Fowler v Commissioners for Her Majesty’s Revenue and Customs

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. Although his status has yet to be determined, the preliminary issue which is the subject of this appeal requires it to be assumed that he undertook those engagements as an employee, rather than as a self-employed contractor.

HMRC claim, but Mr Fowler denies, that the income which he earned from those diving engagements is subject to UK taxation. That depends on how the double taxation treaty between the UK and South Africa (“the Treaty”) applies to a person in his position. In a nutshell, the Treaty provides for employment income to be taxed in the place where it is earned, in the present case in the UK, but for the earnings of self-employed persons to be taxed only where they are resident, in Mr Fowler’s case in South Africa. Thus far the answer might appear to be simple. If (as is to be assumed) Mr Fowler was an employee, then he should be taxable only in the UK.

But the matter is complicated by two factors. The first is that employed divers doing the particular kind of diving work in UK waters which Mr Fowler did are, under UK tax law, to be treated as if they were self-employed for income tax purposes. The second is that terms used in the Treaty, if not defined in the Treaty itself, are to be given the meaning which they have in the tax law, or the general law, of the state seeking to recover tax, here the UK. Thus, if the effect of the UK tax law’s requirement to treat Mr Fowler as if he was self-employed is to govern the meaning of relevant terms in the Treaty, the outcome might be that he was to be treated as self-employed under the Treaty, and therefore taxable, if at all, in South Africa.

This was the conclusion of the majority in the Court of Appeal, from which HMRC appeals to this court. In fact, such an outcome could mean that Mr Fowler was not taxable in either country, because the question whether he was taxable in South Africa would not be governed by the meaning of Treaty terms established by reference to UK tax law. He would probably be treated in South Africa as an employee. To the extent that domestic South African tax legislation did not tax the earnings of residents employed abroad he would not be taxable there or in the UK. There is no general provision in this Treaty, as there is in many others, to deal with what is called “double non-taxation”. But the question whether South Africa did tax the earnings of its residents employed abroad was not investigated in these proceedings so it would be inappropriate to place any weight on this consideration in construing the Treaty.

The Double Taxation Treaty between the UK and South Africa takes the form of a Convention ( and is described in the Treaty as “the Convention”) which came into force in the UK by means of the Double Taxation Relief (Taxes on Income) (South Africa) Order 2002 (SI 2002/3138), being annexed to the order in the form of a Schedule. Its preamble recites that it had been agreed for the purpose of promoting and strengthening the economic relations between the two countries, avoiding double taxation and preventing fiscal evasion. For present purposes the most relevant provisions are as set out below. Other provisions will be mentioned in due course.

Article 1 headed “Persons Covered” provides that:

Article 3 is a definition provision. Paragraph (1) contains a number of specific definitions, some exclusive and some non-exclusive, and all under the preamble “unless the context otherwise requires”. Only three need be quoted.

Article 3(2) is all-important:

Looking at article 3 as a whole, the following points may be noted. First, paragraph (2) provides an “always speaking” means of ascertaining the meaning of terms in the Treaty which are undefined therein. It is always speaking because it requires meaning to be ascertained by reference to the national law of a Contracting State “at that time”, that is at the time when the Treaty falls to be applied. Secondly, the “terms” of the Treaty which fall to be given meaning for the purposes of this appeal are “employment”, “business” and “enterprise”. “Employment” is not a defined term, so that article 3(2) applies to it with full force. But “enterprise” is defined, and “business” has a partial definition, in both cases in article 3(1).

Article 7 is concerned with business profits. Its relevant provisions are as follows:

Applying the definitions in article 3(1) quoted above, if Mr Fowler had been, within the meaning of the Treaty, carrying on an enterprise by his diving activities on the UK continental shelf, it would nonetheless have been an enterprise of South Africa and the profits taxable (if at all) there. This is because it is common ground that he had no permanent establishment in the UK.

Article 14 is about income from employment. It is only necessary to consider paragraph (1):

Article 17 deals with pensions and annuities. Paragraph (1) provides that:

Articles 7, 14 and 17 illustrate one of the main methods by which the Treaty seeks to avoid double taxation, namely by identifying specific categories of income (or profits) and providing for each to be taxable in one or other Contracting State. Thus employment income is taxed where it is earned, whereas business profits are (subject to the rules about permanent establishment) taxable where the relevant business enterprise is resident. By contrast with employment income, pensions are taxable where the employee is resident.

The other main method by which double taxation is avoided is by requiring credit to be given by one contracting state for tax charged or paid in the other. Article 21 headed “Elimination of Double Taxation” is the main provision to this effect. Article 24 headed “Mutual Agreement Procedure” enables a taxpayer to raise an objection to double taxation, leading to resolution by discussion between the competent tax authorities of both states. Finally, the recited objective of dealing with tax evasion is dealt with by provisions for exchange of information and mutual assistance in tax collection in articles 25 and 25A (as, respectively, substituted and inserted by the Schedule to the Double Taxation Relief and International Tax Enforcement (South Africa) Order 2011 (SI 2011/2441)).

