Comprehensive Study of Agricultural IncomeBy CA Abhishek Murali, M.Com, FCA, ACMA, CGMA, CIMA(Lon.), CISA, DISA

Introduction

India is a country that has long been built on the sweat and toil of the farmers in Agriculture. There exists a special place in the hearts of almost every Indian for the word farmer. Owing to this, public discourse of taxation of this income is anathema to the law-makers. India has not taxed agriculture since the country got independence from British rule in 1947, and taxing farmers heavily was always seen as the trademark of colonial oppression. At that time, Indian politicians, all of whom were associated with the freedom struggle, made a conscious decision not to tax agricultural income.

Hence, Agricultural Income has increasingly been used as a tool to plan taxes by Assessees.

Definition of Agricultural Income as per the Income Tax Act, 1961

As per S.2(1A) of the Income Tax Act, 1961, unless the context otherwise requires, the term “agricultural income” means:

a) any rent or revenue derived from land which is situated in India and is used for agricultural purposes;

b) any income derived from such land by—i. agriculture; orii. the performance by a cultivator or receiver of rent-in-kind of any process ordinarily

employed by a cultivator or receiver of rent-in-kind to render the produce raised or received by him fit to be taken to market; or

iii. the sale by a cultivator or receiver of rent-in-kind of the produce raised or received by him, in respect of which no process has been performed other than a process of the nature described in paragraph (ii) of this sub-clause;

c) any income derived from any building owned and occupied by the receiver of the rent or revenue of any such land, or occupied by the cultivator or the receiver of rent-in-kind, of any land with respect to which, or the produce of which, any process mentioned in paragraphs (ii) and (iii) of sub-clause (b) is carried on

Provided that—

i) the building is on or in the immediate vicinity of the land, and is a building which the receiver of the rent or revenue or the cultivator, or the receiver of rent-in-kind, by reason of his connection with the land, requires as a dwelling house, or as a store-house, or other out-building, and

ii) the land is either assessed to land revenue in India or is subject to a local rate assessed and collected by officers of the Government as such or where the land is not so assessed to land revenue or subject to a local rate, it is not situated-

a. in any area which is comprised within the jurisdiction of a municipality (whether known as a municipality, municipal corporation, notified area committee, town area committee, town committee or by any other name) or a cantonment board and which has a population of not less than ten thousand; or

b. in any area within the distance, measured aerially:i. not being more than two kilometres, from the local limits of any

municipality or cantonment board referred to in item (A) and which has a population of more than ten thousand but not exceeding one lakh; or

ii. not being more than six kilometres, from the local limits of any municipality or cantonment board referred to in item (A) and which has a population of more than one lakh but not exceeding ten lakh; or

iii. not being more than eight kilometres, from the local limits of any municipality or cantonment board referred to in item (A) and which has a population of more than ten lakh

Explanations:

1. Revenue derived from land shall not include and shall be deemed never to have included any income arising from the transfer of any land referred to in item (a) or item (b) of sub-clause (iii) of clause (14) of this section.

2. Income derived from any building or land referred to in sub-clause (c) arising from the use of such building or land for any purpose (including letting for residential purpose or for the purpose of any business or profession) other than agriculture falling under sub-clause (a) or sub-clause (b) shall not be agricultural income.

3. For the purposes of this clause, any income derived from saplings or seedlings grown in a nursery shall be deemed to be agricultural income.

4. For the purposes of clause (ii) of the proviso to sub-clause (c), “population” means the population according to the last preceding census of which the relevant figures have been published before the first day of the previous year.

Summary of above:

As per Income Tax Act income earned from any of the under given three sources meant Agricultural Income;

i) Any rent received from land which is used for agricultural purposeAssessees do not have to pay tax on rent or revenue from agricultural land. Such land should, of course, be assessed to land revenue in the country or be subject to a local

rate. Further, there must be a direct link between the agricultural land and the receipt of income by way of rent or other revenue (for instance, a landlord could receive revenue from a tenant).

ii) Income from agricultural operationsAny income derived from such land by agricultural operations including processing of agricultural produce, raised or received as rent in kind so as to render it fit for the market, or sale of such produce.

iii) Income attributable to a farm house:Subject to the condition that building is situated on or in the immediate vicinity of the land and is used as a dwelling house, store house etc. Income from such farm houses is considered agricultural income. The definition of `farm houses’ covers buildings owned and occupied by both cultivators of agricultural land and assessees who receive rent or revenue from agricultural land. The sole purpose of such farmhouses should be for use as dwellings for the cultivators or use as store houses. Normally, the annual value of a building is taxable as `income from house property’. However, in the case of a farm house, the annual value would be deemed agricultural income and would, thus, be exempt from tax.

iv) Income from Nursery OperationsIncome earned from carrying nursery operations is also considered as agricultural income and hence exempt from income tax

Prerequisites of Agricultural Income:

i) There must be a land

ii) The land must be used for agricultural purposes

iii) There must be land cultivation:Some measure of cultivation is necessary for land to have been used for agricultural purposes. The ambit of agriculture covers all land produce like grain, fruits, tea, coffee, spices, commercial crops, plantations, groves, and grasslands.

