internal Revenue (CIR) v. Hongkong Shanghai Banking Corporation Limited – Philippine Branch (G.R. No. 227121, December 9, 2020), the Supreme Court held that the transactions of the taxpayer were part of a legitimate tax avoidance scheme. In this case, to achieve efficiency, the taxpayer entered into two transactions: the transfer of its sales assets, other information technology assets, and merchant agreements in exchange for shares in a company; and the subsequent sale or assignment of the shares of such company at a premium. The first transaction qualified as a tax-free exchange under Section 40(C)(2) of the National Internal Revenue Code, pursuant to which the transferring taxpayer received shares of stock and gained control over the receiving company.

Two days after the incorporation of the corporation that received the assets and issued shares of stocks to the taxpayer in exchange for the fair market value of the assets received, the taxpayer entered into an agreement for the sale or transfer of the shares received pursuant to the exchange. Less than two months later, the sale and transfer of the shares were completed. Since the second transaction was taxable, the taxpayer paid the documentary stamp taxes and capital gains tax on the shares. The CIR insisted that the second transaction involved an alleged sale of “goodwill”, a business asset, and assessed the taxpayer for deficiency income taxes. It was the CIR’s position that the gain derived by the taxpayer on the sale should be subject to the regular corporate income tax (then 35 percent) and not on the capital gains tax on the sale of shares. The Supreme Court was not persuaded. It found that the taxpayer simply availed of tax-saving devices within the means sanctioned by law. More importantly, the court recognized that the methodology was adopted by the taxpayer not merely to reduce taxes but also for a legitimate business purpose, i.e., the restructuring of the business to achieve more efficiency and economies of scale. Consequently, what was employed to minimize taxes was a tax avoidance scheme. The Supreme Court thus held that there was no tax evasion.

Tax evasion, meanwhile, is “a scheme used outside of those lawful means”. It connotes fraud through the use of pretenses and forbidden devices to lessen or defeat taxes. Fraud, in the general sense, “is deemed to comprise anything calculated to deceive, including all acts, omissions, and concealment involving a breach of legal or equitable duty, trust or confidence justly reposed, resulting in damage to another, or by which an undue and unconscionable advantage is taken of another.” (Yutivo Sons Hardware Co. v. Court of Tax Appeals, G.R. No. L-13203, January 28, 1961, 110 Phil. 751-776.) In the landmark case of CIR v. Estate of Toda, Jr. (G.R. No. 147188, September 14, 2004, 481 Phil 626-645), the Supreme Court found that there was tax evasion when the corporate taxpayer transferred real assets to an individual who on the same day transferred the same assets to the corporate buyer at a much a higher price.

The Supreme Court held that the intermediate sale to the individual was to reduce the amount of tax to be paid, especially since the transfer from him to the ultimate buyer would subject the income to the lower 5-percent individual capital gains tax and not the 35-percent corporate income tax for which the original corporate seller would have been liable. The court noted that the intermediate individual buyer’s sole purpose of acquiring and transferring the title of the subject properties on the same day was to create a tax shelter.

Said individual never controlled the property and did not enjoy the normal benefits and burdens of ownership.

Thus, the sale to him was merely a tax ploy, a sham, and without business purpose and economic substance. Doubtless, the execution of the two sales was calculated to mislead the BIR with the end in view of reducing the consequent income tax liability. In a nutshell, in the Toda case, the Supreme Court found that the sale to and from the individual intermediary was prompted more by the mitigation of tax liabilities than legitimate business purposes.

Thus, it constituted tax evasion. It is clear that in both the HSBC and the Toda cases, the Supreme Court applied the “business purpose test.” Pursuant to such, the CIR may ignore the tax benefits of certain transactions motivated solely by tax avoidance or a non-business purpose.

Transactions must have some purpose other than the mere avoidance of taxes; otherwise, they can be struck down as tax evasion, as what happened in the Toda case.

Euney Marie J. Mata-Perez is a CPA-lawyer and the managing partner of Mata-Perez, Tamayo & Francisco (MTF Counsel). She is a corporate, M&A and tax lawyer and was ranked as one of the top 100 lawyers of the Philippines by the Asia Business Law Journal. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. If you have any question or comment, you can email the author at or visit the MTF website at

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