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May 31, 2016

M.F. Fowler v HMRC – The Effect of UK Law on Double Tax Treaties

This case illustrates the complex interactions between domestic tax law and international double tax treaties, and highlights the importance of understanding the historic changes to UK tax law.

The Facts

Mr Fowler was resident in South Africa under the UK-South Africa Double Tax Treaty 2002 (DTT).  Between 2011/2012 and 2012/13 he worked as a qualified diver in the North Sea on the UK’s continental shelf.

HMRC sought to tax his income under Article 14 (Income from Employment) of the DTT. Under this Article, employment income would be chargeable to UK income tax.

Mr Fowler challenged this move by HMRC, instead regarding his income as business profits falling within Article 7 (Business Profits) of the DTT.  As he did not have a "permanent establishment" in the UK, trade profits under this Article would not be subject to UK tax and would instead be chargeable to South Africa.

The central question before the First-Tier Tribunal was: how far does domestic legislation affect international agreements?

The Case

Mr Fowler contended that, under section 15 of the Income Tax (Trading and Other Income) Act 2005, his income was trade income, not employment income.

This provision had originally been enacted in the Finance Act 1978 and deems the employment duties of divers and diving supervisors as carrying on a trade in the UK.

Trade income falls within Article 7 (Business Profits) of the DTT under which business profits carried out by a South African resident would only be chargeable in the UK if they had a permanent UK establishment.

As Mr Fowler had no UK establishment, he contended he was not chargeable to UK income tax.

HMRC contended that Article 14 (Income from Employment) was merely concerned with the right to tax income, not with how it was taxed.  The fact that the UK had chosen to grant special provisions for divers did not alter the legal character of the employer/employee relationship.

Allowing Mr Fowler’s position would, according to HMRC, allow the UK to unilaterally swap between different Articles of the DTT by creating “domestic statutory fiction”.

The Decision

The Tribunal judge emphasised the special rule of interpretation of Article 3(2) of the DTT which requires that terms not defined in the DTT be interpreted according to domestic law.

Article 7 (Business Profits) contained such undefined terms.  As section 15 of ITTOIA 2005 deemed Mr Fowler’s income to be trading income, the judge found that it fell within Article 7 (Business Profits); it was not chargeable to UK income tax.

The judge also dismissed HMRC’s concerns over creating domestic statutory fiction, finding that the recourse to domestic law for undefined terms did not allow states to undermine the DTT.

Article 31(1) of the Vienna Convention on the Law of Treaties requires treaties to be interpreted “in good faith”.

The provisions of section 15 of ITTOA 2005 were not a breach of good faith as they had existed (in some form) long before the DTT was signed in 2002.

However the judge did note that a state changing its domestic law after completing a treaty might contravene this good faith requirement.  In such a case, the interpretation of undefined terms according to Article 3(2) would need to consider the domestic law at time of drafting.

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