Fowler v Commissioners for Her Majesty’s Revenue and Customs

A double taxation treaty allocates taxing rights by reference to real-world legal relationships. A clause giving undefined treaty terms their domestic tax-law meaning does not ordinarily import a domestic statutory fiction unless the fiction changes the meaning of those terms. A deeming provision must be construed by its statutory purpose and applied no further than that purpose requires, while recognising its necessary consequences. A provision treating employed divers’ duties as a trade for income-tax purposes changes the manner in which their employment income is taxed. It does not convert employment into a business enterprise for treaty purposes. Accordingly, where the employment is exercised in the United Kingdom, the treaty article governing employment income applies rather than the article governing business profits.

Mr Fowler was resident in South Africa and worked as a diver on the UK Continental Shelf. For determination of the preliminary issue, the court assumed that he performed the engagements as an employee. Section 15 of the Income Tax (Trading and Other Income) Act 2005 nevertheless required the duties of qualifying employed divers to be treated, for income-tax purposes, as the carrying on of a trade.

The Upper Tribunal reached the view later adopted by the Supreme Court. A majority of the Court of Appeal held that the statutory fiction governed the meaning of the UK–South Africa double taxation treaty, so that the business-profits article applied: [2018] EWCA Civ 2544. The central issue was whether article 3(2), which refers undefined treaty terms to domestic law, imported the section 15 fiction and displaced the treaty article governing employment income.

1. The appeal was allowed unanimously. Lord Briggs delivered the judgment, with which Lord Hodge, Lady Black, Lady Arden and Lord Hamblen agreed. On the assumed facts, article 14 of the UK–South Africa treaty governed the diver’s remuneration and permitted the United Kingdom to tax it.

2. The treaty had to be interpreted as a bilateral international agreement by reference to the ordinary contextual meaning of its terms, its object and its purpose. Article 3(2) was an always-speaking provision: an undefined term took its current meaning under the applicable domestic tax law unless the context required otherwise. That provision did not require treaty articles to be applied to a fictional world created by domestic tax legislation. This approach accorded with Commissioners for Her Majesty’s Revenue and Customs v Anson [2015] STC 1777 and Revenue and Customs Commissioners v Smallwood (2010) 80 TC 536.

3. The extent of a statutory fiction depended primarily on construing the legislation creating it. The court should identify its purpose and the persons between whom it operated. The fiction should extend to its necessary consequences, but not to effects clearly outside its purpose or to anomalous results unless clear language compelled them.

4. Section 15 of the Income Tax (Trading and Other Income) Act 2005 did not redefine “employment”, “employment income”, “trade” or “enterprise”. It began from the premise that the diver was employed and created a fiction under which income from specified employment duties was taxed as trading profit. Section 6(5) of the Income Tax (Earnings and Pensions) Act 2003 confirmed that the income remained employment income.

   The purpose of the fiction was to adjust how an existing UK income-tax liability was calculated, particularly by enabling the more generous expenses regime available to the self-employed. It was not intended to allocate taxing rights between states or render qualifying divers immune from UK taxation. Giving it that wider effect would exceed its purpose and produce an anomalous result.

5. Article 2(1) confirmed that the treaty was not concerned with the manner in which covered taxes were levied. Article 3(2) therefore did not bring the diver within article 7. Article 14 applied to the real employment relationship, while section 15 continued to govern the domestic manner of taxation. The Court of Appeal’s decision was reversed.

1. United Kingdom Supreme Court: In [2020] UKSC 22, the court unanimously allowed HMRC’s appeal and reversed the Court of Appeal’s conclusion that the business-profits article applied.
2. Court of Appeal: By a majority, Henderson and Baker LJJ held that section 15’s statutory fiction governed the treaty analysis and that article 7 applied. Lewison LJ reached the contrary conclusion: [2018] EWCA Civ 2544.
3. Upper Tribunal: Marcus Smith J reached the conclusion subsequently adopted by the Supreme Court. No citation is stated in the judgment.
4. First-tier Tribunal: The tribunal found that the statutory treatment originated in the expenses commonly incurred by the relevant divers. Its full disposition and citation are not stated in the judgment.