Deemed to fail: Fowler v HMRC

Statutory provisions which deem something to be the case that is not, in reality, true are relatively common.  These 'statutory fictions' are particularly abundant in the world of tax.  An interesting case on this has been progressing through the court system, concerning income of a deep-sea diver, a Mr Fowler. The case has reached the Supreme Court and its judgment has just surfaced (Fowler v Revenue and Customs [2020] UKSC 22).

Mr Fowler was South African resident and non-UK resident.  He was employed to dive in the waters of the UK continental shelf. The income that he received from this employment was, in principle, subject to UK tax, on the basis that his employment duties were performed within the UK.  However, there was an argument that the income was exempt from UK tax under the provisions of the double taxation treaty (DTT) between the UK and South Africa.  This would be the case if the income fell within the 'business profits' article of the DTT, as profit of an 'enterprise'. Conversely, if the income fell within the employment income article, there would be no such exemption and the income would be taxed.

There was no doubt at all that, in the real world, the income was employment income. However, scope for argument about the position under the DTT was created by a rather recherché provision of the UK income tax legislation, concerning certain divers and diving supervisors who have been employed to carry out 'seabed diving activities' in the waters of the UK continental shelf.  Under this rarefied rule, the duties of employment of such individuals are 'treated for income tax purposes as the carrying on of a trade in the United Kingdom'.  

Mr Fowler's argument was that, as he was deemed to be trading under the UK income tax legislation, this deeming should be carried to its logical conclusion and his remuneration should be treated as trading profit for the purposes of the DTT , so that it was exempted from UK tax under the 'business profits' article.  Naturally, HMRC took the opposite view.  Who was right?

The Court of Appeal's decision was categorically in favour of Mr Fowler ('... there can be no room for doubt about the answer to this question ...').  Rather amusingly (although not for Mr Fowler), the Supreme Court has come to the opposite conclusion - in a relatively short, unanimous and equally categorical judgment.  It held that the fact that Mr Fowler's income was employment income in the real world overrode the statutory fiction, or rendered it irrelevant.  According to Lord Briggs, who delivered the Supreme Court's judgment, the issue had to be approached with an eye to the presumed purpose of the deeming provision.

Statutory fictions can give rise to acute interpretative conundrums, and it can be terribly difficult to say how far they should be taken.  In well-known cases where this issue has been addressed, it has been stated that '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', and should apply the fiction unless doing so would produce 'unjust, absurd or anomalous results'.  The application of the fiction in Mr Fowler's case certainly would not have produced any injustice, absurdity or anomaly.  Although the unanimity and brevity of the Supreme Court judgment might suggest otherwise, his case could very easily have gone the other way. 

The importance of the decision, for those of us who are not internationally mobile deep-sea divers, concerns the interaction of statutory fictions in the UK tax code with DTT provisions more generally. The UK tax legislation contains a good number of provisions that cause receipts that are capital gain as a matter of general law to be treated for tax purposes as income.  These include offshore income gains, profits from deeply discounted securities and chargeable event gains.  Up to now there has been considerable uncertainty about whether, for the purposes of a DTT, such gains fall within the capital gains article or the 'other income' article.  On the basis of the Fowler decision, the answer appears to be that the capital gains article is the relevant one.

What the Fowler case does not, on any view, address is the treatment under DTTs of deemed income where, in the real world, no income or gain has been realised by the taxpayer at all.  This kind of deemed income is rather common in the UK tax system, and is a different kettle of fish.  Examples include income attributed to individuals under the settlements code, the transfer of assets abroad code, and the rules on offshore reporting funds that don't distribute all their income.  In these cases there is no 'real world' income or gain that can determine which DTT article has jurisdiction.  It seems most likely therefore that these kinds of deemed income must fall within the DTT article that deals with 'other income'.  

However, other views are perhaps possible.  For example, if income is attributed to the settlor of a trust under the settlements code, by reference to income received by the trust, it might be argued that for the purposes of a DTT such attributed income ought to be characterised in the same way as the actual income of the trust; so that, for example, the attributed income should be dealt with under the DTT article dealing with dividend income insofar as the actual trust income is dividends.  This is arguable because the settlements code deems the actual income of the trust to have been received by the settlor.

There are no easy answers to these issues.  Although the Fowler decision has shot a little light into these deep and dark waters, they continue to be somewhat murky.