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A Policy Framework To Prevent Abuse Of Tax Exemption On Agricultural Income

Agriculture has been the bread-earner for a major chunk of the Indian population, however citing the pitiful conditions of farmers under British Rule, the lawmakers decided to not tax their incomes. Although, after seven decades of exemption from taxes, their conditions don't seem to uplift in any way, rather an exploitation of such exemption is at upsurge. This paper attempts to analyse the need for a robust taxation system for agricultural income and how should it be implemented.

Income earned from the commercial production of agricultural land is known as agricultural income, including income derived from farming land, buildings, and commercial produce from horticulture land.

The statute defines agricultural income under Section 2(1A) of the Indian Income Tax Act1 of 1961 as:

  • Rent or any other revenue generated from agricultural land located in India
  • Income generated from agrarian operations including processing of agricultural products
  • Income earned from a farmhouse if it satisfies specific conditions under section 2(1A)
  • Income of a nursery is earned from seedlings or saplings.
Hence from the definition, we can conclude, income from the sale of replanted trees or revenue from the sale of seeds, or payment received as rent for agricultural land or money received from growing creepers & flowers or interest earned by the partner of a firm on capital invested in agricultural operations or profits generated by a partner from the company involved in agricultural business operations, all fall under the purview of agricultural income.

How Is Agricultural Income Taxed?

Exemption
Agricultural income is exempted from the purview of total income under Sec 10(1) of the Income-tax Act, 1961.2 It reads:
"Incomes not included in total income: In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included€” (1) agricultural income."

Indirect levy
Proceeds from the sale or transfer of agricultural property were initially out of the scope of total income as it came under agricultural income under Sec 2 of the Act.3 The loophole is that the agricultural land does not come under the definition of capital assets hence not taxed.

However, the precedence changed in 1970 with the Taxation Laws (Amendment) Act, 1970. The amendment changed the definition of "capital assets" and retrospectively brought agricultural land situated in urban areas under the ambit of "capital gains".

There are certain conditions provided in Sec 54(B)4 which states the exemptions from capital gains.

The primary conditions are as follows:
  • Availability of benefit under Section 54(B) is subject to the entity being an individual or a HUF.
  • Irrespective of whether the land is a long-term capital asset or a short-term capital asset, the transferred asset should be agricultural land.
  • Agricultural land to qualify under this provision should be used for agricultural purposes by the individual or the parents at least for two years immediately preceding the date of transfer.
  • The taxpayer should acquire another agricultural land within two years from the date of transfer of old land.

Partial Integration vis-a-vis The Finance Act, 2014

An indirect levy was brought to the taxation system of agricultural income in the amendment of 20145, called "Partial Integration of Taxes". It provided for primary three conditions, namely:
  • The assessee is "an individual, a HUF, a body of individuals, an association or an artificial juridical person".
  • The taxpayer has income not coming under the purview of "agricultural income", which exceeds the amount exempted.
  • The agricultural income of the assessee is more than INR 5,000.
After the conditions mentioned above are satisfied, the scheme of partial integration can be availed. In FY 2021-22, the exemption limit is INR 2,50,000. However, a higher exemption limit is provided for super senior citizens, i.e. INR 3,00,000 for those born- on or after April 2, 1941, but on or before April 1, 1961, and INR 5,00,000 for those born- on or before April 1, 1941.

However, these tax exemption originally meant for the benefit of the agricultural sector has been abused heavily in last few decades. The shreds of evidence can be found in the audit findings of the Comptroller and Auditor General (hereafter referred to as CAG) in 2019.

What Did CAG's 2019 Audit Find?

The ever-suspected exploitation of exemption of taxes got confirmed in the 2019 CAG report.6 In its report, CAG explained that it had reviewed 6,778 cases out of 22,195 scrutiny assessments carried out by ITD between FY15-FY17 for those assesses who had claimed above Rs. 5,00,000 in agricultural income. A total of Rs 3,656.25 was claimed as agricultural income in those 6,778 cases alone, and to our surprise, Rs 2,544.21 was allowed too. Out of the total claims made, 57% of the claims were of companies.

The shocking assertions of the report were that out of the total cases reviewed, claims of 22.5% exemption cases were allowed without any examination or verification of supporting documents. The documents usually were essential, such as income statements, proof of agricultural income, land records, and crop information. The CAG was of the view that there is no clarity on the assessment process by the officers-in-charge and how they were ensuring that the exemption was allowed for only the eligible assesses who had genuine claims.

Rationale Behind Exemption

What does the Constitution say?

The Constitution of India has provided two entries governing the rules around taxation on agricultural income.
In Entry 82 of the Union List7, it mentions that the Constitution empowers the Union Parliament to legislate on "taxes on income other than agricultural income".
Whereas in Entry 46 of the State List, it is mentioned that the States are entitled exclusively to legislate on "taxes on agricultural income".

