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Interpreting the language in a double taxation agreement

Monday, 09 May 2016   (0 Comments)
Posted by: Author: PwC South Africa
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Author: PwC South Africa

With the steady erosion of international boundaries in commerce, South African residents have become increasingly engaged in international transactions. In so doing, they have also become more exposed to the attentions of the tax authorities in the countries in which they may undertake those transactions. To some extent, the uncertainties of the tax landscape may be mitigated if the host country has entered into a double taxation agreement (DTA) with SA.

A double taxation agreement (DTA) regulates how a contracting state will impose tax on income derived by residents of the other state. However, uncertainty about taxation is not entirely resolved simply because there is a DTA in place.

One of the burning issues is that the language used in a DTA is typically borrowed from a template prepared by an international agency, such as the Organisation for Economic Co-operation and Development (OECD). As the domestic law of each state uses language and principles which have been crafted by its law officers, any differences in interpretation need to be reconciled.

The international templates recognise this difficulty. They provide guidance by including an article relating to interpretation, in which:

  • certain terms are defined specifically; and 
  • a reference point is given in terms of which each contracting state may interpret an undefined term in the manner applied under its domestic law. 

An example is Article 3 of the Model Tax Convention on Income and on Capital, issued by the OECD.

A recent decision from the Tax Tribunal in the United Kingdom has provided an illuminating example of applying these principles of interpretation to a DTA. That this matter involved the DTA between SA and the UK adds to its relevance.

The diver’s dilemma 

In the matter of MH Fowler v HMRC* (TC05009, judgment released 12 April 2016), the UK sought to impose tax on the revenue derived by Mr Fowler, an SA resident person who was employed as a qualified diver to undertake diving work on the UK Continental Shelf, North Sea section.

The issue determined by the Tribunal was a preliminary matter, concerned with identifying which Article of the DTA between SA and the UK was determinative of the dispute.

HMRC had assessed Fowler for tax on the basis that he had derived income from employment, alleging that it was entitled to do so by virtue of Article 14 of the DTA.

Fowler argued that the revenue he had derived was not classifiable as income from employment but as business profits, as set out in Article 7 of the DTA. Therefore, it was not taxable in the UK.

The principles

Under the relevant UK statute, the provisions of a DTA apply for (among other things) taxing the income of non-UK-resident persons that arises from sources in the UK despite anything in any enactment.

The term ‘employment’ is not defined in Article 3(1) of the DTA, and the Tribunal was therefore required to apply the principles set out in Article 3(2) of the DTA. This provides:

"As regards the application of the provisions of this Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which this Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State”.

The Tribunal also noted that a DTA must be interpreted in accordance with Articles 31 and 32 of the Vienna Convention on the Law of Treaties, 1969, quoting the summary of Lord Reed in Anson v Commissioners for HM Revenue & Customs [2015] UKSC 44, at 56:

Put shortly, the aim of interpretation of a treaty is therefore to establish, by objective and rational means, the common intention which can be ascribed to the parties. That intention is ascertained by considering the ordinary meaning of the terms of the treaty in their context and in the light of the treaty's object and purpose. Subsequent agreement as to the interpretation of the treaty, and subsequent practice which establishes agreement between the parties, are also to be taken into account, together with any relevant rules of international law which apply in the relations between the parties. Recourse may also be had to a broader range of references in order to confirm the meaning arrived at on that approach, or if that approach leaves the meaning ambiguous or obscure, or leads to a result which is manifestly absurd or unreasonable.

Fowler contended that he was employed as a diver as contemplated in Section 15 of the Income Tax (Trading and Other Income) Act of the UK and that the remuneration paid to him should be taxed as business profits under the DTA, not as income from employment.

The issue

At the heart of the issue is section 15 of the Income Tax (Trading and Other Income) Act of the UK:

15. Divers and diving supervisors

(1) This section applies if—

(a) a person performs the duties of employment as a diver or diving supervisor in the United Kingdom or in any area designated by Order in Council under section 1(7) of the Continental Shelf Act 1964 (c. 29), 

(b) the duties consist wholly or mainly of seabed diving activities, and 

(c) any employment income from the employment would otherwise be chargeable to tax under Part 2 of ITEPA* 2003. 

(2) The performance of the duties of employment is instead treated for income tax purposes as the carrying on of a trade in the United Kingdom.

Fowler contended that he was employed as a diver as contemplated in this section and that the remuneration paid to him should be taxed as business profits under the DTA, not as income from employment.

He relied on the interpretation placed on the nature of his activities under the tax law of the UK. This stated that his income was not regarded as employment income for income tax purposes.

Brannan J was astute in pointing out that the deeming provision under which Fowler based his argument was not an isolated one and that a number of similar provisions could be found in the statute relied upon by HMRC.

