Agricultural income [Section 10(1)] – Income Tax

Agricultural income [Section 10(1)] :

(i) Section 10(1) provides that agricultural income is not to be included in the total income of the assessee. The reason for totally exempting agricultural income from the scope of central income tax is that under the Constitution, the Parliament has no power to levy a tax on agricultural income.

(ii) Indirect way of taxing agricultural income – However, a method has been laid down to levy tax on agricultural income in an indirect way. This concept is known as partial integration of taxes. It is applicable to individuals, HUF, unregistered firms, AOP, BOI and artificial persons. Two conditions which need to satisfied for partial integration are:

1. The net agricultural income should exceed Rs 5,000 p.a., and

2. Non-agricultural income should exceed the maximum amount not chargeable to tax. (i.e. , Rs 5,00,000 for very senior citizens,Rs 3,00,000 for senior citizens, Rs 2,50,000 for all other individuals and HUFs). It may be noted that aggregation provisions do not apply to company, firm assessed as such (FAS), co-operative society and local authority. The object of aggregating the net agricultural income with non-agricultural income is to tax the non-agricultural income at higher rates. Tax calculation in such cases is as follows:

Step 1: Add non-agricultural income with net agricultural income. Compute tax on the aggregate amount.

Step 2: Add net agricultural income and the maximum exemption limit available to the assessee
(i.e., Rs 2,50,000 / Rs 3,00,000/ Rs 5,00,000). Compute tax on the aggregate amount.

Step 3: Deduct the amount of income tax calculated in step 2 from the income tax calculated in step 1 i.e., Step 1 – Step 2.

Step 4: The sum so arrived at shall be increased by surcharge, if applicable. It would be reduced by the rebate if any available u/s 87A.

Step 5: Thereafter, it would be increase by education cess @2% and secondary and higher education cess @1%. The above concept can be clearly understood with the help of the following illustrations:

Illustration 1
Mr. X, a resident, has provided the following particulars of his income for the P.Y.2 015-16.

i. Income from salary (computed)	– Rs 2,30,000
ii. Income from house property (computed)	– Rs 2,00,000
iii. Agricultural income from a land in Jaipur	– Rs 1,80,000
iv. Expenses incurred for earning agricultural income	– Rs 1,20,000

Compute his tax liability assuming his age is –
(a) 45 years
(b) 70 years

Solution

Computation of total income of Mr. X for the A.Y.2016-17
(a) Computation of tax liability (age 45 years)
For the purpose of partial integration of taxes, Mr. X has satisfied both the conditions i .e.
1. Net agricultural income exceeds ` 5,000 p.a., and
2. Non-agricultural income exceeds the basic exemption limit of Rs 2,50,000.

His tax liability is computed in the following manner:

Particulars

Income from salary

Income from house property

Net agricultural income [Rs 1,80,000 – Rs 1,20,000]

Less: Exempt under section 10(1)

Gross Total Income

Less: Deductions under Chapter VI-A

Total Income

60,000

(60,000)

–

2,30,000

2,00,000

–

4,30,000

Step 1 :	Rs 4,30,000 + Rs 60,000	= Rs 4,90,000.
	Tax on Rs 4,90,000	= Rs 24,000
Step 2 :	Rs 60,000 + Rs 2,50,000	= Rs 3,10,000.
	Tax on Rs 3,10,000	= Rs 6,000 (i.e. 10% of Rs 60,000)
Step 3 :	Rs 24,000 – Rs 6,000	= Rs 18,000.
Step 4& 5 :	Total tax payable	= Rs 18,000 – Rs 2,000 (Rebate u/s 87A) = Rs 16,000
		= Rs 16,000 + 2% of Rs 16,000 + 1% of Rs 16,000 = Rs16,480.

(b) Computation of tax liability (age 70 years)
For the purpose of partial integration of taxes, Mr. X has satisfied both the conditions i.e.
1. Net agricultural income exceeds Rs 5,000 p.a., and
2. Non-agricultural income exceeds the basic exemption limit of Rs 3,00,000.
His tax liability is computed in the following manner:

Step 1 :	Rs 4,30,000 + Rs 60,000	= Rs 4,90,000.
	Tax on Rs 4,90,000	= Rs 19,000 (i.e. 10% of Rs 1,90,000)
Step 2 :	Rs 60,000 + Rs 3,00,000	= Rs 3,60,000.
	Tax on Rs 3,60,000	= Rs 6,000 (i.e. 10% of Rs 60,000)
Step 3 :	Rs 19,000 – Rs 6,000	= Rs 13,000.
Step 4 & 5:	Total tax payable	=Rs 13,000 – Rs 2,000 (Rebate u/s 87A)
		= Rs 11,000 + 2% of Rs 11,000 + 1% of Rs 11,000 = Rs 11,330.

