With increasing prosperity, people living in cities have been buying second homes (which are often farmhouses) and agricultural land in the vicinity of large cities. Since agriculture is a subject reserved for the states under the Indian Constitution, agricultural income cannot be taxed by the central government but only by the state governments. Agricultural income is, therefore, exempt under income-tax laws. Profit on the sale of agricultural land is also exempt from capital gains under income-tax laws. However, not all gains on sale of agricultural land is exempt and, therefore, one needs to understand the extent of the exemption.
Outside the capital gains ambit
Capital gain is chargeable to tax on the transfer of a capital asset. The definition of “capital asset” excludes agricultural land. There are two exceptions to this exclusion. The first is agricultural land that is located within municipal or cantonment board limits, where the population of the municipality/cantonment board is at least 10,000. The second is land which is within certain notified distance (which can be up to 8km) from the limits of notified municipalities/cantonment boards. Agricultural land that is situated in these areas would be a capital asset and the sale of such land would, therefore, be subject to capital gains tax. It is only in the case of agricultural land located outside these areas that capital gains tax liability would not arise on sale.
For most major cities, the maximum permissible distance of 8km has been notified. How is this distance from the municipal limits to be computed—the distance as the crow flies (direct distance) or the distance by road? The road distance is always normally more than the direct distance as roads rarely follow a straight path. One high court decision indicates that the measurement is to be of direct distance, as the crow flies, and not on the basis of the road distance.
For this purpose, a panchayat would not be regarded as a municipality, as a panchayat and a municipality are quite distinct. However, town committees and notified area committees would be considered on a par with municipalities and cantonment boards for the purpose.
Which land is an agricultural land
The other more important aspect is—what exactly is meant by agricultural land? Is it sufficient for agricultural land to be classified so in land revenue records? Or does it actually have to be cultivated? The courts have generally taken a view that it is not merely the land revenue classification as agricultural or non-agricultural that matters, but various other factual aspects need to be taken into account to determine whether the land that is sold is agricultural or not. The matter has to be decided by looking at the cumulative effect of all the facts and not on the basis of any one fact.
Some of the factors considered by courts are: the classification of the land in official records, whether the land is assessed to land revenue (tax) or not, whether the land is capable of being used for cultivation, whether the land is actually being used for cultivation by the owner, the intention of the owner in holding the land and the character of the adjoining land—agricultural, residential, commercial or industrial.
For instance, in a case where land was located in an important and busy thoroughfare, surrounded by industrial and commercial buildings, no agricultural activity was carried out in the vicinity but vegetables were being grown on the land, the Supreme Court has taken the view that mere cultivation would not change the character of the land from non-agricultural to agricultural. In one case, a high court has taken the view that actual agricultural operations are not necessary, but it is sufficient if the land is capable of being used for agriculture. In another decision, a high court has held that the fact that the land is being sold for non-agricultural purposes is one of the factors that is to be considered for the purpose of determining whether the land is agricultural or not.
When it attracts capital gains tax: If agricultural land is being held by an investor to reap the benefit of capital appreciation and is not being cultivated or intended for cultivation, sale of such agricultural land may attract capital gains tax.
Because of the restrictions relating to acquisition of agricultural land, most agricultural land is cornered by politicians and their nominees. Huge profits are made on the sale of agricultural land for various projects by such persons. A genuine agriculturist cultivating agricultural land (which is in the specified areas) is in any case entitled to an exemption if he reinvests the capital gains on sale of agricultural land in acquisition of agricultural land. Would this exemption not suffice for genuine agriculturists? Why provide a route for politically well-connected persons to make windfall tax-free profits?
Even under the Direct Taxes Code (DTC), in its present form, sale of agricultural land would not be subject to capital gains tax. Is such continuation of the exemption really justified? One would have thought that the opportunity presented by the DTC would have been used to plug such a loophole. Unfortunately, the government thinks otherwise.
Gautam Nayak is a chartered accountant.
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