Guidance as to how the Treaty is to be interpreted as a whole is to be found in the Vienna Convention on the Law of Treaties, concluded in May 1969, in OECD commentaries on the OECD Model Tax Convention (“the MTC”), on which the Treaty is based, and in some UK authorities. Beginning with the Vienna Convention, article 31 provides, so far as is relevant, that:

Articles 7 and 14 of the Treaty have their origin in similar but differently numbered provisions in the MTC. The predecessors of articles 7 and 14 are articles 7 and 15 of the MTC. The OECD Commentary on article 15 notes, at para 8.1, that:

The OECD Commentaries are updated from time to time, so that they may (and do in the present case) post-date a particular double taxation treaty. Nonetheless they are to be given such persuasive force as aids to interpretation as the cogency of their reasoning deserves: see Revenue and Customs Comrs v Smallwood (2010) 80 TC 536, para 26(5) per Patten LJ. Existing UK authority gives some relevant general guidance on the interpretation of double taxation treaties. In Comrs for Her Majesty’s Revenue and Customs v Anson [2015] STC 1777 this court was considering the UK / USA Treaty. It was common ground that article 31 of the Vienna Convention applied. At paras 110-111, giving the leading judgment, Lord Reed said:

In the Smallwood case the Court of Appeal was considering the UK / Mauritius double tax treaty. At paras 26-29 Patten LJ provided a useful summary of the correct approach to interpretation, largely based on dicta of Mummery J in Inland Revenue Comrs v Commerzbank AG [1990] STC 285. The whole passage repays reading, but para 29 is worth quoting in full:

Tax on the earnings of employees is regulated by the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”). Section 4 defines “employment”, as follows:

Sections 6 and 7 of ITEPA deal with employment income (section 6(5) as amended by section 882(1) of, and paragraph 585 of Schedule 1 to, the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA”)). The relevant parts are as follows:

Section 5 of ITTOIA contains the primary charging provision on trading profits, in the simplest possible terms:

Section 15, dealing with the income of certain divers and diving supervisors is central to this appeal. It provides:

Certain points about section 15 are plain, and common ground. First, it only applies to a particular class of employed divers, whose employment income would otherwise be taxable under ITEPA. Secondly, the types of divers covered are defined by reference to a particular kind of diving, and only if undertaken in UK or related waters. Thirdly, it may therefore apply only to part of the activities of divers under a particular contract of employment, since they might also be engaged to do other types of diving as well, or diving of the specified type in other waters.

The reason for this particular tax treatment of this class of divers was a matter of some debate in submissions before this court. But the FtT found that it was because, at least at the time of the enactment of the precursor to section 15, section 29 of the Finance Act 1978, this class of divers commonly incurred their own costs, and therefore deserved the more generous expenses regime afforded to the self-employed, by comparison with employees. The FtT relied on an opinion to that effect published by the Office of Tax Simplification in March 2011, in preference to broader but less persuasive observations by the Financial Secretary to the Treasury in February 1978 when announcing the intention to introduce section 29: Hansard (HC Debates), 3 February 1978, written answers, col 359. There is no good reason to doubt that essentially factual finding by the FtT. It is clear that it was not a purpose of the deeming provision in section 15(2) to resolve some legal or factual uncertainty about whether such divers were genuinely employed or self-employed. On the contrary, section 15 applies only to employed divers.

ITTOIA contains two other deeming provisions similar to section 15(2), in section 9(1) relating to farming and market gardening and in section 12(2) relating to the profits of mines and quarries. But neither of these provisions, or their underlying purposes, shed useful light on the issues in this appeal.

There are useful but not conclusive dicta in reported authorities about the way in which, in general, statutory deeming provisions ought to be interpreted and applied. They are not conclusive because they may fairly be said to point in different directions, even if not actually contradictory. The relevant dicta are mainly collected in a summary by Lord Walker in DCC Holdings (UK) Ltd v Revenue and Customs Comrs [2011] 1 WLR 44, paras 37-39, collected from Inland Revenue Comrs v Metrolands (Property Finance) Ltd [1981] 1 WLR 637, Marshall v Kerr [1995] 1 AC 148; 67 TC 56 and Jenks v Dickinson [1997] STC 853. They include the following guidance, which has remained consistent over many years:

The extent of the fiction created by a deeming provision is primarily a matter of construction of the statute in which it appears.

For that purpose the court should ascertain, if it can, the purposes for which and the persons between whom the statutory fiction is to be resorted to, and then apply the deeming provision that far, but not where it would produce effects clearly outside those purposes.

