Determination of taxable income derived from farming

SARS recently published a “DRAFT GUIDE ON THE TAXATION OF FARMING OPERATIONS”. This 77 page is well written and very detailed.

Whilst this article attempts to summarize the guide as concisely as possible it would not be possible.

Farming significantly contributes to job creation and is a major contributor to the gross domestic product of any country. Just as there are many different types of farming operations (pastoral farming, crop farming, plantation farming, aquaculture and game farming), there are also a variety of different methods of conducting farming operations, such as free-range farming, organic farming and conventional farming.

Various factors such as the climate, demand for products as well as the high costs associated with farming have an impact on successful farming. These factors can negatively impact a farmer’s income and expenditure on a regular basis.

To assist farmers, a beneficial set of tax rules applies to farming operations and the income and expenses emanating from such operations. Section 26(1) provides that the taxable income of any person carrying on farming operations shall, in so far as the income is derived from such operations, be determined in accordance with the Act but subject to the First Schedule.

The First Schedule details the computation of taxable income derived from farming operations.

The taxable income from farming operations is combined with the taxable income from other sources to arrive at the taxpayer’s taxable income for the year of assessment. The First Schedule applies regardless of whether a taxpayer derives an assessed loss or a taxable income from farming operations. The First Schedule may also apply even after farming operations have been discontinued.

Section 26 of the Income Tax Act is given below. Whilst this section is easy to read and understand, the provisions of the First Schedule seem far more intimidating. For the sake of this article, those extensive provisions have not been copy/pasted to avoid confusion and information overload.

“26. Determination of taxable income derived from farming.

(1) The taxable income of any person carrying on pastoral, agricultural or other farming operations shall, in so far as it is derived from such operations, be determined in accordance with the provisions of this Act but subject to the provisions of the First Schedule.

(2) In the case of any person who has discontinued carrying on pastoral, agricultural or other farming operations and is still in possession of any livestock or produce, or has entered into a “sheep lease” or similar agreement relating to livestock or produce, which has been taken into account and in respect of which expenditure under the provisions of this Act or any previous Income Tax Act has been allowed in the determination of the taxable income derived by such person when such operations were carried on, the provisions of this Act, but subject to the provisions of paragraphs 1, 2, 3, 4, 5, 6, 7, 9, or 11 of the First Schedule, shall continue to be applicable to that person in respect of such livestock or produce, as the case may be, until the year of assessment during which he disposes of the last of such livestock or produce, notwithstanding the fact that such operations have been discontinued.”

The term “person” is defined in section 1(1) and includes:

• an insolvent estate;
• a deceased estate;
• any trust; and
• any portfolio of a collective investment scheme.

Foreign partnerships are, however, excluded.

Any of the entities included in the definition of “person” may therefore apply the First Schedule with regard to the carrying on of farming operations. A person can also include a natural person (whether farming as a sole proprietor or in partnership), a company and a close corporation.

The terms “taxable income” and “income” are also defined in section 1(1).

“Taxable income” means the aggregate of:

“(a) the amount remaining after deducting from the income of any person all the amounts allowed under Part I of Chapter II to be deducted from or set off against such income; and
(b) all amounts to be included or deemed to be included in the taxable income of any person in terms of this Act;”

The term “income” means “the amount remaining of the gross income of any person for any year or period of assessment after deducting there from any amounts exempt from normal tax under Part I of Chapter II”. For purposes of the First Schedule, “farming income” refers to income derived from farming operations only.

While section 26 stipulates the persons and circumstances under which this section will find application, the First Schedule sets out how to compute the taxable farming income. Generally, the sections contained in Chapters 1, II and III of the Act will apply to farmers unless a special rule in the First Schedule provides specific relief or rules for taxation. In such case, the First Schedule will apply. In the event that a farmer receives income from farming activities as well as from other activities, the former income will be subject to section 26 and the First Schedule while the normal income tax rules will apply to the latter income. The taxable income from farming is combined with the taxable income from other sources to arrive at the taxpayer’s taxable income for the year of assessment.

With regard to making a declaration on an income tax return, special provision is made for farming income when a particular tick box is selected. A farmer will therefore be able to declare farming income as well as non-farming income separately on a return.

The First Schedule applies regardless of whether a taxpayer derives an assessed loss or a taxable income from farming operations.

Section 26 refers to pastoral and agricultural farming operations as well as “other farming activities”. The latter term includes farming activities such as horse breeding, fish farming and bee keeping.

Income derived from farming operations

Under section 26, a person must obtain or derive taxable income from conducting farming operations. To “derive” is to obtain something from a specified source.

Generally, a farmer’s main source of income will be from the sale of the produce grown and harvested or from the sale, breeding or slaughtering of livestock. A farmer may also supplement income by conducting other farming operations which will also be included in income.

These supplementary operations that form part of farming operations include, but is not limited to:

• 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.

Barter transactions

Income from barter transactions is also included in the taxable income from farming operations unless it is of a capital nature in which case CGT may apply. A barter transaction may, for example, occur when a farmer trades livestock or produce for another item other than cash.

The other item does not necessarily have to be related to farming. As long as the item has a monetary value or can be turned into money, such value will be included in taxable income.

Income from the disposition of livestock or produce other than in the ordinary course of farming operations.

Paragraph 11 deals with the disposition of livestock or produce other than in a farmer’s ordinary course of farming operations. The manner in which the livestock or produce is disposed of or applied, determines the amount to be included in the farmer’s income:

• Should a farmer apply any livestock or produce for private or domestic use or consumption during any year of assessment, an amount equal to the cost price of such livestock or produce must be included in income in that year of assessment. If the cost price cannot be readily determined, the market value35 of such livestock or produce must be included [paragraphs 11(a) and 11(A)].
• Under paragraphs 11(b) and 11(B), if a farmer’s livestock or produce is removed from South Africa, an amount equal to the market value of such livestock or produce must be included in income, unless the stock was removed in pursuance of a sale.
• In the event that a farmer donates livestock or produce, the market value of the donated item must be included in income [paragraphs 11(c)(i) and 11(B)].

Additional articles will be written to explain the guidance note in more detail.

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