TAXATION OF AGRICULTURAL INCOME - AN OVERVIEW

Agricultural Sector has always been a sector of great importance all around. It not only employs a huge chunk of population but is also a saviour of many. As per a press release by Ministry of Finance ‘Indian Agriculture contributes to green shoots of the Indian Economy with a Growth Rate of 3.4 Per Cent despite COVID-19 Pandemic’. Hence its importance cannot be uprooted and attached with this is the taxation of such income.

Let us have a look over the provisions relating to taxation of agricultural income as per the Income Tax Act and the rules and regulations made thereunder.

Section 10(1) of the Income Tax Act, 1961, states that in computing the total income of a previous year of any person, agricultural income shall not be included. In other words agricultural income is exempt from income tax under section 10(1). This exemption is not limited to any specific class of persons. Any person (whether Individual, HUF, Company, Association of Persons, Body of Individuals, etc.) can avail such exemption. Here it is necessary to understand the meaning of agricultural income and agriculture.

Meaning of Agricultural Income

As per Section 2(1A) of the Income Tax Act, 1961, agricultural income would mean

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

(Example: If a person rented or leased a land in India and such land is used for agricultural purposes then the rent from such land would be treated as agricultural income).

·      any income derived from a land by the way of agriculture;

·      any income from such land through the performance of any process or activity on the produce (raised or received), rendering it marketable or making it saleable. Such activity should be ordinarily employed by the cultivator or receiver of rent in kind;

(In simple words, if a produce is not saleable in the market in its raw form and its processing is necessary to make it fit for the market then income from such activity will also be agricultural income).

·      any income from such land through sale of produce (raised or received) on which no processing is done (other than as stated in point above);

(In a layman language, if a produce can be sold in its raw form then income from any process or activity performed over such produce will not be categorized as agricultural income. Like processing of potatoes to manufacture chips will not be considered as an agricultural income. It is because potatoes can be sold in the market in its raw form and no further processing is required).

·     
Income from farm building;

(The building should be on or in the immediate vicinity of the land and such building is used as a store house, dwelling house or other out building by the cultivator or receiver of rent by reason of his connection with the land).

·     Any income from saplings or seedlings grown in a nursery

Following points must be noted in relation to agricultural income

Ø  Revenue or income arising from transfer of such land shall not be treated as agricultural income. It shall be taxable under the head ‘Capital Gains’ subject to the applicable provisions.

Ø  Agricultural income would not include any income or rent received on the account of letting any building or land for non- agricultural purpose.

Ø  Here ownership of land is not necessary.

Suppose if the rent is received by original tenant who have further rented land for agricultural purpose then such rent (received by original tenant) shall also be exempt from tax.

Ø  It is important that there should be an activity on land to classify an income as agricultural income.

Meaning of Agriculture

The Income Tax Act, 1961 has not defined the term agriculture. However in the case of CIT v. Raja Benoy Kumar Sahas Roy (1957) 32 ITR 466 (SC) the Supreme Court took a detailed view of what constitutes agriculture.

 It opined that agriculture cannot be restricted to just cultivation of land as there are various other activities as well which are necessary to effectively raise the produce. It classified the operations into two broad categories viz. Basic Operations and Subsequent Operations.

Basic Operations would constitute tilling of land, sowing of seeds, planting and other similar operations requiring expenditure of human skill and labour on land.

Subsequent Operations would constitute other operations like weeding, pruning, cutting, harvesting, making the produce marketable etc.

The Supreme Court held that subsequent operations alone would not constitute agriculture but subsequent operations in conjunction with the basic operations will be classified as agriculture.

So, we can understand it in a way that cultivation of land, growing of crops, tilling of land and other similar operations are must for an activity to be considered as agriculture. All latter activities will subsequently be classified as agriculture.

Whether agricultural income is exempt from central income tax?

Among various questions and doubts relating to taxability of agricultural income, a common question is always asked that “Whether agricultural income is actually exempt from Central Income Tax?”

A simple answer is ‘Yes’.

When Section 10(1) states that agricultural income would not be included in total income then it holds its validity. Also the constitution empowers legislature of any state to make laws relating to the taxation of agricultural income. Hence the Central Government cannot tax such income.

Accordingly such income is not included in computation of total income but such income is deemed as a part of total income for a limited purpose of working out the rate of tax. This is called partial integration of agricultural income and non-agricultural income.

The Budget for the year 1973-74 (known as The Black Budget) provided for the scheme of partial integration of agricultural income and non-agricultural income.

The then Finance Minister stated in his budget speech that “This scheme of partial integration will apply to the case of individuals, Hindu undivided families, unregistered firms, association of persons, bodies of individuals, and artificial juridical persons”. 

