(h) Disintegration of Income into Agricultural and Non-Agricultural Elements Under Income Tax in India

This article delves into the complex provisions of the Income Tax Act, 1961, concerning the disintegration of income into agricultural and non-agricultural components, specifically focusing on situations where income arises from a combination of agricultural activities and other business operations. This disintegration is crucial for calculating taxable income, as agricultural income is generally exempt from income tax under Section 10(1) of the Act.

I. Understanding Agricultural Income: A Foundation

Before discussing disintegration, it's essential to understand what constitutes "agricultural income" under the Income Tax Act. Section 2(1A) defines agricultural income as:

  • Rent or revenue derived from land which is situated in India and is used for agricultural purposes. This includes income received as rent from land leased for agricultural operations.
  • Income derived from such land by:
    • Agricultural operations (tilling, sowing, planting, etc.).
    • Processing of the agricultural produce raised on the land so as to render it fit for the market.
    • Sale of the agricultural produce raised or received as rent in kind.
  • Income derived from a farmhouse subject to certain conditions: The farmhouse must be owned and occupied by the cultivator or receiver of rent-in-kind and situated on or in the immediate vicinity of the agricultural land. It must also be used as a dwelling house, storehouse, or outhouse for the agricultural land.

Key Considerations:

  • Land Location: The land must be situated in India. Income from agricultural land located outside India is taxable.
  • Agricultural Purpose: The land must be used for agricultural purposes, meaning activities directly related to the cultivation of land to produce crops or plants.
  • Direct Nexus: There must be a direct nexus between the agricultural operations and the income earned.

II. The Need for Disintegration: Mixed Income Scenarios

The need for disintegration arises when an assessee earns income from both agricultural and non-agricultural sources. This often occurs when agricultural produce undergoes further processing or manufacturing before being sold, or when agricultural land is used for both agricultural and non-agricultural activities. In such cases, it's necessary to determine the portion of the income attributable to agricultural activities (and thus exempt) and the portion attributable to non-agricultural activities (and thus taxable).

While the Income Tax Act does not explicitly use the term "disintegration," the principle is embedded within various sections and rules, particularly Rule 7 and Rule 8. These rules provide specific methodologies for allocating income between agricultural and non-agricultural components in certain situations.

A. Rule 7: Income from Manufacture of Tea

Rule 7 deals specifically with income derived from the manufacture of tea grown by the seller in India. It prescribes a fixed ratio for determining the agricultural and non-agricultural components of such income:

  • Agricultural Income: 60% of the income is deemed to be agricultural income and is exempt under Section 10(1).
  • Non-Agricultural Income: 40% of the income is deemed to be business income and is taxable.

Example:

If a tea estate derives a profit of ₹10,00,000 from the sale of tea grown and manufactured by it, ₹6,00,000 (60%) will be treated as agricultural income (exempt), and ₹4,00,000 (40%) will be treated as business income (taxable).

B. Rule 8: Income from Rubber Manufacturing

Finance Act, 2024 has amended Rule 8. The ratio of agricultural and non-agricultural income arising from rubber manufacture has been changed.

(1) In the case of an assessee who manufactures rubber from rubber plants grown by him in India, the income derived from the sale of such rubber shall be computed as if it were income derived from business, and forty per cent of such income shall be deemed to be income liable to tax;

(2) In the case of an assessee who manufactures rubber from rubber plants grown by him in India and also purchases rubber from others, the income derived from the sale of rubber shall be computed as if it were income derived from business, and the income so computed shall be reduced by the amount of the purchase price of rubber purchased from others, and forty percent of the income as so reduced shall be deemed to be income liable to tax;

C. Rule 7A and 7B (Omitted): Income from Growing and Manufacturing Coffee

Earlier Rule 7A and 7B provided similar provisions for income derived from the growing and manufacturing of coffee. However, these rules have been omitted from the Income Tax Rules w.e.f. 01.04.2024.

D. General Principles for Other Cases (Where Specific Rules Don't Apply)

When specific rules like Rule 7 or Rule 8 are not applicable, the disintegration of income requires a more detailed analysis of the facts and circumstances of the case. The Assessing Officer will generally consider the following principles:

  • Apportionment Based on Cost: The income may be apportioned based on the cost of agricultural operations versus the cost of non-agricultural operations (processing, manufacturing, marketing, etc.). For example, if 70% of the total cost is attributable to agricultural activities and 30% to non-agricultural activities, the income may be apportioned in the same ratio.
  • Market Value at the Agricultural Stage: One approach is to determine the market value of the agricultural produce at the point where it is ready for sale without further processing. This value is then treated as agricultural income. The remaining profit (the difference between the final sale price and this market value) is treated as business income.
  • Judicial Precedents: Courts have provided guidance on various aspects of disintegration. These precedents are often considered when determining the appropriate method of apportionment.

IV. Key Considerations and Challenges

A. Establishing a Clear Nexus:

Establishing a clear and direct nexus between the agricultural land and the income claimed as agricultural income is crucial. The assessee must demonstrate that the income is directly derived from agricultural operations carried out on the land.

B. Determining the Market Value at the Agricultural Stage:

Determining the market value of agricultural produce at the point where it's ready for sale without further processing can be challenging, especially if there are no comparable sales of similar produce in the market.

C. Documentation and Record Keeping:

Maintaining proper documentation and records is essential to support the claim of agricultural income and the method of disintegration used. This includes records of land ownership, cultivation expenses, processing costs, and sales figures.

D. Burden of Proof:

The burden of proof lies on the assessee to demonstrate that the income qualifies as agricultural income and that the disintegration method used is reasonable and justifiable.

E. Role of the Assessing Officer:

The Assessing Officer has the power to examine the assessee's claim and may disallow the claim if the evidence is insufficient or the disintegration method is not considered appropriate.

V. Relevant Case Laws

Numerous case laws have shaped the interpretation and application of the provisions related to agricultural income and disintegration. Some important ones include:

  • CIT v. Raja Benoy Kumar Sahas Roy (1957) 32 ITR 466 (SC): This landmark case defined the scope of "agricultural operations" and established the principle that the basic operations must be performed on the land.
  • CIT v. Soundarya Nursery (2002) 253 ITR 769 (Mad): This case dealt with the issue of whether income from a nursery is agricultural income. The court held that if the nursery is maintained by basic agricultural operations, the income would qualify as agricultural income.
  • K.S. Venkataraman & Co. (P) Ltd. v. State of Madras (1966) 60 ITR 112 (SC): This case clarified the principles of apportionment of income when agricultural produce is processed and sold.
  • CIT v. Periakaramalai Tea & Produce Co. Ltd. (1980) 121 ITR 698 (Mad): This case discussed the application of Rule 8 (now amended) regarding the apportionment of income from the manufacture and sale of tea.

VI. Conclusion

The disintegration of income into agricultural and non-agricultural components is a critical aspect of income tax assessment in India. While specific rules like Rule 7 and Rule 8 provide guidance for certain industries (tea and rubber), in other cases, a detailed analysis of the facts and circumstances is necessary. Proper documentation, a clear understanding of the legal principles, and reliance on judicial precedents are essential for successfully claiming the exemption for agricultural income and ensuring accurate tax compliance. It is important to note that the Income Tax Act and related rules are subject to amendments, and taxpayers should always refer to the latest provisions and seek professional advice when dealing with complex situations involving agricultural income.