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Tax on Agricultural Income

Holy Cow of the Indian Economy

Govind Bhattacharjee (govind100@hotmail.com) is a retired Director General from the Office of the Comptroller and Auditor General of India and currently a visiting professor at the Asian Development Research Institute, Patna; and visiting senior fellow at the Centre for Multilevel Federalism, New Delhi.

A 2019 Comptroller and Auditor General report has brought out glaring irregularities in the exemptions given to agricultural income for income tax purposes. Exempting large income on agriculture from taxation not only makes the agricultural sector a conduit for money laundering and concealment of black money, but also holds back the much-needed modernisation and reform of the sector. Although everyone agrees on the desirability of taxing agricultural income, successive governments have shied away from it for electoral reasons.

In a white paper on black money released in May 2012, the Central Board of Direct Taxes admitted that:

Giving credit to agricultural income for income-tax purposes without verification of claim allows an avenue for bringing black money into the financial system as agricultural income.

In 2014, the Tax Administration Reforms Commission (TARC) report ­stated emphatically:

Agricultural income is exempt from taxation in spite of large agricultural holdings … a large number of rich farmers, who earn more than salaried employees in the cities, get away with paying no tax in view of the government’s lack of will to consider an agricultural income-tax. (Report 2014: 811)

It further said,

Agricultural income of non-agriculturists is being increasingly used as a conduit to avoid tax and for laundering funds, resulting in leakage to the tune of crores in revenue ­annually. A solution could be to tax large farmers. (Report 2014: 820)

In March 2016, in response to an right to information (RTI) application filed in May 2015 by an Indian Revenue Service (IRS) Officer, the Income Tax Department (ITD) revealed that agricultural income in the country rose exponentially bet­ween 2004 and 2013 and that the agricultural income earned by the 6.57 lakh assessees who had filed returns in 2011 stood at nearly `2,000 lakh crore, which was over 20 times the country’s gross domestic product (GDP) of `84 lakh crore in that year, even though the total area under cultivation and agricultural production had remained almost constant over the period (Hindu 2016). The news created a furore inside and outside Parliament. The officer then filed another RTI application seeking details of top 100 such assessees which the ITD refused to provide, taking refuge under Section 8 1(J) of the RTI Act which prohibited disclosure of personal information unless there was an overriding public interest, which in ITD’s opinion did not exist. However, it was forced to launch an ­investigation in respect of those reporting annual farm income of more than `1 crore, of which there were 307 in the assessment year 2015–16, and subsequently clarified, in January 2017, that it was ­actually due to data entry errors that such huge farm incomes were erroneously reported (Indian Express 2017).

In June 2016, the Rajasva Gyan San­­gam, a two-day conference of tax admi­nistrators also drew attention

on the need to target farmers with non-agricultural income above a certain threshold, an idea that was pitched as a low-hanging fruit that could potentially bolster ongoing efforts to widen the country’s taxpayer base.”

It may be mentioned that of the 25 crore taxpaying households in the country, 15 crore households are designated as agriculturalists and the remaining 10 crore are non-agriculturalists, according to ­estimates produced at the conference.

Agriculture is exempt from income tax under Section 2(1A) of the Income Tax Act which defines agricultural inc­ome as rent/revenue from land, income derived from this land through agriculture and income derived from buildings on that land. Further, unless there is a specific taxing entry in the union or state list under the Seventh Schedule to the Constitution, no tax can be imposed by the union or the state. The tax on agricultural income is listed under the state list (entry 46), and hence the central government cannot tax such income. As such, Section 10 (1) of the Income Tax Act, a Central Act, excludes agricultural income from the computation of total ­income. This exemption would, however, be available only in cases where the income in question constitutes agricultural income within the meaning of Section 2(1A). Thus, farmers who have no other sources of income are not required to file income tax returns. It is only those farmers who derive income from sources other than agriculture who are required to file returns in which any ­agricultural income exceeding `5,000, where the total income excluding net agricultural income that exceeds `2.5 lakh in a year, is to be reported for determination of their appropriate income slab for chargeability of tax. Tax on agricultural income is then deducted from the total tax, and thus computed for the ­assessee.

Nearly four lakh people declaring farm income were granted exemption during 2013–14, with total agricultural income exempted from tax being `9,338 crore in that year. To test the robustness of the mechanism for verification of such exemption claims, the Comptroller and Auditor General of India (CAG) instituted an audit that was guided by me during the initial stages before my retirement. The audit checked 6,778 of the total 22,195 case records of assesses who had reported agricultural more than `5 lakh each between 2014–15 and 2016–17. The final CAG Report No 9 of 2019 containing findings on these subjects was tabled in Parliament on 30 July 2019.

