A farm owner is not necessarily a farmer
08 April 2016
Posted by: Author: PwC South Africa
Author: PwC South Africa
This month the Supreme Court of Appeal finally determined the outcome of a dispute between SARS and a taxpayer concerning the taxation of the proceeds of sale of a farming property on which stood substantial plantations. In this instance, the Court clearly prescribed the approach to be applied in determining whether amounts accruing to a person may be regarded as income from carrying on farming operations.
The case of C:SARS v Kluh Investments (Pty)Ltd  ZASCA 5 (1 March 2016) had originally been contested in the Tax Court, where the Court had found in favour of the Commissioner that the proceeds on the sale of the property constituted gross income from farming. The matter had then proceeded on appeal to the Full Bench of the Western Cape High Court (Kluh Investments (Pty) Ltd v C:SARS 77 SATC 23), which overturned the Tax Court’s decision. SARS then took the issue on appeal to the Supreme Court of Appeal.
The facts in the matter are relatively uncomplicated.
Steinhoff Southern Cape (Pty) Ltd (‘Steinhoff’) had entered into an agreement with the Thesen Group of Companies in 2001 to purchase a forestry, timber-growing and plywood-manufacturing business in Knysna. However, the board of directors of Steinhoff’s ultimate parent company had not approved the transaction because it did not wish to invest in South African fixed property at that time.
The agreement was therefore cancelled and replaced with an agreement in terms of which Steinhoff acquired all of the operating equipment, including the sawmill; while the fixed property, on which there were substantial plantations of indigenous trees, was acquired by the taxpayer (‘Kluh’).
Kluh was a special-purpose vehicle owned by a Swiss finance company. Under the new agreement, Kluh was required to pay R29.5 million for the property and equipment. The purchase consideration was allocated between land (R11.6 million), plantations (R12.5 million) and equipment (R5.4 million). Kluh took possession of the assets in June 2001 and retained the land and plantation but sold the other assets to a third party.
The judgment of Ponnan JA at paragraph  sets out the manner in which Kluh controlled the property subsequent to its acquisition:
When Thesen disposed of the plantation to Kluh in 2001, it was already a mature plantation in rotation. The plantation … had reached the stage where it could annually yield a steady and sufficient number of mature trees for commercial felling, with younger trees taking their place year by year. Steinhoff, which owned the equipment necessary for conducting the plantation operations and employed the employees who worked on the plantation …, was entitled to harvest the timber for its own account. Kluh owned no equipment and had no employees. All operational income and expenditure were earned and incurred by Steinhoff and reflected in its accounts. Thus, Kluh’s financial records and financial statements for the period between the acquisition and the disposal of the plantation reflect no operational income and expenditure. The oral arrangement between Kluh and Steinhoff was for an indefinite duration and, due to the Steinhoff group policy in 2001 not to own land in South Africa, it was expected to endure for a lengthy period – although either party could obviously have terminated the arrangement on reasonable notice. On termination of the arrangement, the plantation would comprise trees of the same volume and quality as at the commencement. This meant that Steinhoff, in conducting the plantation operations, had to keep the plantation in rotation and perform such other pruning, thinning and maintenance as would ensure that, upon termination, it could restore the plantation as in its June 2001 state. Planting was not required as seedlings grew naturally. Steinhoff was required to manage the plantation using best practice so that, what was described as, Forest Stewardship Council certification could be obtained, thereby ensuring that the timber would qualify for export to Europe. Steinhoff, which was responsible for fire protection, had insured the plantation against fire in the light of its obligation to restore the plantation to Kluh at the end of the arrangement. In the event, Kluh derived no income from the actual day-to-day plantation farming operations and incurred no corresponding day-to-day expenditure.
In 2003, the Steinhoff Group of Companies changed its intentions regarding the ownership of land in South Africa. In February 2003, Kluh and Steinhoff concluded an agreement of sale.
Ponnan JA at paragraph  describes the arrangement as follows:
The subject of the sale was described as being ‘the plantation business’, which was defined in clause 3.1 of the agreement as ‘the business of commercial forestry operations, which includes the plantation sales assets, machinery and equipment and plantation contracts carried on by [Kluh] at the plantations and the plantation immovable property as defined, as a going concern’.
After negotiation, the parties finally reached a settlement on 1 June 2004, at which time Steinhoff agreed to purchase the property for R159 million, of which R144.7 million related to‘the plantation’.
SARS assessed Kluh to tax on the proceeds of the sale, contending that the proceeds from the disposal of the plantation constituted income received by or accrued to a farmer, as contemplated in paragraph 14(1) of the First Schedule to the Income Tax Act (‘the Act’).
SARS claimed that it was authorised to assess the income on this basis based on section 26(1) of the Act, which provides that:
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.
Ponnan JA examined the reasoning in the Tax Court and High Court judgments. The learned Judge concluded that the Tax Court had not been justified in declining to accept the testimony of the witnesses from whom evidence was adduced on behalf of Kluh. In so doing, the Tax Court had drawn inferences from documentary evidence, but had not given due regard to the actual conduct of Kluh in relation to the assets. Thus, it was found that the High Court had correctly declined to follow the approach to the evidence adopted in the Tax Court. In effect, the conduct of Kluh in relation to the assets, as recorded earlier, strongly corroborated the testimony of the witnesses.
