Article 3

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.

Lord Brigg, in allowing the appeal, stated (at paras. 30, 31, 33, and 34):

Nothing in the Treaty requires articles 7 and 14 to be applied to the fictional, deemed world which may be created by UK income tax legislation. Rather they are to be applied to the real world, unless the effect of article 3(2) is that a deeming provision alters the meaning which relevant terms of the Treaty would otherwise have. … Were it not for section 15 of ITTOIA, there would be no doubt that article 14, not article 7, would apply to Mr Fowler’s diving activities … .

So the question is whether section 15 gives a different meaning to the relevant terms. That is not how a deeming provision works generally, nor does section 15(2) in particular. …

[S]ection 15 creates this fiction [that the diver is carrying on a trade] not for the purpose of deciding whether qualifying employed divers are to be taxed in the UK upon their employment income, but for the purpose of adjusting how that income is to be taxed, specifically by allowing a more generous regime for the deduction of expenses. … [I]t 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. … [T]o apply the deeming provision in section 15(2) 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.

Nor should article 3(2) of the Treaty be construed so as to bring a qualifying diver within article 7 rather than article 14. 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 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 … .

Two Caymans investment LPs (“RCF IV” and RCF V”) whose limited partners were mostly U.S. residents, realized gains from the disposal of significant shareholdings in an Australian TSX-listed corporation (Talison Lithium) which, through a grandchild corporation held mining leases in Australia and carried out an operation there of mining lithium ores and processing them. Before finding that the U.S.-resident partners’ share of the partnership gains from selling the shares of Talison Lithium was not exempt under Art. 7 of the Australia-U.S. Convention because of the exclusion in Art. 13 for dispositions of (deemed) real property situated in Australia, Pagone J found that such gains were from “entreprises of” the U.S. limited partners, stating (at para. 57) that this expression encompassed “a passive investment activity" of the U.S.-resident partners, and stating further (at para. 57) that:

…in Thiel, their Honours said that “no element of repetition or system should be attributed to [the] expression” “enterprise of one of the Contracting States” by reference to the use of the words “carried on”… . Neither the RCF IV partnership nor the RCF V partnership is a separate taxable entity to be taxed separately from the partners and their agents. The taxable activity in each case was an investment in … Talison Lithium which was carried out on their behalf by their respective General Partners.

The taxpayer was a resident of South Africa for purposes of the U.K-South Africa Convention (the “Treaty”) who, likely as an employee, undertook diving engagements in the UK continental shelf waters. S. 15 of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA”) 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. This was a reference on the question whether the application of s. 15 to the taxpayer would have the effect of deeming his diving income to be treated for purposes of the Treaty as business profits (Art. 7) rather than employment income (Art. 14). His position was that he had no permanent establishment in the U.K., so that his business profits would not be subject to U.K. income tax.

After referring to Art. 3(2) of the Treaty (which corresponded to Art. 3(2) of the OECD Model Convention) and to the interpretive principles established under the Vienna Convention, as judicially interpreted, and before concluding that the taxpayer’s income from diving would fall within Art. 7, Brannan J stated (at paras. 107, 111):

[T]he words “enterprise” and “business” are not defined terms for the purposes of Article 3(2). It follows that the meaning of these terms, as well as the meaning of “salaries, wages and other similar remuneration derived… in respect of an employment”, must be determined in accordance with domestic UK tax law.

…[T]he phrase “[t]he profits of an enterprise” within Article 7 includes the charge to income tax on the “profits of a trade, profession or vocation” within the meaning of section 5 ITTOIA 2005 and that it also includes the profits arising from the deemed trade pursuant to section 15 ITTOIA.

And at paras 113 & 114:

It is the clear purpose of section 15 ITTOIA to re-characterise what would otherwise be the exercise of employment duties as the carrying on of a trade. In so doing, in my view, section 15 ITTOIA has the meaning that the activities of an employed diver in the UK Continental Shelf constitute trading activities and that the income therefrom must be trading income and, consequently, business profits within Article 7 – the treatment is the meaning.

Moreover, section 6(5) ITEPA[Income Tax (Earnings and Pensions Act] excludes income from the charge to income tax on employment income if the income falls within section 15 ITTOIA. This, therefore, has the meaning that, under the provisions of UK tax law which correspond to Article 14, Mr Fowler’s income is not employment income and cannot fall within Article 14.

Brannan J also stated (at para. 115):

If a Contracting State changes its domestic law after the conclusion of a double tax treaty in such a way as to reallocate income from one article to another...that could contravene the requrements of good faith imposed by Article 31(1) of the Vienna Convention... .

That issue did not arise here as s. 15 was enacted well in advance of the Treaty in order to give a break (through greater deductions) to divers, whose activities were dangerous.

In January and May 1984 the taxpayer, who was a resident of Switzerland, paid $150,000 to acquire six units in the Energy Research Group Unit Trust, in November 1984 he sold his six units to Energy Research Group Australia Ltd. for $300,000 to be satisfied by the issuance to him of 600,000 ordinary shares of that company, and in 1985, following a listing of the shares on the Australian Stock Exchange, he sold 252,000 of his shares for $566,307. The majority found that the taxpayer's activities constituted an "enterprise" for purposes of Article 7 of the Australia-Switzerland Convention regardless whether they constitued an isolated adventure or the recurring conduct of a business. Accordingly, the profits of this enterprise were exempt from taxation under the Income Tax Assessment Act 1936 (Australia).