When a farmer delivers his grape harvest to the co-op, do the grapes remain his during the maturation process while they are turned into wine? If so, they would comprise stock in hand and would have to be brought into account in the farmer’s tax return for the year of assessment. This was the question on which the Western Cape Tax Court in Dr A v CSARS Case No 13132 delivered its judgment on 8 December 2014.
For the 2006 to 2008 years of assessment the taxpayer included as closing stock the value of grapes delivered to the co-op on the grounds that they were “produce held and not disposed of” at the end of the year. This was in terms of the First Schedule to the Income Tax Act, 1962, which provides that the tax return of a farmer must bring to account such produce. The value had been based on the estimated yield from the delivered grapes multiplied by the published distilling wine price. For the 2009 year of assessment, the taxpayer’s tax consultant concluded that his previous approach had been incorrect; as a result, he reflected no produce on hand for that year. He did, however, claim a deduction for the produce held and not disposed of at the end of the previous year.
SARS conducted an audit of the 2009 tax return and included a figure for produce on hand. The taxpayer contended that if in principle an amount was to be included, which he disputed, the amount determined by SARS was not fair and reasonable. SARS conceded this and recalculated the value.
Evidence was led that winemaking was a simple process. Wine was nothing more than the controlled outcome of the natural process of growth and decay of grapes, and winemaking was merely a way of controlling and fine tuning the natural transformation of the grape. The taxpayer had delivered his grapes to the co-op in the last month of the year of assessment, and these could not have gone far in the winemaking process because the fermentation process would not yet have run its course.
Further evidence was that about 50% of the winemaker’s costs were incurred before the first batch of grapes was delivered. The pulp had no commercial value, because no winemaker would want to take possession of it before the fermentation process was complete.
The court identified four matters for decision:
1 whether the grapes in process at the end of February constituted produce of the taxpayer;
2 whether the grapes were “held” by the taxpayer during the course of his farming operations;
3 whether the taxpayer had “disposed of” the grapes; and
4 (presumably if the answers to the first three questions were yes, yes and no respectively) what method of computing should be followed in arriving at a value for the grapes in process.
The court was satisfied that the grapes must have been in the very early stages of winemaking and not at a stage where they could be regarded as ready to be sold and delivered.
The taxpayer contended that at the end of the year the grapes were not “produce”, as they had been crushed, pressed, mixed with the grapes of other farmers and had had chemicals added to them. Thus they were no longer identifiable as grapes of the taxpayer.
The court found that the making of wine was part of the activity of wine farming. The crushed and pressed grapes, during the fermentation process, were as much a result of the farming operation as the completed wine would be. They were therefore produce as contemplated.
The court rejected the taxpayer’s claim that, once he had delivered his grapes to the co-op and they had been pooled with the grapes of other members of the co-op, he could no longer be said to have produce held and not disposed of. It was common cause that ownership of the grapes did not pass to the co-op; the co-op acted as agent for the member in controlling the produce, and that the mixing of the grapes with those of other members had the effect of creating joint ownership of the pooled grapes in undivided shares pro rata to each member’s contribution to the pool. This meant that the taxpayer had not disposed of his grapes, even though he no longer had physical possession of them. On delivery and acceptance into the pools at the co-op, the taxpayer acquired a right to the proceeds of the wine in proportion to his contribution of grapes. So his ownership of the grapes was a crucial determining factor for calculating and asserting his right to a fraction of the wine in process and a corresponding portion of the net proceeds of the wine. He had exchanged his right to claim back or exercise control over the grapes for a claim of portion of the net proceeds. The grapes remained the taxpayer’s property and thus constituted produce held and not disposed of.
The court found that SARS’s grounds of assessment were deficient in several respects
1 the value arrived at was “manifestly erroneous, unfair and unreasonable” as a result employing an illogical and incongruous methodology
2 SARS did not respond to the taxpayer’s request for reasons for the assessment as required under the Tax Court Rules. Without knowing the reasons, a taxpayer does not know what case he has to meet. The court referred to the recent decision in CSARS v Pretoria East Motors (Pty) Ltd [1024] ZASCA 91 where the court stated that, although the onus lay with the taxpayer to show that the decision of SARS was wrong, SARS was not free to adopt a supine attitude. It was bound to set out the grounds for the disputed assessments and the taxpayer was bound to respond.
The court remitted the matter back to SARS for a determination “on a proper consideration of all the relevant factors, including allowing the taxpayer the opportunity to rework the costs associated with the closing stock”. So the taxpayer lost insofar as the grapes were found to be produce held and not disposed of, but SARS lost on its deficient valuation methodology.
It is hoped that SARS will learn from this criticism, added to the trenchant rebuke it received from the SCA in Pretoria Motors, and begin to take seriously its obligation to comply with the provisions of the relevant legislation and attendant Rules.
