Deeming provision in UK tax act did not apply to tax treaty, says UK Supreme Court

Out-Law News | 21 May 2020 | 2:26 pm | 2 min. read

A provision in a UK income tax act treating an employed diver as self-employed did not affect the interpretation of the UK/South Africa double tax treaty, the UK's Supreme Court has decided.

“The decision is useful in terms of clarifying how terms will be interpreted in a double tax treaty and confirms that when a fiction is created under one of the signatory's tax codes this will sometimes be disregarded so as not to lead to a result which appears contrary to the purpose of the treaty,” said Jake Landman, a tax disputes expert at Pinsent Masons, the law firm behind Out-law.

The case concerned Martin Fowler, a South African resident diver who undertook diving engagements in the UK Continental Shelf waters.

HMRC claimed that the income he earned from those diving engagements was subject to UK tax, but Fowler claimed that under the terms of the UK/South Africa double tax treaty (the Treaty) it was not taxable in the UK.

The Treaty provides for employment income to be taxed in the place where it is earned, in this case in the UK, but for the earnings of self-employed persons to be taxed only where they are resident, in Fowler’s case in South Africa.

Fowler claimed that since employed divers operating in UK Continental Shelf waters are treated under UK tax law as if they are self-employed for income tax purposes, he should not be treated as an employee when interpreting the Treaty.  

The Supreme Court noted that since Fowler would probably be treated as an employee by the South African tax authorities, this interpretation would probably mean that Fowler was not taxed anywhere on this income.

The Treaty contains no definition of 'employment' but states 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.

"Nothing in the Treaty requires articles 7 [the business profits article] and 14 [the employment income article] to be applied to the fictional, deemed world which may be created by UK income tax legislation," Lord Briggs said giving the judgment of the Supreme Court.

"If one asks, as is required, for what purposes and between whom is the fiction [that employed divers are self employed] 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," Lord Briggs said. "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 … 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."

The Supreme Court said that the Treaty should not be construed so as to bring a qualifying diver within the business profits article of the treaty rather than the employment income article. "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," the judgment said.

The decision of the Supreme Court overturns a majority decision of the Court of Appeal in favour of Fowler.

"This case demonstrates the unpredictable nature of some tax litigation," Landman said. "The First-tier tribunal (FTT) initially found in favour of Fowler before the Upper Tribunal reversed this and then the Court of Appeal reinstated the FTT decision. The Supreme Court has then reversed the decision on appeal again. Essentially the party in the position of the appellant has won at each stage."