The purpose of double tax agreements (“DTA” or “treaty”) between the tax administrations of two countries is to enable the administrations to eliminate double taxation, where each country intends to levy a tax in respect of the same amount of personal income. South Africa has a very favourable treaty network across the world. Generally, the provisions of double tax agreements have preference over local legislation, so one needs to take notice when a court delivers judgment on a matter contained in a DTA.
The Supreme Court in the United Kingdom (UK) recently delivered judgement in Fowler (Respondent) v Commissioners for Her Majesty’s Revenue and Customs (Appellant) (“HMRC”). This is one of the few cases where provisions of the double tax agreement between the UK and South Africa has been tested in a court of law.
Mr Fowler is a deep-sea diver. He is a South African resident (but UK non-resident) and was employed to dive the waters off the UK’s continental shelf. He received income from these diving activities, which was principally subject to tax in the UK, based on the premise that his employment duties were based and performed within the UK. Two interesting arguments can be made of the SA-UK treaty, namely that the income would be exempt under UK tax laws if it was earned and fell within the “business profits” article of the DTA, as profits of an enterprise. A counter to this was that if the income fell within the “employment income” article, there would be no exemption, and would be fully taxable in the UK. The main issue is therefore whether Article 7 (on business profits) of the UK-South Africa Double Taxation Treaty or Article 14 DTC (on income from employment) applies for the purpose of allocating taxing rights in respect of remuneration for services provided by a diver in the UK under a contract of employment.
UK income tax legislation treated employment duties of seabed divers and seabed diving activities as the carrying on of a trade in the UK. Mr Fowler’s argument was that because he was deemed to be “trading” under the UK legislation, the remuneration should be treated as trading profits for the purposes of the SA-UK treaty. His premise was that “employment” was undefined in the DTA, and that the section relied upon the UK’s income tax legislation which reclassified his income as coming from a trade, and not employment. This meant it was exempt from UK tax under the “business profits” article of the DTA. HMRC took the opposing view, arguing that this was taxable employment income within the UK.
The Supreme Court unanimously allowed HMRC’s appeal, holding that Mr Fowler should be treated as an employee and is subject to UK income tax. Expressions in the treaty, such as “salaries, wages and other remuneration”, “employment” and “enterprise”, should be given their ordinary meaning unless domestic legislation alters the meaning which they would otherwise have. UK legislation provides that a person who would otherwise be taxed as an employee is “instead treated” as self-employed for the purposes of domestic income tax.
Deeming provisions of this kind create a “statutory fiction” which should be followed as far as required for the purposes for which the fiction was created. The courts recognised the consequences of that fiction being real, but not where this will produce unjust, absurd or anomalous results. Properly understood, UK legislation taxes the income of an employed diver in a particular manner which includes the fiction that the diver is carrying on a trade. That fiction is not created for the purpose of rendering a qualifying diver immune from tax in the UK, or for adjudicating between the UK and South Africa as potential recipients of tax, but to adjust the basis of a continuing UK income tax liability. Since the treaty is not concerned with the manner in which taxes are levied, it would be contrary to the purposes of the treaty to redefine its scope in reference to UK legislation. It would also be contrary to the purpose of UK legislation and would produce an anomalous result.