(iii) Definition of agricultural income [Section 2(1A)]: This definition is very wide and covers the income of not only the cultivators but also the land holders who might have rented out the lands. Agricultural income may be received in cash or in kind. Three ways: Agricultural income may arise in any one of the following three ways: –

(1) It may be rent or revenue derived from land situated in India and used for agricultural
purposes.

(2) It may be income derived from such land through agriculture or the performance of a process ordinarily employed by a cultivator or receiver of rent in kind to render the produce fit to be taken to the market or through the sale of such agricultural produce in the market.

(3) Lastly, agricultural income may be derived from any farm building required for agricultural operations.
Now let us take a critical look at the following aspects:

(1) Land has to be situated in India – If agricultural lands are situated in a foreign State, the entire income would be taxable.

(2) “Agriculture” and “agricultural purposes” – These terms have not been defined in the Act. However, cultivation of a field involving expenditure of human skill and labour on the land can be broadly termed as agriculture.

(a) ―Agriculture‖ means tilling of the land, sowing of the seeds and similar operations. These are basic operations and require the expenditure of human skill and labour on land itself. Those operations which the agriculturists have to resort to and which are absolutely necessary for the purpose of effectively raising produce from the land are the basic operations.

(b) Operations to be performed after the produce sprouts from the land (e.g., weeding, digging etc.) are subsequent operations. These subsequent operations would be agricultural operations only when taken in conjunction with and as a continuation of the basic operations. Simply performing these subsequent operations without raising such products is not characterized as agriculture.

(c) ―Agriculture‖ comprises within its scope the basic as well as the subsidiary operations regardless of the nature of the produce raised on the land. These produce may be grain, fruits or vegetables necessary for sustenance of human beings including plantation and groves or grass or pasture for consumption of beasts or articles of luxury such as betel, coffee, tea, spices, tobacco or commercial crops like cotton flax, jute hemp and indigo. The term comprises of products of land having some utility either for consumption or for trade and commerce and would include forest products such as sal, tendu leaves etc.

(d) However, the term ‗agriculture‘ cannot be extended to all activities which have some distant relation to land like dairy farming, breeding and rearing of live stock, butter and cheese making and poultry farming. This aspect is discussed in detail later on.

(3) Income from nursery – In the past, there have been court rulings that only if a nursery is maintained by carrying out the basic operations on land and subsequent operations in continuation thereof, income from such nursery would be treated as agricultural income and would qualify for exemption under section 10(1). The Supreme Court has, in CIT v. Raja Benoy Kumar Sahas Roy (1957) 32 ITR 466, held that the basic operations must be performed before any income can be called agricultural income. The basic operations involve cultivation of the ground, in the sense of tilling of the land, sowing of the seeds, planting and other similar operations on the land. Such basic operations demand the expenditure of human labour and skill upon the land itself and further, they are directed to make the crop sprout from the land. Therefore, income derived from sale of plants grown directly in pots would not be treated as agricultural income. However , the Madras High Court, in CIT v. Soundarya Nursery (2000) 241 ITR 530, observed that nursing activity involves carrying out of several operations on land before the saplings were transplanted in suitable containers including pots and thereafter kept in shade or green house for further operation and growth. Therefore, income arising from nursery should be considered as agricultural income.
Explanation 3 to section 2(1A) provides that the income derived from saplings or seedlings grown in a nursery would be deemed to be agricultural income, whether or not the basic operations were carried out on land. This Explanation ratifies the view taken by the Madras High Court in favour of the taxpayer.

(4) Process ordinarily employed – The process to which the agricultural produce is subject should be a process which is ordinarily employed by a cultivator. It may be manual or mechanical. However, it must be employed to render the produce fit to be taken to the market. For example, before making rice fit to be taken to the market we have to remove the basic grain from the hay, we have to remove the chaff from the grain, we have to properly filter them, we have to remove stones etc. and we have to pack the grain in gunny bags. In that condition alone the rice can be taken to the market and sold. This process of making the rice ready for the market may involve manual operations or mechanical operations. All these operations constitute the process ordinarily employed to make the product fit for the market. The produce must retain its original character in spite of the processing unless there is no market for selling it in that condition.

Explanation regarding gains arising on the transfer of urban agricultural land – the capital gains arising from the transfer of such urban agricultural land would not be treated as agricultural income under section 10 but will be taxable under section 45.
Example: Suppose A sells agricultural land situated in New Delhi for Rs 10 lakh and makes a surplus of Rs 8 lakh over its cost of acquisition. This surplus will not constitute agricultural income exempt under section 10(1) and will be taxable under section 45.