These provisions give no sign of historical reasons due to which the agricultural income is not being put under the purview of taxation under the Act. However, a not-so-deep study can also find the plight of farmers in the colonial era when they were subjected to heavy taxes. Since the significant chunk of India's population was sustained on agriculture only, the step to exempt agricultural income from taxation was taken to correct the wrongs done to them.

Operational Hurdles

Hurdles to taxing the agrarian income are innumerable. States like Assam, Bihar, Kerala, and Karnataka, have used their power according to Entry 46 of the State List to implement a taxation structure; however, it is very arbitrary.

Reasons could be:
Taxation is a costly process involving a hefty financial resource, and it is believed that the worth of tax collected will not match this amount.

Farmers even today are very much illiterate to calculate their taxes. Moreover, the calculation in itself is very dicey as it involves several factors that are even arbitrary sometimes.
Taxing of the produce would be calculated for the subsequent year. It would be challenging to define tax slabs because of disproportionate and non-uniform relations between land-holdings and produce.

Taxing the agricultural income would defeat the spirit of federalism mentioned in the Constitution as it has already provided provisions for its taxation by States; hence it cannot be brought under the Central Tax structure.

Political Hurdles

The upholding of this exemption even after seventy years of exemption is largely due to the foul play of politicians. In some way or the other, these exemptions contribute to their vote bank, and hence they do not dare to revoke the same. The politicians argue that the wounds of the colonial era, which heavily taxed the agricultural sector, are still fresh, and any such step to disown the exemption policy will be as unjust as it was then. A downright rejection of such laws by the wealthy landowner and pressure groups parallelly contribute to the continued exemption.

The country has seen many parties, ideologies, and personalities coming to power to frame policies for the nation, but none have dared to bring agricultural income under the purview of taxation. Politicians are allegedly benefitted from such exemptions as it acts as a buttress for the black money rackets by providing foolproof means to circumvent the taxes. All these factors combined have resulted in the prolonged continuation of exemption of taxation on agricultural income.

The Required Legal Framework
Tax evasion at the moment is a child's game as it barely ensures the legitimacy of a claim. Hence, a rule to make tax evasion consistently tricky can be made under which it should be mandatory for all individuals, who disclose agricultural income over, say, Rs 20 lakh (the limit for family Rs 40 lakh) to provide the following information in their income-tax returns:
  • the break-up of agricultural income into sale value of produce
  • rent from land and farmhouse;
  • acres of agricultural land owned and leased with location crops grown, yield, and sale realisation per acre;
  • and details of fertiliser, seeds, and pesticides purchased.

The land ceiling act of every state will come in handy to ascertain whether the assessee who is filing the income-tax returns is showing income from more land than prescribed under the Act or not.

Those assessees selected from the above criteria should be asked to file returns in a separate section observed by officers from a farming background who would better understand agricultural operations. Based on the officer's observations, if he rules that the income shown as agricultural income is disproportionate to the details declared, then the difference could be included under a separate head and taxed at 60%.

Corruption is human nature but not a machine. So to rule out the possibility of corruption, the interface should be less human and more technical, such as email. Further, Section 2 (1A) of the IT Act should be amended to exclude agricultural income rent received from letting out a farm.

Another measure can be categorising of individuals seeking exemption in their income-tax returns. Individuals can be broadly categorised into three domains: a farmer, a professional with an agricultural income, and a public servant disclosing agricultural income. For this categorisation, we first need the definition of a farmer to be included in the IT Act.

The taxation policy can exempt a person from earning only through agricultural means to a specific ceiling limit. However, the other two categories of person, namely any professional or public servant disclosing agricultural income, should be taxed at regular rates. This will ensure that only the marginalised farmers dependent on their agricultural produce should benefit and not wealthy businessmen or politicians.

End-Notes:
  1. The Income- Tax Act, 1995, § 2(1A), No. 43, Acts of Parliament, 1995 (India)
  2. The Income- Tax Act, 1995, § 10(1), No. 43, Acts of Parliament, 1995 (India)
  3. The Income- Tax Act, 1995, § 2, No. 43, Acts of Parliament, 1995 (India)
  4. The Taxation Laws (Amendment) Act, 1970, § 54(B), No. 42, Acts of Parliament, 1970 (India).
  5. The Finance Act, 2014.
  6. Comptroller and Auditor General of India, Assessments Relating to Agricultural Income Report No. 9 of 2019 (Direct Taxes) [Accessed 2 July 2021].
  7. Entry 82, Seventh Schedule, List-I, Constitution of India, 1947
  8. Entry 46, Seventh Schedule, List-II, Constitution of India, 1947

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