The CAG found that in 22.5% of the cases, the exemption on agricultural income was allowed without adequate documentation and verification; in 10.6% of the cases, land records were not available with the department; and in 18.7% of the cases, the proof of agricultural income was missing. Thus, in more than 50% of the cases checked, ­exemptions were allowed without verification. The CAG naturally questioned the robustness of mechanism to verify the correctness of the exemption clai­med, besides highlighting many other lacunae and deficiencies like incorrect exemptions granted for income derived from agricultural land or for partial agri­cultural income as well as non-agricultural incomes, mismatch of exemption figures in assessment orders and ­income tax database, etc. Data entry ­errors were found in 36, or 11% of the cases, where reported agricultural income exceeded `1 crore each, and for which records were available (327 out of total 2,746 such cases). The CAG obser­ved that existence of such errors rendered the database unreliable. On the basis of the above observations, CAG stated that the “ITD needs to tighten its system to allow exemption of income as agricultural income, as currently the system is porous and open to misuse” and lacked “due diligence in verification of records” (Report 2019: 69–94). Such irregularities, however, will continue to beset not only our tax administration but also the much-needed reform and modernisation of our agricultural sector (the largest employer in the country with almost half the country’s population ­being dependent on one-seventh of the national income), so long as the one major distortion in our financial system—exempting all agricultural income from taxes—stands uncorrected. The scale of distortion can be assessed from the fact that some of the exempt income belongs to companies whose profits run into hundreds of crore as shown in Table 1.

Taxation of agricultural income by the centre would warrant an amendment to the Constitution by inserting a taxing entry in the union list with appropriate changes being made in Part XII of the Constitution, and an arrangement of assignment of such taxes to the states. This is not possible without involving the states which only can levy a tax on agricultural income at present. But there can be an alternative mechanism, a tax-rental arrangement suggested by the TARC,

Against a tax free limit of `5 lakh on agricultural income, farmers having a high agricultural income threshold, such as `50 lakh, could be taxed. This will keep small farmers out of the purview of taxation and yet close one escape route for black money. States could pass a resolution under Article 252 of the Constitution, authorising the Centre to impose tax on agricultural income. All taxes collected by the Centre, net of collection costs, could be assigned to the states. This will broaden the taxpayer base and help ­mobilise additional revenue without affecting any but a very miniscule proportion of the very large farmers whose annual income exceeds the threshold limit. (Report 2014: 820)

To expect that states already reeling under agitations by farmers would take a plunge in this regard is unrealistic, while farm lobbyists and interest groups, to protect the interests of the big farmers, would likely prevail upon the centre to reject any such proposal. It, therefore, can be expected that the untaxed agriculture sector will continue to absorb black money and distort the social equity and preclude the reform of agriculture as well as the expansion of tax base. Many committees appointed by the government in the past had proposed to bring agriculture under the tax net, but it has always remained a holy cow of the economy, not be touched. All political parties are deterred by the fear of a backlash by their largest vote banks if agriculture is taxed. As I have argued elsewhere, this fear is based on nothing but a myth, because even if the sector is brought under the tax net, it would only be a minuscule percentage of the total number of farmers who would be affected by such a tax (Bhattacharjee 2017: 42–64).

In August 2019, the Ministry of Agriculture and Farmers’ Welfare released data pertaining to the Agriculture Census 2015–16. The census estimated the total number of operational holdings in the country at 146.45 million and total operated area at 157.82 million hectare. The average size of the holding was estimated at 1.08 hectare compared to 1.15 hectare in 2010–11, in accordance with its steadily declining trend since 1970–71. The size groupwise percentages of the number and area of operational holdings are as shown in ­Table 2 (p 14).

Thus, about 86% of the operational holdings are with the small and marginal farmers only, accounting for almost 47% of the total area under cultivation. The Hindi belt states of Uttar Pradesh, Bihar, Madhya Pradesh and Rajasthan together account for about 40% of the total operational holdings and 38% of total operated area. It is here that feudal relationship and caste considerations play an overwhelming role in shaping the political alignments and voting beh­aviour. For the country as a whole, large, semi-medium and medium holdings ­together account for only about 14% of the total number of holdings, with a disproportionately large share of more than 53% of the total operated area (as against 15% and 55% respectively in 2010–11). Small and marginal farmers are not required to file any income tax returns under the present system if agriculture is their only source of income, and even if the sector is taxed, their ­income threshold will likely remain way below the taxable limits for income. It is only the semi-medium, medium and large farmers who would form the tax base for any future tax on agricultural income. What could be their estimated numbers in absolute terms?