(5) Income from farm building – Income from any farm building which satisfies the following conditions would be agricultural income and would consequently be exempt from tax. Income derived from any such building arising from any other use (other than those discussed below) shall not be agricultural income.

(a) The building should be on or in the immediate vicinity of the agricultural land;

(b) It should be 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 land or the produce of which land the process discussed above is carried on;

(c) The receiver of the rent or revenue or the cultivator or the receiver of rent in kind should, by reason of his connection with such land require it as a dwelling house or other out building. In addition to the above three conditions any one of the following two conditions should also be satisfied:

(i) The land should either be assessed to land revenue in India or be subject to a local rate assessed and collected by the officers of the Government as such or;

(ii) Where the land is not so assessed to land revenue in India or is not subject to local rate:-

(a) It should not be situated in any area as comprised within the jurisdiction of a municipality or a cantonment board and which has a population not less than 10,000.

(b) It should not be situated in any area within such distance, measured aerially, in relation to the range of population according to the last preceding census as shown hereunder –

	Shortest aerial distance from the local limits of a municipality or cantonment board referred to in item (a)	Population according to the last preceding census of which the relevant figures have been published before the first day of the previous year.
(i)	2 kilometers	> 10,000 ≤ 1,00,000
(ii)	6 kilometers	> 1,00,000 ≤ 10,00,000
(iii)	8 kilometers	> 10,00,000

Example

	Area	Shortest aerial distance from the local limits of a municipality or cantonment board referred to in item (a)	Population according to the last preceding census of which the relevant figures have been published before the first day of the previous year.	Is the land situated in this area an agricultural land?
(i)	A	1 km	9,000	Yes
(ii)	B	1.5 kms	12,000	No
(iii)	C	2 kms	11,00,000	No
(iv)	D	3 kms	80,000	Yes
(v)	E	4 kms	3,00,000	No
(vi)	F	5 kms	12,00,000	No
(vii)	G	6 kms	8,000	Yes
(viii)	H	7 kms	4,00,000	Yes
(ix)	I	8 kms	10,50,000	No
(x)	J	9 kms	15,00,000	Yes

(iv) Indirect connection with the land – We have seen above that agricultural income is exempt, whether it is received by the tiller or the landlord. However, non-agricultural income does not become agricultural merely on account of its indirect connection with the land. The following examples will illustrate the above point.

1. A rural society had as its principal business the selling on behalf of its member societies, butter made by these societies from cream sold to them by farmers. The making of butter was a factory process separated from the farm. It was held that the butter resulting from the factory operations separated from the farm was not an agricultural product and the society was, therefore, not entitled to exemption from income tax.

2. X was the managing agent of a company. He was entitled for a commission at the rate of 10% p.a. on the annual net profits of the company. A part of the company‘s income was agricultural income. X claimed that since his remuneration was calculated with reference to income of the company, part of which was agricultural income, such part of the commission as was proportionate to the agricultural income was exempt from income tax. It was held that X received remuneration under a contract for personal service calculated on the amount of profits earned by the company and that remuneration was not an agricultural income.

3. Y owned 100 acres of agricultural land, a part of which was used as pasture for cows. The lands were purely maintained for manuring and other purposes connected with agriculture and only the surplus milk after satisfying the assessee‘s needs was sold. The question arose whether income from such sale of milk was agricultural income. It was held that the regularity with which the sales of milk were effected and quantity of milk sold showed that the assessee carried on regular business of producing milk and selling it as a commercial proposition. Hence, it was not agricultural income.

4. B was a shareholder in certain tea companies, 60% of whose income was exempt from tax as agricultural income. She claimed that 60% of the dividend received by her on her shares in those companies was also exempt from tax as agricultural income. It was held that dividend is derived from the investment made in the shares of the company and is not an agricultural income.

5. In regard to forest trees of spontaneous growth which grow on the soil unaided by any human skill and labour there is no cultivation of the soil at all. Even though operations in the nature of forestry operations performed by the assessee may have the effect of nursing and fostering the growth of such forest trees, it cannot constitute agricultural operations. Income from the sale of such forest trees of spontaneous growth do not, therefore, constitute agricultural income.

(v) Examples of Agricultural income: For better understanding of the concept, certain examples of agricultural income and non-agricultural income are given below:

Agricultural income
1. Income derived from the sale of seeds.
2. Income from growing of flowers and creepers.
3. Rent received from land used for grazing of cattle required for agricultural activities.
4. Income from growing of bamboo.

