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March 15, 2000

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How to harvest a tax-free crop

Murali Iyer

Everybody would love to avoid tax. And a lot of them took the route of buying agricultural land farm houses to make some non-taxable income. The definition of agricultural income under the Income Tax (IT) Act is exhaustive and covers rent or revenue from land being used for agricultural purposes, income from agricultural operations and income from farmhouses.

Rent or Revenue
As per the Income Tax Act, "Rent" is described as periodical or pre-determined payment in cash or kind, while "Revenue" implies a sharing agreement depending on agricultural produce.

Cultivation of land to some extent is necessary for the income to be treated as agricultural income. While growing of crops is covered under agriculture's ambit, activities like poultry farming, dairy farming, aquaculture and sericulture on the same land are not treated as agricultural activity. There is no tax on rent or revenue accruing from such land. The land should be assessed to land revenue in India or subject to a local rate. Moreover, a direct link needs to be established between the land and revenue.

Thus, while rent on land being tilled will be treated as income, interest on late payments is taxable. Owners of agricultural land, tenants who have sub-leased the land and mortgagees of such land - all enjoy tax-free agricultural income.

With SEBI cracking down on plantation companies, a lot less is heard nowadays on that front. As these companies were offering tax-free income, many urban residents were attracted to such schemes for it was their only way of earning agricultural income. What needs to be examined here is whether the buyer gets leasehold rights to the land, or to some trees, or whether he gets rent. If the scheme provides for the investor owning the trees or getting leasehold rights on the land, then it is considered to be agricultural income, and hence tax-free. In the absence of either of the two, any other income is considered non-agricultural income, chargeable to tax.

Agricultural operations
All tillers (whether a tenant or sub-tenant of the land) are deemed as agriculturists and enjoy freedom from tax. Processing of agricultural produce to make it fit for sale in the markets is also covered under the ambit of agricultural income. Here, ownership of the land is not a necessity.

In many cases, raw agricultural produce may not fetch the right market price. To make it marketable, further processing may be necessary. Even though the final objective of the processor is to sell the produce at a higher price, such sales are treated as agricultural income. But if the farmer buys processed product and sells at a profit, such income will be taxed.

Further, if substantial value addition is involved (with the whole character of the primary produce undergoing a sea change), the entire operation is not treated as agricultural income. In such cases, the process will be broken down into primary, secondary and tertiary activities. While the primary and secondary activities will be treated as agricultural income, the rest will be treated as business income (taxable).

Similarly, if you get tempted to get into lumberjacking or cutting down a large growth of trees for tax-free profits, you could be in for a nasty shock. This income will not be treated as agricultural income, as your involvement lies only in cutting, sawing and selling of the trees etc and such profits will be taxed. Activities such as cultivation, soil treatment and others associated with farming have to be indulged in for such an activity to be non-taxable.

The definition of "farmhouse" covers buildings owned and occupied by cultivators of agricultural land as well as assessees who receive rent or revenue from such land. According to the law, the sole purpose of such houses should be as residing places or usage as storehouses. But there are ample instances of these "farmhouses" being used for private parties, conferences, marriages and even being rented out with the revenue being shown as agricultural income! So now, thanks to the first millennium budget, all non-agricultural income from farmhouses are subject to tax.

Sale of agricultural land
Earlier, profit on sale of agricultural land was exempt from tax. But now, agricultural land situated in an urban area or within a distance of 8 km from any notified municipal or cantonment board area is considered a capital asset. Thus, profit from the sale of such land is liable to be taxed as a capital gain. But agricultural land outside the purview of the 8 km limit will be deemed to be in a rural area. Thus, profit from sale or transfer of such land would be considered tax-free.
Although agricultural income is fully exempt from tax, individual assesses are required to club agricultural income along with other sources of income while filing returns based on the specific slab rates. Resultantly, the rate of taxation is higher for them. The methodology followed for calculating assessees' tax liability with agricultural income is:

  • Tax is first calculated on the assessee's net agricultural income plus total non-agricultural income.
  • Tax is then calculated on the basic exemption slab increased by the assessee's net agricultural income.
  • Amount of tax payable by the assessee is the difference between the above two
This methodology is followed only if assessee's non-agricultural income is in excess of the basic exemption slab (Rs 50,000 for assessment year 1999-2000) and agricultural income is higher than Rs 600. Be careful while filing returns and clearly mention agricultural income. Any discrepancy can be met with severe fines and penalties. Also, all receipts of such income and land records should be kept at hand to show the authorities in case of enquiries.

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