The taxpayer was a resident of South Africa for purposes of the U.K-South Africa Convention (the “Treaty”) who, as an employee, undertook diving engagements in the UK continental shelf waters. S. 15 of the Income Tax (Trading and Other Income) Act 2005 deemed divers in the continental shelf area, whose duties consisted mainly of seabed diving activities, to thereby be carrying on a trade in the U.K. The majority of the Court of Appeal restored the decision of the FTT, which was that by virtue of s. 15 the taxpayer’s diving income was to be treated for purposes of the Treaty as business profits (Art. 7) rather than employment income (Art. 14), so that such business was not subject to U.K tax given that he had no U.K permanent establishment.
After referring (at para. 36) to the Marshall v Kerr principle that “because one must treat as real that which is only deemed to be so, one must treat as real the consequences and incidents inevitably flowing from or accompanying that deemed state of affairs, unless prohibited from doing so," Henderson LJ stated (at paras. 39, 42):
The unambiguous effect of the deeming in section 15(2) is … that the performance by Mr Fowler of the relevant diving activities is treated as the carrying on by him of a trade, giving rise to trading income … . This treatment entirely displaces the charge to tax on employment income … . Furthermore, to the extent that Mr Fowler's activities were comprised in the deemed trade, they could not simultaneously be regarded for any income tax purposes as performance by him of the duties of his actual employment.
My approach does not depend to any significant extent on the provisions of article 3(2) … however, I would accept … that the purpose of article 3(2) is to anchor the provisions of the treaty … to the domestic tax law of the Contracting State which is applying the treaty.
In his concurring reasons, Baker LJ stated (at para. 47):
The term "employment" is not defined in the treaty and, under article 3(2), is ascribed the meaning that it has under UK tax law. Under that law, in respect of his seabed diving activities as defined in s.15…, Mr Fowler is deemed not to be in employment but rather carrying on a trade. Insofar as his income falls within s.15, it follows that it is not remuneration in respect of an employment under UK law and as a result article 14 of the treaty does not apply. Mr Fowler's income … therefore falls within article 7.
In the dissenting reasons, Lewison LJ stated (at para 13) that Art. 3(2) permitted reference to the general common law of England to determine the meaning of “employment,” and further stated (at para. 22):
I cannot extract from [a South African] case the general proposition that a word used in a double tax treaty to describe a particular source of income or gain necessarily encompasses a domestic deeming provision, particularly where the word in question is defined in domestic tax law … .