NITI Aayog proposes tax on agriculture income: pros & cons

Taxing agricultural income has been an emotive subject in the Indian context. However, taxing agricultural income at minimal rates of about 5% can help rather than hurt our poor farmers.Finance minister Arun Jaitley has categorically stated that government has no plan to tax agricultural income. This followed a proposal by Niti Aayog member Bibek Debroy to levy such a tax.

• Few experts are seeing Finance Minister’s statement as unfortunate as it shows that the default mode of India’s policy makers is to ring fence agriculture and hamper its modernisation. It ignores the linkages between the agriculture and non-agriculture sectors which, among other things, allows for tax evasion.

What is the Issue?

• But policymakers have begun to voice the opinion of Bibek Debroy, the latest being Chief Economic Adviser Arvind Subramanian who made it clear that taxing farm income is a State subject.

• The public image of farming being a poor man’s venture and the sizeable vote share that farmers enjoy have made the idea of farm taxes a political taboo.

• The frequent distress faced by poor or marginal farmers, which could be attributed to structural issues other than taxation, hasn’t helped matters either.

• But India has a presence of rich farmers as well and there exists as a strong justification for taxing them in order to widen the country’s embarrassingly narrow tax base.

• Mr. Debroy suggested that an appropriate tax policy should draw a distinction between rich and poor farmers, thereby addressing the widespread political apprehension of bringing agriculture under the tax net.

• It is no secret that India’s tax base, standing at a minuscule 5.9% of the working population, is already among the lowest in the world.

• This unnecessarily burdens the more formal sectors of the economy that are already overtaxed; at the same time, it handicaps government spending on the social sector.

Background:

Given the importance of access to finance, the policy in India has been to compel banks to lend to the underserved.

• However, access to formal finance remains a challenge even after decades of implementation of such policies. This demonstrates that such coercive policies have borne little fruit.

• Also, the burgeoning problem of farmer distress in India despite the existence of the priority sector lending programme for more than three decades is a case in point.

Present scenario:

The Income Tax Act through section 10(1) exempt’s agricultural income from tax and it includes,

• Any rent or revenue derived from land which is situated in India and is used for agricultural purposes.

• Any income derived from such land by agriculture operations including processing of agricultural produce so as to render it fit for the market or sale of such produce.

• Any income attributable to a farm house subject to satisfaction of certain conditions specified in this regard in section 2(1A).

Why tax on agricultural income is a good idea?

• Any serious campaign to widen the tax base and curb black money should address what income tax department reports have shown: agricultural income is used as a conduit to avoid tax. There is nothing to worry as a tax on agricultural income will exclude most of India’s 90 million agricultural households as their average income is way below the threshold income.

• Taxing agricultural income can improve access to finance to a large section of farmers because verified income tax returns can provide a credible signal of the earnings potential of a farmer. Such verifiable information can help to separate conscientious and productive farmers from the unscrupulous or unproductive farmers. Such separation can be very useful in not only enabling access to finance but also entered using the cost of credit borne by farmers.

• Taxing also helps banks to carefully eliminate strategic defaulter intending to exploit the lax enforcement standards prevalent in the country. Well-directed agricultural loans would not only enhance agricultural productivity, but also hasten the movement of unproductive agricultural workers to the manufacturing sector.

• Taxation requires regular and systematic maintenance of accounts which would further help the farmers to secure need based loans on documented records.

• Huge sum of income is rotated through farm sector and it is given the shape of agricultural income to subvert taxation.

• Inadequate or nil maintenance of accounts lead to nepotism and corruption in availing the bank credit. The poor farmer ends up at the mercy of bank officers which leads to his exploitation.

• Scarce loans forwarded to the farmer become insufficient for his needs and it forces him to show up at the doorsteps of the informal moneylenders. This leads to the start of debt trap cycle.

• Verified income tax returns provide credibility to the farmer which can be used to obtain adequate loans from formal credit channels.

• Banks get easier access to reliable, valid and quantifiable data upon which the credit can be advanced without fear of default on loan.

• Adequate formal documentation would help the Government to identify the difference between small and big farmers by which the targeted subsidy schemes in future can be rolled out to benefit the needy.

• Involvement of agriculture in direct channels of taxation would improve GDP to tax ratio which would help the government to raise its revenue for more social sector spending.

• Maintenance of accounts would help the farmers to realise their revenue potential and possible migration from the primary to secondary sector of the economy, in case of decreased efficiency and revenues.

How taxing helps both small and big farmers?

Suppose both farmers file income tax returns every year. In this case, the big farmer can present his income tax return to the loan officer in order to demonstrate his earning potential. In the case of small farmers, income tax returns can provide a reasonably credible measure of earnings potential because they would neither have the high income nor the incentives to hide such high levels of income.