Non-agricultural income
1. Income from breeding of livestock.
2. Income from poultry farming.
3. Income from fisheries.
4. Income from dairy farming.

(vi) Apportionment in certain cases – Where the agricultural produce like tea, cotton, tobacco, sugarcane etc. are subjected to a manufacturing process and the manufactured product is sold, the profit on such sales will consist of agricultural income as well as business income. That portion of the profit representing agricultural income will be exempted. For this purpose, Rules 7, 7A, 7B & 8 of Income-tax Rules, 1962 provides the basis of apportionment.

(a) Rule 7 – Income from growing and manufacturing of any product other than tea : Where income is partially agricultural income and partially income chargeable to income-tax under the head ‘profits and gains of business‘, the market value of any agricultural produce which has been raised by the assessee or received by him as rent in kind and which has been utilised as raw material in such business or the sale receipts of which are included in the accounts of the business shall be deducted. No further deduction shall be made in respect of any expenditure incurred by the assessee as a cultivator or receiver of rent in kind.

Determination of market value – There are two possibilities here:
(a) The agricultural produce is capable of being sold in the market either in its raw stage or after application of any ordinary process to make it fit to be taken to the market. In such a case, the value calculated at the average price at which it has been so sold during the relevant previous year will be the market value.

(b) It is possible that the agricultural produce is not capable of being ordinarily sold in the market in its raw form or after application of any ordinary process. in such case the market value will be the total of the following:—
(i) The expenses of cultivation;
(ii) The land revenue or rent paid for the area in which it was grown; and
(iii) Such amount as the Assessing Officer finds having regard to the circumstances in each case to represent at reasonable profit.

Illustration 2
Mr. B grows sugarcane and uses the same for the purpose of manufacturing sugar in his factory. 30% of sugarcane produce is sold for ` 10 lacs, and the cost of cultivation of such sugarcane is Rs 5 lacs. The cost of cultivation of the balance sugarcane (70%) is Rs 14 lacs and the market value of the same is Rs 22 lacs. After incurring Rs 1.5 lacs in the manufacturing process on the balance sugarcane, the sugar was sold for Rs 25 lacs. Compute B’s business income and agricultural income.

Solution
Income from sale of sugarcane gives rise to agricultural income and from sale of sugar gives rise to business income.

Business income	= Sales – Market value of 70% of sugarcane produce – Manufacturing expenses
	= Rs 25 lacs – Rs 22 lacs – Rs 1.5 lacs
	= Rs 1.5 lacs.
Agricultural income	= Market value of sugarcane produce – Cost of cultivation
	= [Rs 10 lacs + Rs 22 lacs] – [Rs 5 lacs + Rs 14 lacs]
	= Rs 32 lacs – Rs 19 lacs
	= Rs 13 lacs.

(b) Rule 7A – Income from growing and manufacturing of rubber : This rule is applicable when income derived from the sale of latex or cenex or latex based crepes or
brown crepes manufactured from field latex or coagulum obtained from rubber plants grown by the seller in India. In such cases 35% profits on sale is taxable as business income under the head profits and gains from business or profession, and the balance 65% is agricultural income and is exempt.
Illustration 3
Mr. C manufactures latex from the rubber plants grown by him in India. These are then sold in the market for Rs 30 lacs. The cost of growing rubber plants is Rs 10 lacs and that of manufacturing latex is Rs 8 lacs. Compute his total income.
Solution
The total income of Mr. C comprises of agricultural income and business income.

Total profits from the sale of latex	= Rs 30 lacs – Rs 10 lacs – Rs 8 lacs	= Rs 12 lacs.
Agricultural income	= 65% of Rs 12 lacs.	= Rs 7.8 lacs
Business income	= 35% of Rs 12 lacs.	= Rs 4.2 lacs

(a) In case of income derived from the sale of coffee grown and cured by the seller in India, 25% profits on sale is taxable as business income under the head ―Profits and gains from business or profession‖, and the balance 75% is agricultural income and is exempt.

(b) In case of income derived from the sale of coffee grown, cured, roasted and grounded by the seller in India, with or without mixing chicory or other flavoring ingredients, 40% profits on sale is taxable as business income under the head ―Profits and gains from business or profession‖, and the balance 60% is agricultural income and is exempt.

(d) Rule 8 – Income from growing and manufacturing of tea : This rule applies only in cases where the assessee himself grows tea leaves and manufactures tea in India. In such cases 40% profits on sale is taxable as business income under the head ―Profits and gains from business or profession‖, and the balance 60% is agricultural income and is exempt.

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