Later several writ petitions were filed to declare Section 2(2) of Finance Act 1977 as ultra vires and illegal but the Madras High Court in case of A. Loganathan And Others vs A. Loganathan And Others on 14 December, 1993 upholds the constitutional validity of the scheme of partial integration and observed that it do not violate Article 14 and Article 19 of the constitution.

Understanding the scheme of Partial Integration

This scheme is used for calculating tax liability of individuals, Hindu undivided families, association of persons, bodies of individuals, and artificial juridical persons if following conditions are met:

• The net agricultural income (during the previous year) exceeds Rs. 5,000; and
• The non-agricultural income exceeds the maximum amount not chargeable to tax (i.e. the   basic exemption of Rs. 2,50,000 or 3,00,000 or 5,00,000 as the case may be).

Method of Partial Integration

1)   Calculate total income including net agricultural income.

      (Total Income = Net Agricultural Income + Non-Agricultural Income)

 2)   Compute the tax on total income (as arrived in point (1) above).

 3)   Add net agricultural income to the basic exemption limit as applicable.

     (Total Income =Net Agricultural Income + Basic Exemption Limit)

 4)   Calculate the tax on Total Income (as arrived in point (3) above).

 5)   Deduct the tax calculated in point (4) from the tax calculated in point (2)

      [Difference = Tax in (2) – Tax in (4)]

 6)   Now add surcharge (if applicable) to the sum calculated in point (5), adjust it for rebate   and add health and education cess. The amount so arrived is the income tax payable.

Final words on the scheme of Partial Integration

Under this scheme the agricultural income is used to determine the rate of tax for non-agricultural income. This scheme pushes the non-agricultural income towards a higher tax bracket while the agricultural income is included in the lowest slab.

 The reason of such scheme was to mobilize resources from agricultural sector and to reduce tax disparities among the persons having similar income. Here it should be understood that agricultural income is not subject to tax but it is being used to calculate the tax on non-agricultural income.

Understanding Composite Income

Suppose a manufacturer grows rubber and thereafter he process the raw material (rubber) in his industry and sell out the final product in the market. Now this whole process (from growing rubber to selling the processed final product) is a combination of agricultural activity and non-agricultural activity. Thus the final profit will be a summation of agricultural income and non-agricultural income which requires segregation. To resolve this issue Rule 7, 7A, 7B and 8 of Income Tax Rules are notified. It is important to segregate such incomes as their tax treatment is different.

Rule 7A: Income from manufacture of rubber

In case of sale of rubber (grown and processed) by the assessee, only 35% of income shall be liable to tax. Putting it differently we can say that in case of manufacturing and processing of rubber, out of total income only 35% shall be taxed as business income and rest 65% of income shall be exempt.

While computing such income allowance shall be made in respect of cost of planting rubber plants in replacement of plants that have died or become permanently useless.

 Rule 7B: Income from manufacture of coffee

·      In case of coffee (grown and cured) by assessee in India only 25% of income shall be liable to tax as business income.

·      In case of coffee (grown, cured, roasted and grounded) by assessee in India only 40% of income shall be liable to tax as business income.

              While computing such income allowance shall be made in respect of cost of            planting coffee plants in replacement of plants that have died or become                    permanently useless.

 Rule 8: Income from manufacture of tea

 In case of sale of tea (grown and manufactured) by the assesse only 40% of income shall be liable to tax as business income.

While computing such income allowance shall be made in respect of cost of planting bushes in replacement of bushes that have died or become permanently useless.

 Rule 7: Income which is partially agricultural and partially from    business

 In cases where the income is partially agricultural and partially from business, the income chargeable to tax shall be reduced by market value of the agricultural produce.

Business Income = Sale of final produce – Market value of agricultural produce.

 Market value means: 

1.   Where produce can be sold in the market in its raw state or after the application of any process which is ordinarily carried out on such produce to make it fit for the market, the market value shall be the average price at which it is sold in relevant previous year.

2.   Where produce cannot be sold in market in its raw state or after the application of any aforesaid process, the market value shall be aggregate of expenses of cultivation, land revenue or rent of such area and a reasonable amount (as determined by AO) which represent the profit.

  

Finally we can conclude that for calculating tax on agricultural income we need to first identify following:

·         Whether an activity constitutes agriculture?

·         Whether the income is agricultural income?

·         Whether the income is a composite income which requires segregation?

·         The amount of net agricultural income and non-agricultural income.

·         The class of person in which assessee falls?

 

Note for Readers’ Attention:

 This article has been authored for general information purpose only. The interpretations of law herein are personal views of the author and may vary on case to case basis. It does not solicit any class of person to act on the basis of opinion expressed in this article. The author expects general prudence and due diligence from readers. Thank you for your patience and time.