The agricultural census showed that there were 138 million holdings in India in 2010–11, of which 118 million were held by marginal and small farmers (93 million marginal and 25 million small). These figures can be related to the 2011 Census figures, according to which there were 313 million main workers in the country, of which 176 million (56.6%) were engaged in “agricultural and allied activities.” The number of cultivators were 127 million. Using the number of holdings by small and marginal farmers as a proxy for their number, we can roughly estimate that the number of small and marginal farmers were 118 million, about 93% of the total. The rem­aining 9 million, or about 7% farmers who share between them 53% of the ­total cultivable land would be the target group for any future taxation on their agricultural income. They may be politically influential but otherwise do not constitute a major vote bank. Further, going by the past trends which indicate that the number of small and marginal farmers and their share in the total number of operational holdings have incre­ased continuously since 1970–71 as shown in Table 3 (p 15) and this trend is likely to continue. The number of medium and large farmers are not likely to increase drastically in the future so as to constitute a major vote bank ever in future for any party. But, even most of these nine million farmers would not have to pay much tax.

According to the latest Situation Asse­ssment Survey of Agricultural Households, conducted in the 70th Round of NSS during January 2013 to December 2013, the average monthly ­income per agricultural households during the agricultural year July 2012–June 2013 was estimated at `6,426.90, as shown in ­Table 4 (p 15). The net receipt from farm business (cultivation and farming of animals) accounted for about 60% of the average monthly income per agricultural household. The average monthly consumption expenditure per agricultural household was estimated at `6,223, as against estimated income of `6,426, with hardly any scope for saving or capital investment in agriculture. Only for the large farmers (>10 ha of holding), the income was `41,388 per month, above the income tax threshold, with substantial potential for savings. Thus, only the large famers who account for a miniscule 0.57% of the total number operational holdings and 9% of the total operational area will be primarily liable to pay any income tax. That should not affect the electoral fortunes of any party in the foreseeable future.

It is not that agriculture was always out of the tax net in India. Before the present Income Tax Act of 1961, the previous Income Tax Act of 1860 used to tax agricultural income till 1886 before it was abolished. Uttar Pradesh introduced agricultural income tax in 1948, only to repeal in 1957. Even now income from tea, coffee and rubber plantations is taxed. Under Rule 8 of the Income Tax Rules, 1962, income derived from the sale of tea grown and manufactured by the seller in India is treated as income derived from business, and 40% of such income is taxed. Similar provisions also exist for rubber and coffee plantations under Rules 7A and 7B of the Income Tax Rules, respectively. But leaving agricultural income taxation to individual states will render such income being taxed at different rates in different states, distorting the market for agricultural produces. Also, given the highly informal nature of business in this sector, administering such tax will initially pose serious problems, but that is expected of any new domain of taxation.

In 2017–18, besides 8 lakh corporate asssessees, only 5.38 crore individuals filed tax returns in a country of 130 crore citizens, and 4.77 crore or only 3.7% of population paid any taxes (44% in United States for comparison). The majority (3.61 crore) paid tax at the lowest slab rate of 10%. Only 37 lakh paid tax at the highest rate—mostly from the organised sector, thanks to compulsory Tax Deducted at Source. To instil a culture of tax payment and to expand the tax base, the untaxed agricultural sector must be brought under the tax net.

In 1925, the Indian Taxation Enquiry Committee had noted,

There is no historical or theoretical justification for the continued exemption from the income tax of income derived from agriculture. There are, however, administrative and political objections to the removal of the exemption at the present time.

Nine decades have since passed by, and no government has thought about addressing those administrative and ­political objections. How many more decades would we need to do that?

References

Bhattacharjee, Govind (2017): “Taxing Agricultural Income,” Indian Journal of Public Audit and ­Accountability, Vol X, No 1, Institute of Public Auditors of India, New Delhi.

Hindu (2016): “Farmers Grow Massive Incomes for Select Few,” 19 March, New Delhi.

Indian Express (2017): “Income Surge Behind Farm Tax Proposal Was Data Entry Error,” 26 January, New Delhi.

Rediff.com (2016): “Not Just Rich Farmers, Even Agri Cos with `215 Crore Profit Pay No Tax,” 16 May.

Report (2014): “Third Report of the Tax Administration Reform Commission (2014),” Government of India.

— (2019): Report No 9 of 2019 (Direct Taxes) of the Comptroller and Auditor General of ­India, New Delhi.

 

Updated On : 20th Oct, 2020

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