• With this, now the loan officer too has a credible basis to distinguish between the borrowers. More importantly, the borrower need not depend on a particular loan officer or a particular bank.

• This also improves the bargaining power of the borrowers by enabling them to tap multiple sources for financing.

What is the impact on farmers?

• The proposed measure will make no difference to the vast majority of those engaged in agricultural activity.

• As per the 2010-11 Agriculture Census, over 95% of India’s 13.84 crore operational holdings are of below four hectares (10 acres) size.

• Not many farmers falling within this holding limit would be drawing an annual income above Rs 5 lakh, which currently attracts zero personal tax liability with rebate.

• Farmers can also be entitled to claim depreciation on fixed assets from tractors and drip irrigation systems to cattle and carry-forward their losses from year to year.

• This will not only ensure that the bulk of agricultural incomes remain untaxed, but also incentivize farmers to undertake productivity boosting investments in their land.

• Farmers who are cultivating less than, say, 10 acres will, thus, have nothing to fear if agricultural incomes are brought under the tax net.

Why it is difficult to introduce this new tax?

The public image of farming being a poor man’s venture and the sizeable vote share that farmers enjoy have made the idea of farm taxes a political taboo.

The frequent distress faced by poor or marginal farmers, which could be attributed to structural issues other than taxation, hasn’t helped matters either. Besides, it requires a Constitutional amendment as the taxation of the income from agriculture is a subject falling under the states’ domain.

Concerns:

However, in the absence of accompanying reforms, a tax on high-income farmers will result only in driving resources away from agriculture into other sectors. It would make no difference to poorer farmers stuck in agriculture, merely because of the lack of opportunities.

• Imposition of tax could lead to credit flowing only to big farmers as they have higher income to show.

• It would be an onerous task to admit the illiterate and ignorant small farmers into the formal direct taxation structure as they may be prone to exploitation by tax planners and officials.

• The case for treating agriculture on a par with other sectors is thus clear.

• But policymakers must also show equal care and urgency in addressing the structural issues facing the sector.

• This includes, among many, reforms to the broken agricultural supply chain that still leaves farmers at the mercy of middlemen cartels.

• Such reforms are crucial if farming is to become a sustainable enterprise in the long run.

• Else, a tax on high-income farmers will result only in driving resources away from agriculture into other sectors.

• It would make no difference to poorer farmers stuck in agriculture, merely because of the lack of opportunities.

• In this context, the historical transition of labour and other resources from agriculture into other sectors is particularly useful to keep in mind.

• The said transition has been very slow in India; in fact, according to Census figures, the size of the farm workforce increased by 28.9 million between 2001 and 2011.

• This is due to a combination of factors, but one in particular is worth noting: the difficulty agricultural workers face in finding jobs in other more advanced sectors.

• A tax on lucrative high value farm ventures, which affects their ability to absorb labourers from low-value farming, could make life more difficult for farmers unable to make the cut in industry or services.

• Given this, policymakers ought to tread carefully as they move forward on a long overdue fiscal reform.

• The government should build a consensus across the political spectrum, given the fact that this is such a politically sensitive issue and constitutional provisions fall under the State list.

• India cannot afford it to end up in a logjam like in the case of Land Acquisition Bill.

• The government should grab the issue by its root for the benefits of the small farmers.

• Experts believe that taxing agricultural income could lead to higher agricultural productivity and lower default on credit. India should be ready to bite this bullet too but with a consensual and productive approach.

Reasons over the proposal to tax agricultural income miss the point

• First, Section 2 (1A) of the Income Tax Act defines agricultural income as rent/revenue from land, income derived from this land through agriculture and income derived from buildings on that land. Second, Section 10 (1) of the Income Tax Act excludes agricultural income from a computation of total income. Neither of these sections is dispute-free and chartered accountants and lawyers have been enriched via these. But broadly, these propositions are true.

• Third, conditions on the sale of agricultural land vary from state to state. In some states, there is a requirement that land can only be sold to “farmers”. But not every state requires this. When there is a stipulation, there are no credible checks on “farmer’s certificates”, in addition to circumvention through the leasing route.

Fourth, in the Seventh Schedule, Entry 82 in the Union List mentions taxes other than agricultural income, while Entry 46 in the State List mentions taxes on agricultural income. Therefore, arguing that this is in the State List is valid. But, if I have apoplexy at the mention of an agricultural income tax, there can be only two conclusions: I don’t know that some states tax agricultural income, or I am denying state legislatures their right to tax agricultural income.

• Fifth, long before the Income Tax Act of 1961, there was the Income Tax Act of 1860, now forgotten. This was the introduction of income tax in India (in a modern sense) and it was meant to be temporary. Wonder of wonders, it taxed agricultural income till 1886.

