The Cape High Court sets aside a judgment of the Tax Court in relation to plantation farming
10 October 2014
Posted by: Author: PwC South Africa
Author: PwC South Africa
The decision of the Full Court of the Western Cape High Court in
Kluh Investments (Pty) Ltd v CSARS  ZAWCHC 141, where
judgment was handed down on 9 September 2014, involved an appeal against the
Tax Court decision of Davis J in ITC 1860 (2013) 75 SATC 329.
High Court judgment of Rogers J (Treverso DJP and Allie J concurring) goes
further than merely reaching a different conclusion on the facts, for it
clarifies the inter-relationship between section 26(1) of the Income Tax Act 58
of 1962 and para 14 of the First Schedule – key provisions in the taxation of
the proceeds of the disposal of a plantation.
The disputed assessment had
included in gross income the amount derived by the appellant, Kluh Investments
(Pty) Ltd (‘Kluh’), from the disposal of a plantation, on the basis that this amount, though
inherently of a capital nature, was deemed to be income in terms of para 14 of
the First Schedule to the Income Tax Act 58 of 1962.
central issue in the appeal was whether para 14 of the First Schedule was
applicable to the proceeds of the disposal in the particular circumstances of
this case. If it was not applicable, the proceeds in question would retain
their character as capital.
relevant statutory provisions
Section 26(1) of the Income Tax Act provides that –
taxable income of any person carrying on pastoral, agricultural or other
farming operations shall, insofar 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.
Para 14(1) of the Frist Schedule provides that -
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.
In this regard, para 16 of the First Schedule defines a plantation as –
artificially established tree as ordinarily understood (not being a tree of the
nature described in paragraph 12(1)(g)) or any forest of such trees and
includes any natural extension of such trees.
in the Thesen group (for brevity, ‘Thesen’) had previously owned property in
Knysna on which they conducted forestry, timber-growing and plywood
manufacturing businesses. The plantation in issue had once been owned by
2001, Steinhoff Southern Cape (Pty) Ltd (‘Steinhoff’) purchased Thesen’s Knysna
assets as a going concern for R45 million, but the transaction in this form was
vetoed by Steinhoff’s board of directors because they did not want their
company to own fixed property in South Africa. Steinhoff therefore looked for a
third party to acquire the fixed property to enable the transaction to go
the event, Kluh was that third party, and it bought the land and the plantation
two years, in the light of escalating timber prices and the scarcity of
plantation resources, Steinhoff changed its policy and decided that it wanted
to acquire ownership of the plantation and the land after all, which it duly
bought back from Kluh.
The subject of the sale was
described as ‘the plantation business’, defined in the agreement as the
machinery, equipment, plantation contracts and immovable property as a going
concern. The purchase price
of the plantation (defined in the agreement as the standing timber on the land,
including the plantation business) was R144 million.
In the additional assessment
issued by SARS, the R144 million was treated as part of Kluh’s gross income in
terms of para 14 of the First Schedule. In other words, SARS did not regard the
proceeds of the disposal of the plantation as a capital transaction, contending
instead that section 26(1), read with para 14 of the First Schedule, deemed the
proceeds of the disposal of the plantation to be gross income when it accrued
In its grounds of appeal (see the
judgment at para ), Kluh alleged that its intention had been to acquire and
hold the land and the plantation as a long-term investment; that, by agreement,
Steinhoff was entitled to conduct the plantation operations for its own benefit;
and consequently, that the proceeds of the disposal of the plantation by
Kluh were capital and not subject to tax (since the capital gains tax regime
had not yet come into force) and that these proceeds did not fall within the
scope of para 14 of the First Schedule.
arguments and counter-
arguments in the Tax Court and the High Court
SARS‘s first line of argument
(see the judgment at para ) was that the mere disposal of an operating
plantation by Kluh was sufficient to trigger the provisions of para 14 of the
First Schedule, and that it was not necessary for the requirements of section 26(1)
to be fulfilled before para 14 could apply.
alternative, SARS argued (see para ) that, although Steinhoff may have
functioned as an independent contractor and not as Kluh’s agent in performing
plantation operations, those activities were not only being conducted on land
owned by Kluh, but that Kluh retained a direct interest in the operations,
inter alia because Steinhoff was required to comply with agreed standards and
to restore the plantation to Kluh on termination of the arrangement with the
same volume of timber. SARS argued that there was therefore –
sufficiently close connection’ between the proceeds of the disposal of the
plantation and the conducting of the plantation operations over the intervening
two year period to trigger the operation of section 26(1) and para 14 of the
onus of proof
The onus was on Kluh to prove on a balance of probability that the
proceeds from the disposal of the
plantation in 2004 were not subject to tax. The onus of proof in this regard
was laid down in section 82 of the Income Tax Act, subsequently substituted by
section 102 of the Tax Administration Act 28 of 2011.
noted above, SARS had put forward two alternative bases on which s 26(1), read
with para 14 of the First Schedule, would apply to the proceeds.
judgment of the Tax Court
The High Court judgment (see para ) records that the Tax Court
found in favour of SARS on the alternative basis put forward by SARS (namely
that Kluh had retained a direct interest in the plantation operations and that
this was sufficient to trigger the application of section 26(1) and para 14 of
the First Schedule) and that
the High Court therefore did not need to consider the first basis for the
assessment, namely that the mere disposal of an operating plantation was in
itself sufficient to trigger those statutory provisions.
