By Esther van Schalkwyk, Senior Tax Consultant at BDO SA
A wine farmer recently discovered that ‘produce held and not disposed of’ includes the pulp of grapes which were harvested and delivered to a wine co-operative where, it was mixed with the pulp of other members. The farmer had retained an undivided share in the pooled pulp held by the co-operative which was to be sold as wine on behalf of its members.
The farmer under discussion was the appellant in Avenant vs SARS, in which the Supreme Court of Appeal (SCA) handed down judgement on 1 June 2016 in favour of SARS.
When submitting their annual income tax returns, farmers are required to include in their income the value of all livestock or produce held and not disposed of at the beginning and end of each year of assessment. Where traders are allowed to deduct the cost of purchasing trading stock, they are also required to include the value of closing stock held and not disposed of at the end of the year of assessment in calculating their taxable income. It is now settled law that trading stock also includes partly manufactured goods or so-called ‘work-in-progress’ which need not be in a saleable form.
In the case of Avenant vs SARS, the SCA held that the meaning attributed to ‘livestock and produce held and not disposed of’ should accord with the meaning attributed to ‘trading stock held and not disposed of’ in terms of the ordinary rules of the Income Tax Act relating to trading stock. Farmers should therefore also be mindful of including work-in-progress (which does not need to be in a saleable form) as part of their produce held and not disposed of at the beginning and end of each year of assessment.
Avenant had delivered all of his harvested grapes to a wine co-operative as at the end of his 2009 year of assessment. At year-end the harvested grapes had already been pressed into pulp and were mixed with the pulp of other members of the co-operative. The co-operative was responsible for making, packaging, marketing and selling the wine. Each farmer who contributed to the pool would share in the net proceeds of the sale of the wine, pro rata to that farmer’s contribution and after the co-operative had deducted its expenditure. The co-operative did not hold the pulp on its own behalf but rather on behalf of its members who retained joint ownership, each in an undivided share of the pooled pulp and later of the pooled wine, pro-rata to their contributions of grapes.
The SCA held that the processing of the grapes by being pressed into a pulp and starting the natural fermentation process (even if chemicals had been added) did not transform the grapes into something essentially different from the produce of the harvest.
Avenant’s main argument before the SCA was that the pulp which he had delivered to the co-operative did not constitute ‘produce held and not disposed of’ by him at the end of the year of assessment. The SCA however agreed with SARS that where a trader retains ownership of produce without necessarily retaining possession, that produce is considered to be held and not disposed of for purposes of calculating the farmer’s taxable income.
Although the pulp did not have a market value, SARS is allowed to fix any fair and reasonable value on produce to be included in a farmer’s return. The SCA reiterated that the difficulty (whether perceived or real) in determining a value for work-in-progress does not permit a court to deviate from the plain language of the Income Tax Act. The SCA was satisfied that the distilling wine price would place a fair and reasonable value on Avenant’s closing stock because the distilling wine price had an ascertainable value and favoured the taxpayer as most wines would fetch a higher price than distilling wine.
There are a few important points to take from this judgement. Farmers should be mindful to include in their taxable income their work-in-progress as ‘produce held and not disposed of’ at the end of each tax year - work-in-progress need not be in a saleable form. SARS may fix any fair and reasonable value for ‘produce held and not disposed of’ (which need not be market value). Even though a farmer may have given up possession and mixed his produce with other produce not owned by him, he will still be required to account for his pro-rata share of the produce as closing stock if he retains ownership of the produce.
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