Not far enough to let the taxpayer escape UK tax under the UK/South Africa Tax Treaty, according to the Supreme Court in Fowler v HMRC. In its recent judgment, overturning the Court of Appeal’s decision, the Supreme Court held that a South African resident diver was taxable in the UK on income from activities carried out in UK waters.

Although the case involves income from diving activities, which is admittedly rather niche, it illustrates more generally the challenges of working out the extent to which a statutory deeming provision should apply. Does the deeming provision extend only to the immediate purpose addressed by the provision, or does it go further? Is there any place for deeming provisions in the interpretation of tax treaties?

Deeming provisions

The deeming provision in question is section 15(2) of the Income Tax (Trading and Other Income) Act 2005. 

It provides that a qualifying diver who would otherwise be taxed as an employee is instead treated as self-employed for “income tax purposes”. Mr Fowler had argued this deemed self-employment treatment had to be carried over into the construction of the UK/South Africa Treaty. This would mean he would be taxed as a self-employed person under article 7 of the Treaty (and taxable only in South Africa where he was resident as he did not have a permanent establishment in the UK) rather than taxed as an employee under article 14 (and taxable only in the UK, where he worked). If Mr Fowler’s argument succeeded, he was unlikely to be actually subject to significant tax in South Africa because of the domestic law.

According to guidance on deeming provisions from earlier cases, the court must ascertain the purpose of the statutory provision and should not apply the deeming provision so far as to produce unjust, absurd or anomalous results unless the court is required to by clear language.

The purpose of the section 15(2) deeming provision, as the First-tier Tribunal established, is to give divers operating on the UK continental shelf more generous rights for deducting expenses than a normal employee would get (because historically employed divers provided their own equipment), but without taking them outside the UK income tax charge altogether. Accordingly, the fiction created by section 15(2) does not decide whether qualifying divers are to be taxed in the UK upon their employment income, but determines how that income is to be taxed in the UK by applying a more generous deduction of expenses regime. The UK legislation itself continues to recognise the income being charged to tax under section 15(2) as employment income (section 6(5) of the Income Tax (Earnings and Pensions) Act 2003).

The Supreme Court held that to apply the deeming provision to alter the meaning of terms in the Treaty with the result of rendering a qualifying diver immune from UK tax would be contrary to its purpose and would produce an anomalous result.

Treaty construction

The question whether article 7 or article 14 applies to Mr Fowler’s diving activities depends on the construction of those articles in the context of the UK/South Africa Treaty as a whole and its purposes.

Article 3(2) of the Treaty provides that any term not defined in the Treaty shall, unless the context otherwise requires, have the meaning that it has under domestic law for the purposes of the taxes to which the Treaty applies at the time when the Treaty falls to be applied. Is the domestic meaning for these purposes the “normal” domestic meaning or the deemed meaning?

The Supreme Court considered the purpose of a tax treaty is not to alter the basis of taxation adopted in each of the Contracting States or to dictate to each Contracting State how it should tax particular forms of receipts. The purpose of a tax treaty is to resolve issues of double taxation. The Supreme Court concluded that 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.

It is important to remember that a tax treaty is a bilateral, negotiated text. To permit, as the Court of Appeal did, the deeming provision to be applied to the Treaty, would result in the UK ceding its taxing rights to the diving income to South Africa rather than those rights remaining with the UK as negotiated under the Treaty. The Supreme Court’s decision is a good result for HMRC and a useful addition to the cases on treaty interpretation.