Tax Court (see para ) had been unpersuaded by oral testimony that Kluh was
a plantation business and had set great store by the references in contractual
documentation and directors’ resolutions recording the appointment of Steinhoff
to manage the plantation for Kluh and that what had been sold to Steinhoff
in 2003 was a plantation business as a going concern.
approach of the Full High Court on appeal
On appeal, the Western Cape High Court regarded the critical question (see para  of the
judgment) as being essentially a legal one that arose from the undisputed
facts, namely the import of the oral arrangement by which Steinhoff was
permitted to conduct the plantation operations and the further undisputed fact
that Kluh retained the ownership of the land and had a commercial interest in
the plantation’s being restored to it in due course in good condition and with
the same volume of growing timber.
Kluh, for its part, could not
dispute that it had retained ownership of the land on which the plantation
stood (that is to say, the bare dominium) and that it had
a commercial interest in the restoration of the plantation to it in due course
in good condition.
J held that two distinct issues had been conflated
Giving the unanimous judgment of
the High Court, Rogers J said (at para ) that SARS’s argument, which was
based on the closeness of the connection between the proceeds of the disposal
and the conducting of farming operations, erroneously conflated two separate
issues – as did the judgment of the Tax
J said that section 26(1) does not apply merely by virtue of the fact that
there has accrued to the taxpayer income that has been ‘derived from’ farming
operations; the section applies to a person carrying on farming operations to
the extent that his income is derived from such operations.
Rogers J said that two questions
must therefore be answered: (i) Was the person whom SARS wished to tax a person
who was carrying on farming operations during the year of assessment in
question? (ii) If so, did the particular
item of income in dispute derive from those farming operations?
J said (at para ) that where the first of these two questions was placed in
issue, it was not permissible to proceed directly to the second question as
though it would provide an answer to the first. Thus, he said –
question is not whether the accrual to the taxpayer of a particular item of
income is directly connected to the farming operations of any person but
whether it is directly connected to (i.e. derived from) the farming operations
of the taxpayer himself.
J said (at para ) that some Tax Court decisions, such as ITC 166 (1930) 5
SATC 85 and ITC 1630 (1996) 60 SATC 59, had erred in conflating these two
questions. He said that the anterior question is whether the taxpayer to whom
income has accrued is a person who was carrying on farming operations.
interpretation of section
26(1) in the High Court judgment
The analysis of Rogers J of the
language of section 26(1) throws into doubt the long-established and widely held
view that income derived by the owner of a farm who leases it in terms of a
partiarian lease (that is to say, a lease in which the rent is expressed as
being a stipulated proportion of the produce of the land, or a proportion of
the proceeds derived from a disposal of the produce) invariably constitutes, in
the hands of the land-owner, ‘income derived from farming operations’ for the
purposes of the Income Tax Act.
Rogers J took the view that this
conclusion overlooks the fact
that, for income to be farming income in the hands of the land-owner as
envisaged in section 26(1), the land-owner must be the person carrying on
farming operations. This, said Rogers J (at para ), would indeed be the
case if a partiarian lease constituted a partnership, but would not be so if
such an arrangement was no more than a lease.
In the view of Rogers J, there
can thus be no fixed rule that the consideration accruing to a land-owner in
the form of a share of crops or a share of their proceeds is always income from
farming operations and not simply rent.
followed, said Rogers J, that the real issue in the present case was not the
secondary one (whether there was a sufficiently close connection between the
income and the farming operations) but the threshold enquiry, namely whether
Kluh had been carrying on farming operations at all.
From this it followed that SARS
could succeed in its argument that the proceeds of the disposal were deemed to
be gross income in terms of para 14 of the First Schedule if, and only if, Kluh
had been carrying on farming operations. Rogers J said (at
para ) that –
thus consider that there must be conduct by the taxpayer apart from disposing
of a plantation previously acquired by the taxpayer in order to
constitute the carrying on by him of farming operations. (Emphasis added).
the alternative basis of the assessment issued by SARS in respect of the
farming operations on Kluh’s land carried on by Steinhoff, Rogers J said (at
para ) that it was clear that Steinhoff was not engaged in these activities
as an agent for Kluh, but was doing so for its own account.
The mere fact, said Rogers J,
that Steinhoff was obliged to maintain the plantation and return it at the end
of the arrangement with the same volume of timber, did not suffice for
Steinhoff’s farming operations to be attributed to Kluh. Nor (see para )
was the oral arrangement between Kluh and Steinhoff a lease, because no rental
was payable. Moreover, there was no question of Kluh’s having any share of the
profits from the farming operations conducted by Steinhoff.
Indeed, Rogers J held (at para ), Kluh had
not even begun conducting plantation operations and had, from the outset, made the plantation available to
Steinhoff so that the latter could conduct plantation operations for its own
profit and loss.
conclusion of the High
Rogers J concluded (at para )
that section 26(1) was not applicable in the present case. It followed that the
Tax Court had erred in applying this provision together with para 14 of the
First Schedule, and the appeal against the assessment should have been decided
in favour of Kluh.
In short, the finding of the High
Court was that Kluh had not been carrying on farming operations, and that the
threshold requirement anterior to the application of para 14 of the First
Schedule had not been satisfied.
this it followed that the proceeds of the disposal of the plantation that
accrued to Kluh were capital in its hands, and were not an accrual of deemed
income in terms of para 14 of the First Schedule.
This article first appeared on pwc.co.za.