On 1 March 2016 the Supreme Court of Appeal in CSARS v Kluh Investments (Pty) Ltd, case No 115/2015, confirmed the decision of the Western Cape High Court that the taxpayer was not conducting farming operations. In doing so it provided a good example of the correct approach to interpreting fiscal, and indeed any, legislation.
In 2001 Steinhoff Southern Cape (Pty) Ltd acquired property in Knysna on which forestry, timber growing and plywood manufacturing was conducted. However, Steinhoff’s ultimate European holding company blocked the purchase because of its then policy not to invest in fixed property in South Africa. So Steinhoff had to find somebody to own the land. The solution was to transfer the plantation and land to Kluh while Steinhoff acquired the machinery and equipment and the sawmill.
Two years later, there was a change of heart, driven by increasing timber prices and scarcity of plantation resources. As a result, Kluh disposed of the plantation contracts, the forestry operations and the plantation immovable property to Steinhoff as a going concern.
SARS taxed Kluh on the proceeds of disposal of the plantation, based on section 26(1) read with paragraph 14(1) of the First Schedule to the Income Tax Act, 1962. Kluh appealed unsuccessfully to the Cape tax court but was successful on appeal to the High Court, which led SARS to appeal to the SCA. Section 26(1) provides that the taxable income of a person carrying on farming operations must be determined in accordance with the provisions of the First Schedule. Paragraph 14(1) provides that any amount received by or accrued to any farmer (my emphasis) in respect of the disposal of a plantation forms part of gross income. The primary issue was thus whether Kluh was carrying on farming operations.
The evidence was that Kluh from the beginning had wanted nothing to do with any farming operations. It had “neither the appetite for the risks associated with farming nor the requisite skills, equipment and personnel to undertake farming operations”. The sole reason for its existence was to acquire bare ownership of the land and plantation. The parties had agreed from the start that Steinhoff had the right to conduct the farming operations and had on termination of the agreement to return the plantation to Kluh in the state in which it had been at inception of the agreement.
As the SCA found, SARS in its argument put the cart before the horse. First, that the purpose of paragraph 14(1) was to extend tax liability by treating the proceeds of disposal of a plantation as gross income. Second, that the mere sale of a plantation constitutes farming operations, irrespective of the extent of the actual conduct of the taxpayer in the farming operations. Third, that Steinhoff had conducted the farming operations on behalf of Kluh.
The court found that before one could consider whether the First Schedule applied, the taxpayer had to be carrying on farming operations as contemplated in section 26(1). Only then was one at large to consider the First Schedule. In response to the first of SARS’ three submissions, the court noted that paragraph 14 is a deeming provision. It is axiomatic that when something is deemed to be something else it is in fact not that something else. It followed that, in the absence of paragraph 14, a plantation would be a capital asset, and only if a farmer disposed of it would the proceeds be deemed to be gross income. Second, SARS’ argument was misleading in its assertion that the Act recognises the disposal of a plantation as the carrying on of farming operations. The first hurdle was section 26(1) before any aspect of the First Schedule could apply. As to the third submission of SARS, according to the facts Kluh did not have the right to the yield of the plantation; it did not have the use of the land and the plantation, and it derived no income from them. These it had granted to Steinhoff.
In the result, the appeal failed and was dismissed with costs.
This judgment provides a useful lesson in the correct approach to the interpretation of legislation, in this case the Income Tax Act. The word “farmer” in paragraph 14(1) means that SARS has to show that the taxpayer has met the requirements of section 26(1) before the First Schedule applies. It is not the case that, if a taxpayer carries out an activity contemplated in the First Schedule, it automatically means that section 26(1) applies to the taxpayer.
Peter Surtees
