Fowler v Commissioners for Her Majesty’s Revenue and Customs [2020] UKSC 22

A South African resident diver who worked on the UK Continental Shelf argued that a UK rule treating certain employed divers as if they were carrying on a trade also changed how the UK–South Africa double tax treaty applied to his pay. The Supreme Court disagreed. On the assumption that he was an employee, the treaty permits the UK to tax his earnings as employment income; the statutory fiction affects only how that UK tax is calculated.

The dispute

Mr Martin Fowler, a qualified diver resident in South Africa, undertook diving engagements in the waters of the UK Continental Shelf during the 2011/12 and 2012/13 tax years. Whether he was an employee or a self-employed contractor had not yet been decided. This appeal concerned a preliminary issue, and the court had to assume that he worked as an employee.

HMRC said that the income from those engagements was taxable in the UK. Mr Fowler said that it was not. The answer depended on the double taxation treaty between the UK and South Africa, given effect in the UK by the Double Taxation Relief (Taxes on Income) (South Africa) Order 2002. The treaty was agreed to promote economic relations, avoid double taxation and prevent fiscal evasion.

How the treaty divides taxing rights

The treaty identifies categories of income and allocates taxing rights between the two states. Under article 14, salaries, wages and similar remuneration from employment are taxable only in the employee’s state of residence unless the employment is exercised in the other state. If it is exercised there, that other state may tax the remuneration. The treaty does not require it to do so, and it does not stop the state of residence from taxing foreign earnings. Article 21 then requires credit to be given so that the same income is not taxed twice.

Article 7 deals with business profits. The profits of an enterprise of one state are taxable only in that state unless the enterprise carries on business in the other state through a permanent establishment there. It was common ground that Mr Fowler had no permanent establishment in the UK. If his diving counted as an enterprise of South Africa, article 7 would therefore leave the profits taxable, if at all, only in South Africa.

Article 3(2) provides that a term which the treaty does not define is, unless the context otherwise requires, to have the meaning it has at the time under the law of the state applying the treaty for the taxes covered by the treaty. A meaning in that state’s tax law prevails over a meaning in its other laws. “Employment” is not defined in the treaty. “Enterprise” is defined, and “business” is partly defined, in article 3(1).

Lord Briggs noted that this treaty, unlike many others, has no general provision dealing with what is called double non-taxation. If UK law and the treaty both excluded the earnings, and South Africa treated Mr Fowler as an employee whose foreign earnings were not taxed, he might be taxable in neither country. Whether South Africa taxed residents employed abroad was not investigated, so the court placed no weight on that possibility when construing the treaty.

The UK deeming rule for certain divers

Employment income is ordinarily charged under the Income Tax (Earnings and Pensions) Act 2003. Section 6(5) of that Act says that employment income is not charged under that Part if it falls within the trading-income charge in the Income Tax (Trading and Other Income) Act 2005 because of section 15 of that Act.

Section 15 applies only where a person performs the duties of employment as a diver or diving supervisor in the UK, or in an area designated under the Continental Shelf Act 1964; the duties consist wholly or mainly of specified seabed diving activities; and the employment income would otherwise be chargeable under the 2003 Act. In that case, the performance of the duties of employment is instead treated for income tax purposes as the carrying on of a trade in the UK. The rule can apply to only part of the work under a contract, if the diver also does other work or the same kind of diving elsewhere.

The First-tier Tribunal found that this treatment, originating in section 29 of the Finance Act 1978, existed because divers of this class commonly incurred their own costs and were to have the more generous expenses regime available to self-employed people. Lord Briggs saw no good reason to doubt that finding. The provision was not meant to resolve uncertainty about whether such divers were really employed or self-employed: it applies only to employed divers.

The disagreement below

Mr Fowler argued that section 15 required his duties to be treated as a trade for UK income-tax purposes and therefore, through article 3(2), for the treaty. On that argument article 7 applied rather than article 14. Henderson and Baker LJJ, the majority in the Court of Appeal, accepted it. Lewison LJ, and Marcus Smith J in the Upper Tribunal, reached the opposite conclusion. HMRC appealed.

The Supreme Court’s reasoning

Lord Briggs, with whom Lord Hodge, Lady Black, Lady Arden and Lord Hamblen agreed, started from the construction of articles 7 and 14 in the context and purposes of the treaty. The meaning of their terms is found, where article 3(2) requires it, in UK income-tax law. Nothing in the treaty requires those articles to be applied to a fictional world created by UK legislation. They apply to the real world unless article 3(2) means that a deeming provision changes the meaning which the treaty terms would otherwise have. Lord Briggs considered that reading to be supported by the OECD commentary on the model convention on which the treaty is based, and by the need to treat the treaty as a negotiated bilateral agreement rather than as a purely English text.

Without section 15, article 14 would apply on the assumed facts. Section 4 of the 2003 Act defines employment, and the remuneration would be employment income under sections 6 and 7. UK tax law would not treat Mr Fowler as making trade profits or his business as that of an enterprise.

Section 15 does not work by giving those terms a different meaning. It uses “employment” and “employment income” in the same sense as the 2003 Act, and “trade” in its conventional sense. Introduced by the word “instead”, it then provides that income from the performance of those employment duties is to be taxed as if, contrary to the fact, it were profits of a trade. Section 6(5) itself recognises that the income charged under section 15 is employment income. The fiction adjusts the basis of a continuing UK charge, in particular by allowing more generous deduction of expenses. It is not created in order to decide whether a qualifying diver is taxable in the UK, or to choose between the UK and South Africa as the recipient of the tax.

Lord Briggs therefore held that using section 15 to change the meaning of the treaty terms, and so to make a qualifying diver immune from UK tax, would go beyond the fiction’s purpose and would be anomalous. Article 3(2) should not be read so as to bring such a diver within article 7 rather than article 14. That would also be contrary to the treaty’s purposes. As article 2(1) recognises, the treaty is not concerned with the manner in which taxes falling within it are levied. Section 15 charges income tax on an employed diver’s employment income, but does so in a particular manner which includes the fiction that the diver is carrying on a trade.

Verdict: The Supreme Court unanimously allowed HMRC’s appeal. If Mr Fowler was employed, the treaty permitted the UK to tax his remuneration under article 14. The special rule for calculating an employed diver’s tax did not convert his pay into business profits under article 7. His actual employment status was outside the preliminary issue.

Source: Fowler v Commissioners for Her Majesty’s Revenue and Customs [2020] UKSC 22