Farming income vs lease income

A recent decision of the High Court of the Western Cape will be of interest to plantation farmers.

Peter O’Halloran - Tax advice

The Tax Court had upheld a SARS assessment of an additional R110 million against a company that had sold valuable farmland upon which a mature plantation existed. The company appealed the decision of the Tax Court and the matter was heard by the Western Cape High Court.

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In 2001, a farmer asked the appellant, Kluh Investments, to purchase a plantation so that he could manage and farm it. He chose this approach because he was wary of investing funds in fixed property in South Africa at the time. In 2004, the buyer had a change of heart and purchased the land from the appellant for a large sum. By then the plantation had been equipped and staffed and was making a good income.

The appellant had held the land as a long-term investment and recorded the sale proceeds for tax purposes as capital in nature, which meant that capital gains tax, rather than income tax, was payable.

Income, not gain
In terms of Section 26 of the Income Tax Act and Paragraph 14 of the First Schedule, the proceeds of a sale of a plantation by a farmer is deemed to be income and therefore the seller cannot make a capital gain. Thus, SARS had assessed the appellant to tax on income by way of a re-assessment of the 2004 year.

The Tax Court had upheld a submission by SARS that the sale proceeds of the appellant were closely connected to plantation farming, and that Paragraph 14 had to apply. In other words, the proceeds were deemed to be income, even though, strictly speaking, the appellant was a landholder, not a farmer.

In the High Court, Judge Rogers held that in order to determine the closeness of the connection between the sale proceeds and the conducting of farming operations, two questions must be answered:

  • Was the person that SARS wished to tax carrying out farming operations during the year of assessment in question?
  • If so, did the particular item of income in dispute derive from those farming operations?

The judge emphasised that the question was not whether the accrual to the taxpayer of a particular item of income was directly connected to the farming operations of any person, but whether it was directly connected to or derived from the farming operations of the taxpayer.

Judgement – no farming was done
The judge went on to examine case law and to discuss certain leases of farming land. He held that if a lessor were not farming as such, the lease income would not be income from farming operations. In the end, the High Court overturned the decision of the Tax Court, holding that Article 14 of the First Schedule did not apply because the appellant had not conducted farming operations as per Section 26 of the Income Tax Act.

The case, number A48/2014, was heard in the Western Cape High Court. The parties were Kluh Investments (Pty) Ltd v
The Commissioner SARS.