Based on that conduct, Ponnan JA observed (at ):
Thus from the very beginning Kluh wanted nothing to do with any farming operations. Quite apart from the fact that it had neither the appetite for the risks associated with farming nor the requisite skills, equipment and personnel to undertake farming operations, the whole raison d’être of Kluh’s involvement was to acquire bare ownership of the land and the plantation, which Steinhoff was prevented from doing. That being so, it was hardly surprising that the full court answered, what it described as the ‘threshold enquiry’, thus (para 83):
This finding in the High Court should have effectively disposed of the entire inquiry: logically, if Kluh was not subject to the provisions of section 26(1) of the Act, the First Schedule could not apply to it.
‘. . . Here, however, the appellant did not even start to conduct plantation operations. From the outset the appellant made the plantation available to Steinhoff so that the latter could conduct plantation operations for its own profit and loss.’
SARS, however, was more persistent. It argued (as recorded in ) that:
… first, the purpose of paragraph 14(1) of the First Schedule to the Act is to extend tax liability by treating the proceeds of the disposal of a plantation as gross income; second, the mere disposal of a plantation by its owner constitutes the conduct of farming operations for purposes of s 26(1), irrespective of the extent to which the owner was involved in the actual conduct of farming operations prior to or separately from such disposal, and, third, the farming operations were conducted by Steinhoff ‘on behalf of’ Kluh.
As to the first issue Ponnan JA identified that SARS was attempting to put the cart before the horse, and found (at ):
Paragraph 14(1) is a deeming provision which, on its own wording, only applies to a farmer in respect of such farmer’s gross income. ‘A farmer’ in that provision is clearly a short-hand for a person carrying on farming operations as contemplated in s 26(1). Carrying on ‘farming operations’ as contemplated in s 26(1), is clearly the necessary prerequisite that triggers the applicability of the whole of the First Schedule, including the deeming provision in paragraph 14(1). It must follow that the deeming provision itself cannot be employed to determine whether or not a taxpayer is ‘a farmer’ or differently put ‘a person carrying on farming operations’. Accordingly, the content of the deeming provision in paragraph 14(1) … is the consequence of carrying on farming operations, and cannot itself be determinative of whether a person is or is not carrying on farming operations i.e. whether a person is ‘a farmer’ as contemplated in paragraph 14(1). In short, the deeming provision in paragraph 14(1), on its plain wording, only applies to farmers, and logically one cannot use the deeming provision itself to determine who is and who is not a farmer.
The second issue, that mere disposal of a plantation ‘makes’ a person a farmer for purposes of paragraph 14(1) of the First Schedule was rejected. It was found that SARS had misconstrued the purpose of the provision. Ponnan JA stated :
Even where the taxpayer is a farmer, paragraph 14(1) contemplates that the proceeds of the disposal of a plantation are in fact of a capital nature. This is why a farmer’s proceeds from the disposal of a plantation are deemed not to be of a capital nature and are required to be included in the farmer’s gross income in terms of paragraph 14(1). Such proceeds are not ‘captured by s 26(1)’, as suggested by SARS, but simply included in paragraph 14(1). It may be so that s 26(1) brings the deeming provision in paragraph 14(1) into operation, but it is wrong to say that the mere disposal of a plantation is therefore recognised as a farming operation. It seems to me, that the presence or absence of what is signified by the ‘carrying on of farming operations’ as contemplated in s 26(1), and by the words ‘a farmer’ and ‘such farmer’s’ in paragraph 14(1), must therefore be determined without placing any reliance on the deeming provision in paragraph 14(1).
Finally, the assertion that Kluh was carrying on farming operations through the agency of Steinhoff was found not to be supported by the evidence. To this contention, Ponnan JA responded (at ):
But, even if Steinhoff in some sense acted on behalf of Kluh, that would not make Kluh a farmer as contemplated in paragraph 14(1). On the facts, Kluh did not have the right to the yield of the plantation – it had granted this right to Steinhoff for the duration of the agreement. Kluh also did not have the use of the land and the plantation, which right it once again had granted to Steinhoff for the duration of the agreement between them. And Kluh did not derive any income from the land and the plantation, the use of which it had granted to Steinhoff to farm for its own benefit, on its own behalf, and for its own account. Thus, the only entity which could be regarded as a ‘farmer’ (as contemplated in paragraph 14(1)) in relation to the plantation owned by Kluh, was Steinhoff.
Judgment was accordingly given in favour of Kluh and the appeal was dismissed.
Two salient features emerge from the judgment in this matter:
- In examining the testimony of witnesses, courts should be astute to consider the evidence as a whole, and not look for support of its findings in discrete pieces of the evidence. The full spectrum of circumstances provided clear evidence that Kluh was not carrying on farming operations, yet the Tax Court was persuaded to discount the testimony of witnesses and determine the issue not by looking at the conduct of Kluh in relation to the land but by reference to a range of documents and the descriptions contained in those documents.
- In the interpretation of a specific provision in the Act which is part of a Schedule which acquires its authority from an empowering provision (a specific section) in the body of the Act, one must first identify whether the taxpayer falls within the scope of the empowering provision. The provisions of the Schedule do not extend the authority of the empowering provision – the Schedule acquires no greater authority than is given to it under the empowering provision. In effect, the Schedule cannot determine whether the empowering provision applies, the empowering provision determines whether the Schedule applies.
This article first appeared on pwc.co.za.