Demystifying the debate over tax on agricultural income

Recently, Bibek Debroy – an economist in the NITI Aayog (the think tank of the Indian government) – suggested the taxation of agricultural income to widen the tax base and raise greater revenue for schemes in the social sector. He added that the threshold for agricultural income would be based on the average income from 3 to 5 years due to the proclivity for agricultural income to fluctuate. However, in a press conference, Arun Jaitley dismissed the idea that the government intended to levy a tax on agricultural income.

Given that more than 70% of Indians rely on agriculture as a source of income, agricultural tax is a contentious matter in India.

When income tax was introduced in India by the British in 1886, agricultural income was exempted as farmers were subject to other levies. In 1935, the crown transferred land revenue (and thus agricultural income tax) to the provinces. These provinces became states when India became independent. The Indian constitution adopted this facet of British legislation and thus, today, agriculture is in the concurrent list.

Under Section 2 (1A) of the IT Act, agricultural income is defined as revenue/rent from land, income earned by practicing agriculture on the land and income earned from structures built on that land. Section 10 of the IT Act has an exemption clause that prohibits the central government from imposing a tax on agricultural income earned by any individual, entity, or corporate company. Thus, under this clause, even Agro-companies are eligible for tax exemptions.

Presently 6 states in India have legislation regarding agricultural tax, namely, West Bengal, Kerala, Tamil Nadu, Bihar, Assam, and Odisha. Rajasthan and Uttar Pradesh introduced agricultural taxes but then rolled them back. However, only agricultural income from plantations is taxed in some of the aforementioned states.

Arguments in favour of taxing agricultural income

A number of studies have elucidated on the impact of agricultural taxes in India – majority of them advocate taxing agricultural income above a certain threshold. In 1947, the expert committee on financial provisions to the Constituent Assembly advocated that the center consult states to settle the matter. Even Dr. B.R. Ambedkar believed that agricultural income should be taxed as taxation should be based on the income/paying capacity of the individual – thus, according to him, rich farmers should be taxed. Case for an Agricultural Income Tax (1961) by Yoginder K. Alagh found that an agricultural tax results in a rise in state revenue. The K.N. Raj Committee on Taxation of Agricultural Wealth and Income (1972) advocated instituting an Agricultural Holding Tax (AHT) instead of land revenue and taxing rich farmers. The Planning Commission study of cooperative farms found that tax exemptions available to cooperative farms result in tax avoidance as mechanized farms having hired labour take advantage of these exceptions. The Vijay Kelkar committee report (2002) found that lack of agricultural taxation violates vertical and horizontal equity. Tax Administration Reform Commission (2014) states that non-agriculturists use of agricultural income for laundering funds and avoiding tax. Such activities reduce the revenue of the state. 70th round of the National Sample Survey finds that 86% of agricultural households in India own land holding measuring less than 2 hectares. Thus, in the event of an agricultural tax being introduced, low income farmers would not be taxed.

Furthermore, agricultural income has to be declared even if it is not taxable. Thus, it has been found that between 2007-08 and 2015-16, about 2,746 individuals and entities declared agricultural income equaling Rs.1 cr. In 2014-15, of the top 10 claimants of agricultural income tax exemptions in India, 9 were co-operations. In 2011-12 and 2012-13, huge discrepancies were found in agricultural income by former income-tax chief commissioner, Vijay Sharma.

In addition to the above, it should be noted that India has a very low rate of tax compliance. Thus, taxing agricultural income will increase India’s tax revenue. The revenue so collected can be reinvested in agriculture and associated technologies to increase agricultural productivity and thus raise agricultural income.

Additionally, farmers may save more if agricultural income becomes taxable because they may be encouraged to make investments in LIC policies or in the Public Provident Fund to reduce their taxable income as investment in these vehicles in tax deductible. Using the funds so saved, farmers may be able to invest in residential housing and thus reduce the burden on the government to provide housing to the poor. Illiterate farmers will also be able to comply with the formalities as section 44AD of the IT act, allowing business persons with turnover less than Rs.1 cr to not maintain written accounts and being taxed presumptively, can be extended to farmers with similar income.

Arguments against taxing agricultural income

Political opposition to agricultural taxation is largely driven by the rural elite who’s income would become taxable – political back lash against an agricultural tax would result in fewer votes and funds from this voter block.

Furthermore, it is administratively difficult to implement an agricultural tax in a developing country like India. In the World Bank paper titled ‘Taxing Agriculture In A Developing Country: A Possible Approach’ (2004), the author Indira Rajaraman showed the twin problems of the lack of standardized account keeping and the prevalence of payments in kind/cash present barriers to the imposition of an agricultural tax in developing countries.

There are 120 million potential tax assesses in the agricultural sector. Furthermore, agricultural information systems are lacking in as India crop estimates are derived from satellite imaging and arrivals. Given that a majority of Indian farmers are either landless laborers, have small holdings and/or work in the unorganized sector, identification of farmers eligible for taxation would be difficult for states.

There are also technical issues to be resolved before agricultural tax can be levied. Should the tax be levied on agricultural income (i.e. the net income of farmers) or the value of agricultural output? It is easier to gauge and track the value of output sold vis-à-vis the net income of the farmer as the latter involves computation of expenses, depreciation and preparation of a profit and loss account. However, a significant amount of the output is not sold. This marketable surplus ranges between 65% and 100% depending on whether the produce is commercial or food crop. The presence of marketable surplus and under reporting complicates the calculation of the value of agricultural output.

Those who oppose the tax also state that to reduce tax evasion through the route of agricultural income, evaders should be identified rather than imposing a blanket tax on agricultural income. They also argue that large farmers should avoid the tax net by under reporting output and overstating expenses.

It is also feared that agricultural taxation may become a tool for the harassment of small and petty farmers by the officials in charge of collecting the tax.

It is also argued that agriculture is already effectively subject to taxation due to various regulatory hurdles. For instance, restricting internal trade and export bans during times of inflation amount to a tax on income of farmers. In the case of mandi taxes, the seller is often an intermediary and not the farmer. Thus, the mandi taxes an individual who may be paying taxes already and inflates the price of the product.

Bottom line

The agricultural tax will bypass majority of India’s 90 million agricultural households as their income will lie below the Rs.5 lakh threshold proposed by most committees. However, administrative and technical hurdles persist. To tackle the same, Indira Rajaraman recommends a crop specific tax, measured and implemented by the panchayat for flexibility and accuracy. To incentivize payment of taxes in the agriculture sector, she advocates for the investment of agriculture tax yields into agricultural infrastructure. The development of a dense National Agricultural Market will also help in imposing tax at source.

Thus, while the economic arguments for an agricultural tax are very strong, due to the prevalence of vote bank politics, its implementation remains unfeasible.