However, the breeding of livestock, aqua culture, dairy farming, and poultry farming on agricultural land cannot be construed as agricultural operations

iv) If rental income is received, then some agricultural activities must be undertaken on the land, for rent to be exempt from income tax

v) Ownership is not essential:In the case of rent or revenue, it is essential that the Assessee have an interest in the land. However, in the case of agricultural operations it isn’t necessary that the person conducting the operations be the owner of the land. He could be just a tenant or a sub-tenant. In other words, all tillers of land are agriculturists and enjoy exemption from tax

However, where a person just sells processed produce without actually carrying out any agricultural or processing operations, the income would not be regarded as agricultural income.

Likewise, in cases where the produce is subjected to substantial processing that changes the very character of the product (for instance, canning of fruits), the entire operations cannot be regarded as agricultural operations. The profit from the sale of such processed products would have to be apportioned between agricultural income and business income. Further, the income from trees that have been cut and sold as timber is not considered agricultural income since there is no active involvement in operations like cultivation and soil treatment

Section 10(1) of the Income Tax Act specifies that agricultural income earned by a taxpayer in India is exempt from tax.

Taxability of Agricultural Income after amendment in Finance Act, 2014

Agricultural income is considered for rate purposes while computing the income tax liability, if following two conditions are cumulatively satisfied:

1. Net Agricultural income exceeds Rs. 5,000/- for previous year; and2. Total income, excluding net Agricultural income, exceeds the basic exemption limit

However, if aggregate agricultural income of the assessee is up to Rs. 5,000/- during FY 2015, then the entire income shall be exempt from tax.

Once the above conditions are satisfied, the following steps should be followed:

Step 1: Calculate tax including agricultural income earned, without exempting the same

Step 2: Add agricultural income earned to the applicable slab limit and calculate tax on the same. Eg: If the applicable slab limit to you is Rs.250,000 (<60 years age), then you will add your agricultural income to Rs.250,000 and calculate the tax applicable on the same

Step 3: Tax payable in Step 1 minus Tax payable in Step 2

The amount as per Step 3 will be the tax that is payable, subject to deductions and cess.

Will sale of Agricultural Land be subject to Capital Gains Tax?

Prior to 1970, profit on the sale or transfer of all agricultural land was considered rent or revenue derived from the land. Such profit was, therefore, tax-exempt as agricultural income. There were several favourable judgments of various Courts, across the country on the issue. However, noticing there exists a loophole

However, in 1970, vide a retrospective amendment, the definition of agricultural land was changed. A land qualifies to be agricultural land if it is not situated in any area which is comprised within the jurisdiction of a municipality or a cantonment board, and which does not have a population of 10,000 or more according to the last preceding census which has been published before the 1st day of the previous year in which the sale of land takes place, and it is not situated less than 8 KMs from the local limits of any municipality or board.

In short, the land has to be situated:

a) In a jurisdiction with a population of 10,000 people or lesserb) Atleast 8 KMs away from the limits of a municipality or cantonment board

If, by the test above, the land is agricultural land, it will not form part of the definition of a capital asset and so there will be no capital gains on the sale of such land.

The Finance Act, 2000 inserted a new Explanation in Section 2(1A) to clarify that any income from such building or land arising from the use of the building or land for any purpose other than agriculture, would not be included in the definition of “agricultural income”. Eg: Letting out building for rental income or for purposes of business, then it will not be considered to be agricultural income

Important Case Laws:

Bacha F. Guzdar v. C.I.T., Bombay (1955 AIR 740)

The Appellant, Bacha, was a shareholder in 2 companies who were engaged in the business of growing and manufacturing tea. They received dividends from the above companies which was brought to tax by the Income Tax. The appellant claimed that the dividends received are eligible to a beneficial tax rates under the Income Tax Act, 1922; as growing of tea is agricultural income.

However, the Supreme Court held that Agricultural income as defined in the Act is obviously intended to refer to the revenue received by direct association with the land which is used for agricultural purposes and not by indirectly extending it to cases where that revenue or part thereof changes hands either by way of distribution of dividends or otherwise.

In fact, the dividend is derived from the investment made in the shares of the company and the foundation of it rests on the contractual relations between the company and the shareholder. Dividend is not derived by a shareholder by his direct relationship with the land. Therefore whosoever receives profit from the land directly is entitled to the exemption.

A shareholder does not receive profit directly from land, though the company may be involved in agricultural activities and is not entitled for exemption

Is Horticulture Also Agriculture? - CIT vs Raja Benoy Kumar Sahas Roy (1957) 32 ITR 466 (SC)

In this case the court emphasized that certain basic operations should be carried out alongwith subsequent operations. The Supreme Court observed that if the integrated activity of the agriculturist, viz., agriculture, which includes the basic operations and the subsequent operations, is undertaken and performed in regard to any land, that land can be said to have been used for agricultural purposes and the income derived therefrom can be said to be agricultural income derived from the land by agriculture. In the very same judgment, the Supreme Court also considered the other activities in relation to the land or having connection with the land including breeding and rearing of live-stock, dairy-farming, butter and cheese-making, poultry-farming, etc.

