Fowler v Revenue and Customs [2020] UKSC 22

Mr Fowler, a South African-resident diver, worked in UK waters. The Supreme Court held that section 15 ITTOIA's deeming provision, treating employed divers as self-employed traders, did not alter the meaning of 'employment' under the UK-South Africa Double Taxation Treaty, making his income UK-taxable.

Facts

Mr Martin Fowler is a qualified diver resident in the Republic of South Africa. During the 2011/12 and 2012/13 tax years, he undertook diving engagements in the waters of the UK Continental Shelf. For the purposes of the preliminary issue before the court, it was to be assumed that he undertook those engagements as an employee rather than as a self-employed contractor. HMRC contended that his diving income was subject to UK taxation; Mr Fowler denied this.

The matter turned on the interaction between the UK-South Africa Double Taxation Treaty (implemented by SI 2002/3138) and section 15 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA). Under the Treaty, employment income is taxable where it is earned (article 14), whereas business profits of an enterprise are taxable only in the state of residence where there is no permanent establishment (article 7). Section 15 of ITTOIA provides that where an employed diver performs qualifying seabed diving duties in the UK or designated waters, the performance of the duties of employment is ‘instead treated for income tax purposes as the carrying on of a trade in the United Kingdom’.

Issues

The principal issue was whether the deeming provision in section 15(2) of ITTOIA operated to alter the meaning of terms (particularly ’employment’, ‘profits’, and ‘enterprise’) in articles 7 and 14 of the Treaty, by virtue of article 3(2) of the Treaty (which requires undefined terms to bear the meaning given under the domestic tax law of the state applying the Treaty). If so, Mr Fowler would fall within article 7 and be taxable only in South Africa; if not, he would fall within article 14 and be taxable in the UK.

Arguments

For Mr Fowler (Respondent)

Mr Schwarz argued that section 15 of ITTOIA compelled the court to treat a qualifying diver as carrying on a trade for all purposes under UK income tax law and consequently also under the Treaty by operation of article 3(2). This would mean article 7, rather than article 14, applied, rendering the income taxable only in South Africa. This submission had been accepted by the majority in the Court of Appeal (Henderson and Baker LJJ).

For HMRC (Appellant)

HMRC contended that section 15 did not alter the meaning of terms used in the Treaty. Section 15 only adjusts the manner in which employment income is taxed (principally to permit a more generous expenses regime) and does not recharacterise the underlying relationship as self-employment for Treaty purposes.

Judgment

The Supreme Court, with Lord Briggs giving the judgment with which Lord Hodge, Lady Black, Lady Arden and Lord Hamblen agreed, unanimously allowed HMRC’s appeal.

Interpretation of the Treaty

Lord Briggs began by noting that the Treaty must be interpreted in accordance with the Vienna Convention on the Law of Treaties, the OECD Commentaries on the Model Tax Convention, and relevant UK authority including Anson [2015] STC 1777 and Smallwood (2010) 80 TC 536. Treaties are to be construed in an international, not exclusively English, manner and reflect reciprocal obligations between contracting states.

Principles governing deeming provisions

Lord Briggs drew upon the authorities summarised by Lord Walker in DCC Holdings (UK) Ltd v Revenue and Customs Comrs [2011] 1 WLR 44 and articulated the guiding principles: the extent of the statutory fiction is primarily a question of construction; the court must identify the purposes for which and persons between whom the fiction operates; a deeming provision should not produce unjust, absurd or anomalous results unless compelled by clear language; but equally the court should not shrink from the inevitable corollaries of the fiction. He recalled Lord Asquith’s famous dictum in East End Dwellings Co Ltd v Finsbury Borough Council [1952] AC 109:

The statute says that you must imagine a certain state of affairs; it does not say that having done so, you must cause or permit your imagination to boggle when it comes to the inevitable corollaries of that state of affairs.

Application to section 15 and the Treaty

The court held that the articles of the Treaty apply to the real world and not to a fictional world created by UK tax legislation, unless article 3(2) requires a different meaning to be given to Treaty terms because of a deeming provision. Section 15 did not alter the meaning of ’employment’, ‘profits’, or ‘enterprise’ within the Treaty. Section 15(1) and (2) use ’employment’ in precisely the same way as sections 4, 6 and 7 of ITEPA; the provision then introduces, by the word ‘instead’, a fiction that employment income is to be taxed as though it were the profits of a trade.

Critically, the purpose of section 15 is not to determine whether qualifying employed divers are to be taxed in the UK, nor to adjudicate between the UK and South Africa. As the First-tier Tribunal had found, its purpose is to afford such divers the more generous expenses regime available to the self-employed. Section 6(5) of ITEPA expressly acknowledges that the income charged under section 15 is employment income. Applying the deeming provision so as to remove UK taxing rights under the Treaty would therefore fall outside the purpose of the fiction and produce an anomalous result.

Further, article 2(1) of the Treaty makes clear that the Treaty is not concerned with the manner in which taxes are levied. Section 15 concerns precisely that – the manner of taxation – and therefore should not be construed so as to shift a qualifying diver from article 14 to article 7.

Implications

The decision clarifies the relationship between domestic deeming provisions and the interpretation of double taxation treaties under provisions equivalent to article 3(2) of the OECD Model. A domestic statutory fiction that recharacterises the manner in which income is taxed will not necessarily alter the meaning of terms used in a double taxation treaty. The purpose for which the deeming provision was enacted is central: where it exists to adjust the mechanics of taxation (such as deductibility of expenses) rather than to resolve any genuine question of legal status, it will not be transposed into the treaty context.

The decision is significant for employed divers working on the UK Continental Shelf who are resident in treaty partner states: their earnings remain within the scope of article 14-type provisions and are taxable in the UK. More broadly, the judgment offers useful guidance on the proper approach to interpreting deeming provisions in a cross-border context and reinforces the principle that treaties must be interpreted in an international rather than purely domestic sense, consistently with Anson and Smallwood.

The court’s reasoning is carefully tied to the particular purpose of section 15 (as factually found by the First-tier Tribunal) and to the structure of the UK-South Africa Treaty. It does not hold that all domestic deeming provisions will be disregarded for treaty purposes; the answer in each case will depend on construing the particular deeming provision and the particular treaty. The question of Mr Fowler’s actual status as employee or self-employed contractor remained to be determined.

Verdict: The Supreme Court unanimously allowed HMRC’s appeal, holding that section 15 of ITTOIA 2005 did not alter the meaning of ’employment’ or related terms in the UK-South Africa Double Taxation Treaty. Accordingly, article 14 (income from employment) rather than article 7 (business profits) applied, and Mr Fowler’s diving earnings were taxable in the UK on the assumption that he was an employee.

Source: Fowler v Revenue and Customs [2020] UKSC 22