Tax avoidance is an exercise where the assessee tries to take advantage of the loopholes of law and by-passes it. With all this he remains outside the purview of law. Without resorting to illegal ways one effects a reduction in one’s tax liability.
1. Avoidance of tax does not include every case of reduction of tax liability. There would be no avoidance of tax in cases where the assesse enters into a transaction which has the effect of diminishing his income and consequently reducing his tax liability. Tax avoidance postulates that the assessee is in receipt of an amount which is really in truth his income liable to tax but on which he avoids payment of tax by some artifice or device apparently showing the income as accruing to another person at the same time making it available for use and enjoyment by the assessee himself. CIT v Sakarlal Balabhai 69 ITR 186 (Guj.).
2. The distinction between ‘evasion’ and ‘avoidance’ has been discussed by the Wanchoo Committee in their report as follows:
3.Tax evasion and tax avoidance : “The distinction between ‘evasion’ and ‘avoidance’, therefore, is largely dependent on the difference in methods of escape resorted to. Some are instances of merely availing, strictly in accordance with law, the tax exemptions or tax privileges offered by the government. Others are manoeuvres involving an element of deceit, misrepresentation of facts, falsification of accounts, including down right fraud. The first represents what is truly tax planning, the latter tax evasion. However, between these two extremes, there lies a vast domain for selecting a variety of methods which constitute tax avoidance.
4. “Avoidance of tax is not tax evasion and it carries no ignominy with it, for, it is sound law and certainly not bad morality for anybody to so arrange his affairs as to reduce the brunt of taxation to the minimum.” Aruna Group of Estates v State of Madras  55 ITR 642 (Mad.). Tax Evasion, is however, unethical, anti-social and undersirable. If a person has incurred a liability to tax, anything done to avoid payment thereof is held to be evasion. Similarly, although liability to tax is not incurred, a colourable transaction involving an element of illegality or circumvention of tax law would amount to evasion. Tax evasion is, to say, the least, illegal and deserves contempt.