What changed in 1886, or between 1860 and 1886? The answer had more to do with general resentment against colonial rule, and less to do with agricultural income taxation directly. Sixth, in 1932, there was the Federal Finance Committee of the Round Table Conference and its report. If we have the present constitutional structure, that’s because of this report and the Government of India Act (1935).

• Seventh, we have had Agricultural Income Tax Acts in Bihar (1938), Assam (1939), Bengal (1944), Orissa (1948), Uttar Pradesh (1948), Hyderabad (1950), Travancore and Cochin (1951) and Madras and Old Mysore State (1955). Eighth, this isn’t entirely history .

we still have the Assam Agricultural Income Tax Act (1939), the Bihar Agricultural Income Tax (1939), the Kerala Agricultural Income Tax Act (1991), the Tamil Nadu Agricultural Income Tax Act (1955), the Orissa Agricultural Income Tax Act (1947), the Maharashtra Agricultural Income Tax (1962) and the Bengal Agricultural Income Tax Act (1944), or so I think.

• Unlike the Karnataka Agricultural Income Tax Act (1957), repealed in 2016, I am not aware of these statutes having been repealed. Therefore, it isn’t true that states don’t tax agricultural income, though it’s true that they tax some kinds of agricultural income, such as plantations. Ninth, it isn’t as if this issue was discovered yesterday.

The issue of taxing agricultural income (and wealth) goes back to the 1960s. There must be a unified system of taxation across states. Agricultural income taxation must be integrated with non-agricultural income taxation. Land revenue tax hasn’t quite worked and must be replaced.

• There is a considerable amount of literature from the 1960s and 1970s, based on such principles. To those who wonder about how an agricultural income tax will be implemented, may suggested reading the 1972 Raj Committee Report on Taxation of Agricultural Wealth and Income.

You don’t have to agree with the committee’s agricultural holding tax idea, but it isn’t as if no one has thought about implementation. May I also suggest the Fourth Five Year Plan (1969-74) document and the report of the Fifth Finance Commission (1969) as well? Indeed, if one looks for strong arguments in favour of agricultural income taxation, one will find them in the report of the Taxation Enquiry Commission (1953-54).

• Tenth, there can be problems with generalisations. I guess, in logic, this would be called a fallacy of composition: Epimenides is poor; Epimenides is Cretan. Therefore, all Cretans are poor. Now, read “farmer” instead of Epimenides. Not realising there are thresholds, irrespective of whether in agriculture or non-agriculture, is a deliberate attempt at obfuscation. Eleventh, in 2002, there was the report of the Vijay Kelkar Task Force on direct taxes.

This made the point that not taxing agricultural income violates horizontal and vertical equity and it “encourages laundering of non-agricultural income as agricultural income, that is, it has become a conduit for tax evasion. Both the arguments are empirically verifiable.”

• This empirical validation was done on the basis of tax returns in Mumbai. This report proposed, “A tax rental arrangement should be designed whereby states should pass a resolution under Article 252 of the Constitution authorising the Central government to impose income tax on agricultural income.

The taxes collected by the Centre would however be assigned to the states. Most agricultural farmers would continue to remain out of the tax net.” At that time, estimates were that 95 per cent of farmers would be below the threshold.

• Twelfth: Consider some figures from an RTI application filed by Vijay Sharma last year. In 2012, 8,12,426 individual tax payers disclosed agricultural income. The average income per individual assesses was Rs 83 crore. Do the multiplication and the mind boggles.

In assessment year 2015-16, 307 individuals reported an agricultural income of more than one crore rupees a year. In 2014-15, a company made profits of Rs 215 crores, but claiming the agricultural income exemption, it paid no tax.

Way ahead:

A move to tax agriculture should be packaged with steps to help farmers. For instance, sudden export bans on a commodity when international prices are soaring amounts to imposing a cap on farmer incomes. In the same vein, restrictions on movement within India distort agricultural trade.

Agricultural products too need a common market and farmers should be freed of shackles which tie them to designated wholesalers. One way to proceed could be to act on a proposal of the last tax administration reforms committee, which suggested a high threshold of Rs 50 lakh annually. To facilitate these move state governments will have to be enlisted to follow the relevant constitutional procedure.

The income tax department will soon scrutinize all high value cash deposits and cross check if it is in line with the land holdings of the farmer and the corresponding yields. In case there is a large discrepancy, the farmer will be asked to explain this difference.

Exemption of agricultural income from tax provides an opportunity to those intent on tax evasion. Unless this loophole is plugged the problem will recur. Taxing agricultural income can be done without hurting farmers who have borne the brunt of agrarian distress. Therefore, it is an idea worth pursuing.

By Gudipati Rajendera Kumar