What Constitutes "Farming Operations" in Terms of Section 26 (1) of the Income Tax Act
In the recent case of CSARS v Kluh Investments (Pty) Ltd, the Supreme Court of Appeal ("SCA") had to determine whether the taxpayer was conducting farming operations for the purposes of section 26(1) of the Income Tax Act 58 of 1962 ("Income Tax Act"), read with paragraph 14 of the first schedule (deals with the computation of taxable income derived from pastoral, agricultural or other farming operations). Section 26(1) and paragraph 14 of the first schedule state:
26. Determination of taxable income derived from farming.—(1) The taxable income of any person carrying on pastoral, agricultural or other farming operations shall, in so far as it is derived from such operations, be determined in accordance with the provisions of this Act but subject to the provisions of the First Schedule.
14. (1) Any amount received by or accrued to a farmer in respect of the disposal of any plantation shall, whether such plantation is disposed of separately or with the land on which it is growing, be deemed not to be a receipt or accrual of a capital nature and shall form part of such farmer’s gross income.
(2) Where any plantation is disposed of by a farmer with the land on which it is growing the amount to be included in such farmer’s gross income in terms of sub-paragraph (1) shall—
(a) if the amount representing the consideration payable in respect of the disposal of the plantation is agreed to between the parties to the transaction, be the amount so agreed to; or
(b) failing such agreement, be such portion of the consideration payable in respect of the disposal of the land and the plantation as represents the consideration payable for the plantation.
*Item (b) was substituted by s. 80 of Act No. 25 of 2015 in March this year.
Fact of the case
In terms of the facts of this case Steinhoff Southern Cape (Pty) Ltd ("Steinhoff") concluded a written agreement with Thesen Company (Pty) Ltd ("Thesen") for the purchase and sale of property, upon which they conducted forestry operations. However, Steinhoff had a policy at the time that prevented it from acquiring fixed property in South Africa.
In order to circumvent this policy, Steinhoff entered into an agreement with Kluh Investments ("the taxpayer") during October 2001. In terms of this agreement, the taxpayer purchased the tree plantation and land from Thesen and Steinhoff purchased the equipment necessary for conducting and managing the plantation. During 2003, timber prices began to escalate and consequently, Steinhoff decided to purchase the tree plantation from the taxpayer ("the sale").
As a result of the sale, SARS assessed the taxpayer on the basis that the proceeds from the sale fell within its gross income by virtue of section 26(1) of the Income Tax Act read with paragraph 14(1) of the first schedule. SARS held the view that the disposal of the plantation itself is recognised by the Income Tax Act as farming operations.
The taxpayer contended that it was not carrying on farming operations as Steinhoff solely managed the plantation.
The Tax Court held that the question as to whether or not a taxpayer is carrying on farming operations is a question of fact, followed by a twofold enquiry: Firstly; the taxpayer must have been carrying on farming operations during the year of assessments concerned; and, secondly, is the income in dispute derived from farming operations (only if the first requirement is met, does the second part of the enquiry become relevant). The Tax Court found in favour of SARS and held that the proceeds of the sale did form part of the taxpayer's gross income. However on appeal, the Western Cape Division of the High Court held that the Tax Court had erred in applying section 26(1) of the Income Tax Act read with paragraph 14(1) of the first schedule. The court held that apart from the mere disposal of the tree plantation by the taxpayer, there must have been further evidence that the taxpayer was in fact carrying on farming operations. In this case, the High Court found that Steinhoff had in fact managed the farm for its own account and not for the taxpayer; therefore the proceeds were not gross income in the hands of the taxpayer but capital.
SARS appealed the matter to the Supreme Court of Appeal ("SCA"). The SCA found that the taxpayer was not conducting farming operations for its own benefit as it did not derive income or incur any expenses from farming operations. The court agreed that Steinhoff had in fact managed the farming operations and the proceeds of the sale did not constitute gross income in terms of section 26(1) of the Income Tax Act. The appeal was dismissed with costs.