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Farmer’s produce ‘held and not disposed of’ by him at year-end

09 March 2015   (0 Comments)
Posted by: Author: PwC South Africa
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Author: PwC South Africa

Does a farmer’s produce ‘held and not disposed of’ by him at year-end include produce that has been delivered to a co-operative and mixed with that of other farmers?

The meaning of the expression ‘trading stock held and not disposed of at the end of a taxpayer’s year of assessment’ is, in most circumstances, clear beyond disputation.

But this is not the case where the trading stock has passed out of the possession of the taxpayer. This is illustrated by the decision of the Cape Town Tax Court in A v Commissioner for the South African Revenue Service [2014] ZATC 3,which was handed down on 8 December 2014.

This case involved a taxpayer who was a wine farmer. It was common cause (see the judgment at para [32]) that he was conducting farming operations as envisaged in section 26(1) of the Income Tax Act 58 of 1962 and that his income was derived from such operations.

The court cited with approval from the decision in Ko-operatiewe Wynbouwers Vereniging van Zuid-Afrika Bpk v Industrial Council for the Building Industry 1949 (2) SA 600 (A) (A) at 614, where it was held that –

wine farming consists of a number of different operations, such as cultivation of vineyards, pruning of the grape vines, rendering the vines free from disease, gathering the crop, pressing the grapes into wine and probably delivering the finished product to the ‘first buyer’.

It was not in dispute (see para [27] of the judgment) that, at the end of the appellant’s 2009 year of assessment, that is to say, at midnight on 28 February 2009, the taxpayer had no harvested grapes in his possession, as all of his grape harvest had been delivered to the farming co-operative of which he was a member.

SARS determined the value of the produce held and not disposed of at R789 338. By contrast, the taxpayer contended (see para [28]) that the value of produce held and not disposed of by him at the end of the year was nil – in other words, he argued that he had disposed of all of his produce.

The nature of ‘wine in process’

The dispute turned on fiscal aspects of wine in process, that is to say, harvested wine grapes that have been crushed in order to press out the juice and are being fermented as part of the wine-making process.

The taxpayer contended (see para [35]) that wine in process that was in the possession of the co-operative to which he had delivered his harvest was not produce as envisaged in the First Schedule to the Income Tax Act because, by that stage, his grapes had been crushed and mixed with the grapes of other farmers by the co-operative to which he had delivered his harvest; consequently, the grapes were no longer identifiable as his.

The taxpayer argued further (see para [39]) that once he had delivered his grapes to the co-operative and they had been mixed with grapes delivered by other members, his grapes could no longer be said to be produce that was held and not disposed of by him – even though (as discussed further, below) it was common cause that a member of the co-operative does not transfer ownership of his produce when it is delivered to the co-operative, and that the co-operative acts as agent for its members.

Legal consequences of delivery to a co-operative and commingling with the produce of other farmers

It was common cause, said the court (at para [41]), that the mixing of the taxpayer’s grapes with those of other farmers by the co-operative, such that identification of his grapes became impossible, resulted in the contributing farmers having joint ownership in undivided shares of the pooled grapes and later joint ownership of the pooled wine, pro-rata to their respective contributions of grapes to the pool.

The court noted (at para [36]) that the term produce is not defined in the Act, and that there is no reported decision regarding its interpretation in an income tax context.

SARS contended that paras 2, 3(1) and 9 of the First Schedule to the Income Tax Act, which deal with the valuation of a taxpayer’s opening stock and closing stock, had to be applied to the wine in process – in other words, that the value of the wine in process that had been delivered to the co-operative constituted the taxpayer’s closing stock (that is to say, stock ‘held and not disposed of’), the value of which (minus the value of the taxpayer’s opening stock) had to be included in the taxpayer’s income for that year.

As was noted, above, it was not disputed (see para [40]) that a member of a farming co-operative does not, on delivery, transfer ownership of his produce to theco-operative and that the co-operative acts as an agent for the member. It was also common cause (see para [41]) that –

the mixing or mingling of a member’s grapes or grape juice with that of other members, without the intention of transferring ownership but in circumstances where the further identification of each member’s own grapes is not possible, has the effect of creating joint ownership, in undivided shares, of the pooled grapes and later, of the pooled wine pro-rata according to each member’s contribution of the grapes to the pool.

Thus, after delivery of his grapes to the co-operative, the taxpayer became a co-owner in undivided shares, first in the pool of crushed grapes, and thereafter in the pool of wine.

Against this background, the issue to be addressed by the court was whether the taxpayer’s grapes, after delivery to the co-operative and after mixing with the grapes of other farmers, could properly be described as produce that was held and not disposed of by him.

The court held (at para [45]) that –

The complete phrase ‘held and not disposed of’ makes it patently clear that the produce must have formed part of the farmer’s farming produce and the farmer must still have a legal right to the produce as at the financial year end. . . . It does not mean that the farmer must have had physical possession or control of the produce at the year end. If that was what the legislature intended, it would have used words that clearly conveyed that meaning. (emphasis added)

The court said further (at para [58]) that –

It can accordingly not be said in the sui generis contractual relationship between the co-operative and the farmer/member, that the grapes were disposed of in the commercial and legal sense contemplated by section 3(1) of the First Schedule. 

Allie J concluded (at para [59]) that –

I find that the grapes picked at end of February 2009 is [sic] produce in [sic] the farming operations that were held by appellant. Once they were crushed and pressed, under the auspices of [the co-operative], they remained the property of the appellant, albeit in fractional ownership. Appellant did not disposed [sic] of them until after the end of February 2009, when the grapes were finally processed into wine and sold.

Had the taxpayer discharged the onus of proving the assessment wrong?

Allie J quoted from the decision of the Supreme Court of Appeal in Commissioner for the South African Revenue Service v Pretoria East Motors [2014] SAXCA 91 at para[6], where the court said that – 

The present appeal must therefore be approached on the basis that the onus was on the taxpayer to show on a preponderance of probability that the decisions of SARS against which it appealed were wrong (CIR v SA Mutual Unit Trust Management Co Ltd [1990] SA[1990]ZASCA [1990] (4) 529 (A) at 538D). That, however, is not to suggest that SARS was free to simply adopt a supine attitude. It was bound before the appeal to set out the grounds for the disputed assessments and the taxpayer was obliged to respond with the grounds of appeal and these delineate the disputes between the parties.

Allie J concluded (at para [63]) – 

I am not persuaded, in the light of the errors in calculation conceded on behalf of respondent and proved by the appellant that the amount assessed is fair and reasonable.

Allie J went on to say that, given the paucity of evidence on the issue of valuation, the court was not in a position to substitute SARS’s calculations with its own; the court therefore could not make a determination in this regard and the matter had to be referred back to SARS for further consideration and re-assessment in the light of the finding by the court (at para [60]) that the grapes delivered to the co-operative as at the end of February 2009 constituted the taxpayer’s closing stock in relation to his farming operations and should have been reflected as such in his income tax return.

Conclusion

This decision holds that trading stock held and not disposed of by a taxpayer at the end of a year of assessment includes trading stock still owned by him, even though(see paras [46] and [48]) it may no longer be in his possession or under his physical control, and even though at that juncture he has become no more than a co-owner in undivided shares of a pool of similar trading stock that has been commingled with the trading stock of other farmers. It was held that, for a farmer’s produce to be held and not disposed of by him at the end of a year of assessment, it was sufficient that the farmer had a legal right in the produce as at the end of the year of assessment.

This article first appeared on pwc.com.


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