Taxing the Un-taxed: the curious case of Exempt Agricultural Income of Rich Farmers in India

The Premise:

In April 2022, the Public Accounts Committee tabled a report in the Parliament on ‘Assessments relating to Agricultural Income’ in which the committee noted that – more than 21 lakh taxpayers claimed agricultural income in their 2020-21 returns and nearly 60,000 of them had reported agricultural income exceeding Rs. 10 lakhs.

Background to the development:

Agriculture is exempt from income tax under Section 10(1). Taxes on agricultural income falls under Entry 46 in ‘State List’ under the Constitution of India. Thus, only the State Governments are competent to enact legislations for taxation of agricultural income and levy income tax. Thus, farmers who have no other sources of income are not required to file income tax returns.

In 2002, the Kelkar Committee (Task Force on Direct Tax) stated that:

The exemption to agriculture income “distorts both horizontal and vertical equity” and “encourages laundering of non-agricultural income as agricultural income, i.e., it has become a conduit for tax evasion”.

In May 2012, the Central Board of Direct Taxes in a report stated 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 report stated:

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.

As agricultural income is exempt under the provisions of the Income Tax Act, giving credit to agricultural income for income tax purposes without adequate verification of claim may involve risk of allowance of exemption on ineligible incomes resulting in loss of revenue to the Government. This treatment creates major distortions in our financial system. The scale of distortion can be assessed from the fact that some of the exempt agricultural income belongs to major companies, as can be viewed in the table below:

During 2013-14, nearly four lakh people declaring farm income were granted exemption, with total agricultural income exempted from tax amounting to ₹ 9,338 crore. The Comptroller and Auditor General of India (CAG) conducted an audit to assess the robustness of the mechanism for verifying such exemption claims.

The Bombshell: 2019 CAG Report

In 2019, a report published by the CAG, studied a sample of 6,778 cases out of 22,195 scrutiny assessments carried out by the income tax department during 2014-15 to 2016-17, of those who had an agriculture income claim of more than ₹ 5 lakhs. The agricultural income of ₹ 3,656.25 crore were claimed in these 6,778 cases of which ₹ 2,544.21 crore were allowed. The CAG report observed that:

• Out of the ₹ 3,656.25 crore, 57% was claimed by companies and 37% by Individual assessees
• Exemption on agricultural income was granted in 22.5% of the cases without adequate documentation and verification and agriculture income allowed was worth about Rs. 500 crore in these cases
• In 10.6% of the cases, land records were not available with the department
• In 18.7% of the cases, proof of agricultural income was missing
• Data Entry errors were observed in 11% of the cases
• Further, mistakes in levying interest, incorrect allowances of business expenditure, errors in computation of the income etc. were also observed.

The report noted that such lacunae in the system such as not verifying the expenditures would give way to bringing in black money/unaccounted money into the financial system under the garb of agricultural income.

The Way Forward:

In 2012, a study carried out by National Institute of Public Finance and Policy (NIPFP) estimated that the potential of tax revenue from agricultural income at about 1.2% of the GDP in FY-2008 or 9% of the agriculture GDP of that year. It said the states could earn additional revenue of about 19% by taxing agricultural income.

The biggest opposition to the taxation of agricultural incomes in India has been political in nature as most of the people living in rural areas are dependent upon agriculture in a direct or indirect manner. This situation has been to the advantage of rich farmers who have been more vehemently opposed to the increased taxation of agricultural income in India.

The Public Accounts Committee report on ‘Assessments relating to Agricultural Income’ in April 2022, it examined certain paragraphs of the 2019 CAG report emphasized the importance of strictly adhering to the procedures for document verification in order to grant exemptions.

The Committee suggested to come up with a mechanism for categorization of cases of agricultural income into three slabs- above ₹ 10 lakhs, ₹ 50 lakhs, and ₹ 1 crore in Computer Aided Scrutiny Selection (CASS) to target high evasion risk cases.

Conclusion:

It is critical to strike the right balance between taxing agricultural income and not undermining the agricultural sector. The government’s current focus on bringing farmers into the formal system through digital economy is a step in the right direction.