A reference was made to CIT - Madras vs Sundara Mudaliar (AIR 1950 Mad 566), where Hon’ble V.Sastri observed

“Pasture land used for the feeding and rearing of live-stock is land used for agricultural purposes: Emperor v. Alexander Allen. Rearing of live-stock such as cows, buffaloes, sheep and poultry is included in 'husbandry'. These animals are considered to be the products of the soil, just like crops, roots, flowers and trees, for they live on the land and derive their sustenance from the soil and its produce: Glanely v. Wightman; Commissioner of Income-tax, Burma v. Kokine Dairy Co. It is not therefore legitimate, in my opinion, to confine the word 'agriculture' to the cultivation of an open field with annual or periodical crops like wheat, rice, ragi, cotton, tobacco, jute, etc. Casuarina is usually raised on dry lands of poor quality, and it is usual to find the same land used alternatively for the cultivation of ordinary cereal crops like groundnut, gingelly, cholam, kambu, etc. and for the raising of casuarina plantations. The land bears the dry assessment whatever be the nature of the crop raised”

This enlarged connotation of the term "agriculture" has been tinged by the dictionary meanings ascribed to it in Murray's Oxford Dictionary and Webster's Dictionary quoted above which understood the term as including the allied pursuits of rearing, feeding and management of live-stock and also including husbandry, farming, horticulture, etc., in the widest sense, as also butter, cheese-making, etc. We shall have to consider at the appropriate stage as to how far such enlargement is warranted by the definition of "agricultural income" as given in section 2(1)(a) of the Indian Income-tax Act.

The cases above noted all of them involve some expenditure of human skill and labour either on the land or the produce of the land, for without such expenditure there would be no question of the income derived from such land being agricultural income.

Though the above decision did not decide on the matter of horticulture being agriculture, the observation of the Hon’ble Supreme Court gives veracity to the argument itself.

In CIT vs Soundarya Nursery (2000 241 ITR 530 Mad), the question was raised whether the income from sale of plants grown directly in the pots and the sale of seeds, can be treated as agricultural income within the meaning of Section 2(1) of the Income-tax Act, 1961. The Tribunal had held that, since the plants were not grown in the pots directly, but they are, after several operations carried out in the land, viz., cutting, gootying and inarching for the plants, transplanted in suitable containers, including pots and kept in the green house or in shade, and the trees were grown on the land directly. Significant contribution of human labour and energy is essential to do the same and therefore, it will be considered to be an agricultural activity.

The Madras High Court referred to the case of Raja Benoy Kumar and stated that all the products of the land, which have some utility either for consumption or for trade or commerce, if they are based on land, would be agricultural products. Here, it is not the case of the Revenue that without performing the basic operations, only the subsequent operations, as described in the decision of the apex court have been performed by the assessee. If the plants sold by the assessee in pots were the result of the basic operations on the land on expending human skill and labour thereon and it is only after the performance of the basic operations on the land, the resultant product grown or such part thereof as was suitable for being nurtured in a pot, was separated and placed in a pot and nurtured with water and by placing them in the green house or in shade and after performing several operations, such as weeding, watering, manuring, etc., they are made ready for sale as plants all these questions would be agricultural operations all this involves human skill and effort. Thus, the plants sold by the assessee in pots were the result of primary as well as subsequent operations comprehended within the term "agriculture" and they are clearly the products of agriculture.

The High Court further stated that it is not possible for the seeds to exist without the mother plants, and the mother plant, it is nobody's case, was not grown on land. It is also not the case of the Revenue that the seeds were the result of the wild growth and not on account of cultivation by the assessee. The seeds were clearly a product of agriculture and the income derived from the sale of seeds, was agricultural income.

In Karra Jayabhyarathi, Vedayapalem, Nellore-4 vs Income Tax Officer, Ward-Ii, Nellore (2005-TIOL-205-ITAT-HYD), the Hon’ble single member bench of Hyderabad held that Income derived from fishing over land covered by water and which is not used for any agricultural purposes cannot be treated as income from agricultures inasmuch as fish cannot be treated as the produce of the land. The bench also placed reliance on decisions which stated that the word ‘agriculture’ even in its widest import, has received some sort of definite and restricted meaning, and I find it difficult to bring fishery under the heading ‘agriculture’ even in its widest sense as ordinarily understood.

Therefore, income derived from fishing over land covered by water and which is not used for any agricultural purposes cannot be treated as income from agricultural inasmuch as fish cannot be treated as the produce of the land, since their element is water and therefore, their cultivation and welfare depend in no sense upon agriculture.

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