HMRC asserted that the term ‘income from employment’ fell to be interpreted under common usage and not by reference to the deeming provision in the domestic law.In this regard, the word ‘shall’ used in Article 3(2) was not to be regarded as mandatory, but merely as an aid to interpretation.

The decision

The initial decision related to the application of Article 3(2) of the DTA. Brannan J noted (paragraph 99 of the decision):

Article 3(2) of the Treaty mandates that any term not defined in the Treaty ‘shall’ have the meaning that it has [applicable under] the tax laws of the Contracting State applying the Treaty (i.e. the UK). The meaning shall be that for the purposes of the taxes to which the Treaty applies.

Parties to a DTA are required to apply the terms of the DTA in good faith, having regard to the object and purpose of the DTA. A distinction is found in the DTA between the use of the words ‘shall’ and ‘may’, and the importance of the distinction was emphasised in paragraph 101, where Brannan J noted:

Throughout the Treaty the words ‘shall’ and ‘may’ are used deliberately to indicate mandatory and permissive provisions.

Where the DTA directs that terms must be interpreted based on the domestic principles of the state applying its provisions, the normal rules of interpretation apply to the process of arriving at the meaning and application of those terms.

After providing an illustration of the different effect of these words used in the DTA in the context of dividend income and employment income, Brannan J observed (paragraph 101):

The essential point is that those drafting the Treaty (and the OECD Model Convention on which the Treaty is based) were careful to use the word ‘shall’ when a mandatory provision was intended … The use of the word ‘shall’ in Article 3(2) indicates that recourse must be had to the relevant provisions of domestic tax law in priority to any other meaning, unless the context otherwise requires.

Brannan J then examined whether the DTA contained an acceptable definition of the terms ‘enterprise’, ‘business’ and ‘salaries, wages and other similar remuneration derived … in respect of an employment’, and concluded that these terms were not defined, which meant that the domestic law would have to apply in defining them.

Brannan J emphasised the difficulty of assimilating treaty terms with the language in domestic law, stating (paragraph 108):

The terms that are at issue in this appeal, are, of course, derived from the OECD Model Convention. The OECD Model Convention is intended to apply in a standardised form to a very large number of different countries and tax codes. Its language is, therefore, in many cases conceptual rather than precise. The language of the Treaty must, for this reason, be interpreted as expressing concepts which broadly correspond to the detailed provisions of domestic tax codes.

In relation to the term ‘profits of an enterprise’ found in Article 7 of the DTA, the broadly corresponding term in the relevant UK legislation is ‘profits of a trade, vocation or profession’. The question then became whether the term ‘trade’ in the domestic law applied in its normal usage or in terms of the extended meaning assigned in respect of the activities of a deep sea diver.

Brannan J found that the term ‘salaries, wages and other similar remuneration derived … in respect of an employment’ for purposes of Article 14 of the DTA related to items that are regarded as taxable under the relevant provisions of the UK statute as remuneration and not as income from trade.

He further justified his decision by pointing to the fact that the classification of income from diving operations as income from trade was already enacted under the UK tax law when the DTA was concluded, and provided the necessary ‘context’ for his deliberations.

It was therefore decided that the income derived by Fowler was income from trade, to be dealt with under Article 7 of the DTA and not Article 14.

The takeaway

A DTA may impose rules for interpreting terms that are found in its provisions.

Where the DTA directs that terms must be interpreted based on the domestic principles of the state applying its provisions, the normal rules of interpretation apply to the process of arriving at the meaning and application of those terms.

Similar considerations appear to have applied in the matter of C:SARS v Tradehold Ltd 74 SATC 263 (SCA). In that matter, SARS argued that the term ‘alienation’ in the SA–Luxembourg DTA was not to be assimilated to the term ‘disposal’ in the Income Tax Act in the context of a deemed disposal. The Court applied the same logic as that applied by Brannan J, holding at page 271 that the term ‘alienation’ included deemed disposals:

Article 13 is widely cast. It includes within its ambit capital gains derived from the alienation of all property. It is reasonable to suppose that the parties to the DTA were aware of the provisions of the Eighth Schedule and must have intended Art 13 to apply to capital gains of the kind provided in the Schedule. It is of significance that no distinction is drawn in Art 13(4) between capital gains that arise from actual or deemed alienations of property. There is moreover no reason in principle why the parties to the DTA would have intended that Art 13 should apply only to taxes on actual capital gains resulting from actual alienations of property.

The decision in MH Fowler v HMRC therefore sits comfortably with the application of the principles of interpretation applied in our courts in respect of undefined terms in a DTA.

* ITEPA: Income Tax (Earnings and Pensions) Act 2003

This article first appeared on

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