But those purposes may be difficult to ascertain, and Parliament may not find it easy to prescribe with precision the intended limits of the artificial assumption which the deeming provision requires to be made.

A deeming provision should not be applied so far as to produce unjust, absurd or anomalous results, unless the court is compelled to do so by clear language.

But the court should not shrink from applying the fiction created by the deeming provision to the consequences which would inevitably flow from the fiction being real. As Lord Asquith memorably put it in East End Dwellings Co Ltd v Finsbury Borough Council [1952] AC 109, at 133:

Mr Jonathan Schwarz for Mr Fowler persuaded a majority of the Court of Appeal (Henderson and Baker LJJ), and has sought to persuade this court, that section 15 of ITTOIA compels us to treat a qualifying diver as carrying on a trade for all purposes under UK income tax law and therefore also under the Treaty as required by article 3(2), with the result that article 7 rather than article 14 applies to the taxation of his earnings. As Henderson LJ put it in the Court of Appeal at para 38:

Like Lewison LJ and Marcus Smith J in the Upper Tribunal I have, with respect, reached the opposite conclusion. My reasons follow. The starting point is that the question which of articles 7 and 14 of the Treaty applies to Mr Fowler’s diving activities depends upon the true construction of those articles, in the context of the Treaty as a whole and its purposes, with the meaning of terms within those articles ascertained as required by article 3(2) by reference to UK income tax law. The relevant terms are, in article 7, “profits” and “enterprise of a contracting state” and, in article 14, “salaries, wages and other similar remuneration” and “employment”.

Nothing in the Treaty requires articles 7 and 14 to be applied to the fictional, deemed world which may be created by UK income tax legislation. Rather they are to be applied to the real world, unless the effect of article 3(2) is that a deeming provision alters the meaning which relevant terms of the Treaty would otherwise have. This much is confirmed by paragraph 8(11) of the OECD Commentary quoted above, and it would be contrary to the requirement to treat the Treaty as a bilateral international agreement to do otherwise, as required by the dicta in the Anson case. Were it not for section 15 of ITTOIA, there would be no doubt that article 14, not article 7, would apply to Mr Fowler’s diving activities, at least on the necessary but as yet untested assumption that he really was an employee. The meaning of “employment” is laid down in section 4 of ITEPA, and his remuneration plainly constitutes employment income within sections 6 and 7. UK tax law would not regard him as making profits from a trade, or his business as being that of an establishment.

So the question is whether section 15 gives a different meaning to the relevant terms. That is not how a deeming provision works generally, nor does section 15(2) in particular. Section 15(1) uses “employment” and “employment income” in exactly the same way as is prescribed by sections 4, 6 and 7 of ITEPA, and the phrase “performance of the duties of employment” in section 15(2) again uses “employment” in the same way. Section 15 is about the taxation of income arising from the performance of those duties of employment but, introduced by the word “instead”, provides that the income is to be taxed as if, contrary to the fact, it was profits of a trade.

Section 15 also uses “trade” in its conventional sense and does not therefore alter the meaning of “enterprise” in article 7, it being common ground that enterprise is descriptive of a business, and that business includes trade. In short, nothing in section 15 purports to alter the settled meaning of the relevant terms of the Treaty, viewed from the perspective of UK tax law. Rather it takes the usual meaning of those terms as its starting point, and erects a fiction which, applying those terms in their usual meaning, leads to a different way of recovering income tax from qualifying divers.

Furthermore section 15 creates this fiction not for the purpose of deciding whether qualifying employed divers are to be taxed in the UK upon their employment income, but for the purpose of adjusting how that income is to be taxed, specifically by allowing a more generous regime for the deduction of expenses. This appears clearly from the express language of section 6(5) of ITEPA, which recognises that the income being charged to tax under section 15 is indeed employment income. If one asks, as is required, for what purposes and between whom is the fiction created, it is plainly not for the purpose of rendering a qualifying diver immune from tax in the UK, nor adjudicating between the UK and South Africa as the potential recipient of tax. It is for the purpose of adjusting the basis of a continuing UK income tax liability which arises from the receipt of employment income. Therefore to apply the deeming provision in section 15(2) so as to alter the meaning of terms in the Treaty with the result of rendering a qualifying diver immune from UK taxation would be contrary to its purpose. It would also produce an anomalous result.

Nor should article 3(2) of the Treaty be construed so as to bring a qualifying diver within article 7 rather than article 14. To do so would be contrary to the purposes of the Treaty. This is because, as is recognised by article 2(1), the Treaty is not concerned with the manner in which taxes falling within the scope of the Treaty are levied. Section 15, understood in the light of section 6(5) of ITEPA, charges income tax on the employment income of an employed diver, but in a particular manner which includes the fiction that the diver is carrying on a trade.

For those reasons I would allow this appeal.