Welcome clarity on the taxation of farmers in South Africa?
Welcome clarity on the taxation of farmers in South Africa?
Farming and agriculture form the lifeblood of any economy. It is no wonder that the Income Tax Act 58 of 1962 (Act) provides for a special set of beneficial rules applicable to farmers in South Africa. This special taxation regime is by and large set out in the First Schedule to the Act.
Even though the South African Revenue Service (SARS) has already issued an interpretation note on “Game Farming”, namely Interpretation Note 69, SARS has previously not provided an extensive explanatory note or guide on the First Schedule. Farmers would therefore have welcomed the publishing of the SARS Draft Guide on the Taxation of Farming Operations on 22 September 2022 (Draft Guide). This article discusses some of the key guidance notes contained in the Draft Guide.
Meaning of farming operations
In order for the special tax regime in the First Schedule to apply there are a number of requirements that need to be met. Arguably, the most important is the requirement that the person is “carrying on pastoral, agricultural or other farming operations”. This is because only taxable income derived from the carrying on of such operations will fall within the special taxation regime. Even though ultimately, it is a factual question whether a person is carrying on pastoral, agricultural or other farming operations, SARS’ Draft Guide indicates that the term “other farming activities” generally includes activities such as horse breeding, fish farming and bee keeping.
SARS’ Draft Guide discusses various case law on the meaning of “carrying on pastoral, agricultural or other farming operations” including ITC 1324 42 SATC 288 where a grower who merely intended to sell crops that were surplus to his needs was judged to not be carrying on farming operations. The Draft Guide thus confirms that one must be conducting a trade in farming and there must be an overall profit-making intention.
Another important issue that the Draft Guide considers is the position of two persons, where one person owns the land on which the farming operations are conducted, and another person physically conducts the farming operations. Ultimately, it is also a question of fact as to which person will be considered to be “farming” and thus benefit from the special taxation regime. Example 1 on page 8 of the Draft Guide provides that if a person leases land from another entity where the first person physically conducts the farming operations (in this case wine farming), it is the first person that will generally be considered to be farming.
According to the SARS Draft Guide, the owner of the land will not be involved in the farming operations as the rental income is derived from the ownership of the land and not farming operations. Interestingly, the Draft Guide states that if the rental payments were not fixed amounts but determined as a percentage of the turnover from the activities conducted on the vineyard, the owner of the land might apply the First Schedule to determine its taxable income derived from farming.
Notably, it is only income “derived from farming” that falls within the special tax regime in the First Schedule. This means that not all income from farming will necessarily fall within the First Schedule as there must be a connection between the income earned and the farming operations. Some examples the Draft Guide provides of “supplementary farming operations” include the sale of manure; the sale of firewood; the letting of grazing rights if the rental amount is derived from farming proceeds; the sale of plantation and forest produce; prize money received, for example, best wool or biggest pumpkin; or compensation received from the Government for the compulsory destruction of livestock due to disease.
Conversely, the Draft Guide states that, amongst other things, packing of fruit for other farmers; stakes won by a farmer as a result of racing horses which were bred by the farmer; and accommodation and catering activities for people spending holidays on the farm do not constitute farming activities. In those circumstances, the normal tax principles apply to such income.
Valuation of closing and opening stock
Another important aspect which the Draft Guide discusses is the calculation of opening and closing trading stock of a farmer including livestock and produce. Notably, the Draft Guide confirms that a farmer’s consumable stores, for example fuel and spares used for farming equipment, and non-livestock or non-produce items do not have to be taken into account as closing stock for purposes of the First Schedule.
In addition, the Draft Guide discusses the use of standard values of livestock fixed by regulation, apart from game livestock. Farmers can also adopt a different value (other than the standard value) provided that it is not more than 20% higher or lower than the standard value fixed by the regulations. If a farmer adopts a different value, it is bound by that value, and it cannot be altered or varied. Valuation of stock and produce is therefore an important taxation concept for farmers.
Deduction of capital expenditure
Generally, unless one of the special capital allowances in the Act apply, one cannot deduct capital expenses from income. However, one of the most beneficial aspects of the First Schedule to the Act pertaining to farming operations is that paragraph 12 provides for a special dispensation for farmers which allows for a deduction in respect of specified capital expenses.
Paragraph 3.6.1(b) of the Draft Guide discusses some of the capital development expenditure that can be claimed under paragraph 12 of the First Schedule, including expenditure incurred in relation to the eradication of noxious plants and alien invasive vegetation; the prevention of soil erosion; dipping tanks; dams, irrigation schemes, boreholes and pumping plants; fences; and the erection of, or extensions, additions or improvements (other than repairs) to, buildings used in connection with farming operations, other than those used for domestic purposes.
Notably, the Draft Guide also discusses the deduction of costs incurred in relation to the building of roads and bridges as well as electrical infrastructure. Importantly, however, not all expenses incurred in respect of infrastructure will potentially fall within paragraph 12 of the First Schedule as one must be able to show that the relevant roads and bridges are used in connection with the farming operations (which the Draft Guide interprets to mean “in respect of” farming operations). In addition, electrical infrastructure costs must be wholly or mainly used for farming purposes, which SARS interprets to mean more than 50%. Electrical infrastructure that also services the farmer’s domestic premises will therefore also need to be factored in when considering this provision.
Deduction of costs incurred in relation to renewable energy
Given the ongoing electricity crisis in South Africa, farmers would be well advised to also study the provisions in the Act regarding he deduction of plant and machinery used in the course of providing renewable energy. Some key provisions mentioned in the Draft Guide include section 12B(h) which states that should a farmer use the plant or machinery in the production of renewable energy which is used in farming operations, then they will be entitled to an accelerated capital depreciation allowance on the plant and machinery.
Expropriation of land
The Draft Guide also discusses aspects of taxation relevant to where a farmer’s land is expropriated. It specifically refers to the reduced tax rate applicable to the “excess farming profits” derived on land that is expropriated as well as the capital gains tax consequences on the disposal of the land. Notably, the Draft Guide indicates that paragraph 65 of the Eighth Schedule to the Act may apply to defer the capital gain on the disposal of the land on the basis that it was disposed of involuntarily.
SARS’ Draft Guide provides welcome clarity regarding several aspects of the special taxation regime applicable to a vital industry of South Africa’s economy. Farmers would be well advised to study the Draft Guide and submit comments to the SARS Legal & Policy Division to the extent that further clarification is required regarding any aspects of the Draft Guide. The due date for submission of public comments is 25 November 2022.
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