Land Within or in Vicinity of Municipality or Cantonment: Items (a) and (b) under Indian Income Tax

Understanding the tax implications of land transactions is crucial for any individual or entity dealing with real estate in India. Specifically, the location of the land plays a significant role in determining its taxability under the Income Tax Act, 1961. This article delves into the intricacies of Items (a) and (b) concerning land situated within or in the vicinity of a municipality or cantonment board, focusing on their impact on capital gains tax.

Understanding Capital Assets and Land

Before delving into the specifics of Items (a) and (b), it is essential to understand the definition of a "capital asset" under Section 2(14) of the Income Tax Act. A capital asset includes property of any kind held by an assessee, whether or not connected with his business or profession. However, the following are specifically excluded:

• Stock-in-trade, consumable stores, or raw materials held for the purposes of his business or profession.
• Personal effects, that is to say, movable property (including wearing apparel and furniture) held for personal use by the assessee or any member of his family dependent on him. However, this exclusion does not apply to jewellery, archaeological collections, drawings, paintings, sculptures, or any work of art.
• Agricultural land in India (subject to certain conditions, as discussed below).
• 6 ½ % Gold Bonds, 1977, or 7% Gold Bonds, 1980, or National Defence Gold Bonds, 1980, issued by the Central Government.
• Special Bearer Bonds, 1991.
• Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999, or deposit certificates issued under the Gold Monetisation Scheme, 2015.

Exemption of Agricultural Land from Capital Gains Tax

Crucially, agricultural land in India is generally exempt from capital gains tax. However, this exemption is not absolute. It is contingent on the land meeting specific criteria related to its location and usage. The Income Tax Act, through Section 2(14), defines the conditions under which agricultural land is considered a capital asset and therefore subject to capital gains tax. Items (a) and (b) of the definition deal directly with the location aspect.

Item (a): Land Situated Within a Municipality or Cantonment Board

Item (a) of Section 2(14) addresses agricultural land situated within the jurisdiction of a municipality or cantonment board. To understand this fully, we need to define a municipality and a cantonment board.

• Municipality: A municipality is a local self-government body responsible for providing civic amenities and services within a defined urban area. The structure and powers of municipalities are governed by state laws, which can vary across different states in India.
• Cantonment Board: A cantonment board is a local body established for municipal administration of cantonment areas. These areas are established for military purposes and are administered by the Ministry of Defence.

The Key Condition: If the agricultural land is situated within the local limits of any municipality (whether known as a municipality, municipal corporation, notified area committee, town area committee, town committee, or by any other name) or within any cantonment board, it is considered a capital asset and therefore subject to capital gains tax. The area within these boundaries is typically deemed to have potential for non-agricultural use, making it subject to taxation.

Implications: The sale of such agricultural land within municipal or cantonment limits will attract capital gains tax. The gains will be classified as either short-term or long-term capital gains depending on the period of holding of the asset. Holding period calculation is crucial to determine the applicable tax rate.

Item (b): Land Situated Outside but in the Vicinity of a Municipality or Cantonment Board

Item (b) of Section 2(14) addresses a more nuanced situation: agricultural land situated outside the limits of a municipality or cantonment board but within a specified distance from its boundaries. This provision is designed to capture land that, while technically outside the municipal/cantonment limits, is still closely connected to the urban or military area and likely to have development potential.

The Population Threshold and Distance Criteria: This item introduces a population threshold and distance criteria to determine whether land outside a municipality/cantonment is considered a capital asset. The land is considered a capital asset if:

• The municipality or cantonment board has a population of ten thousand or more according to the last preceding census; and

• The land is situated at any distance within the distance range specified below, measured aerially (as the crow flies) from the local limits of such municipality or cantonment board:

  • Not exceeding 2 kilometers: If the population of the municipality or cantonment board is more than 10,000 but not exceeding 1 lakh.
  • Not exceeding 6 kilometers: If the population of the municipality or cantonment board is more than 1 lakh but not exceeding 10 lakhs.
  • Not exceeding 8 kilometers: If the population of the municipality or cantonment board is more than 10 lakhs.

Key Considerations:

• Population Census: The population figures are determined by the "last preceding census." This means that the census figures relevant at the time of transfer (sale) of the land will be used to determine the population and therefore the applicable distance limit.
• Aerial Distance: The distance is measured aerially, also known as "as the crow flies." This is a straight-line distance between the boundary of the municipality/cantonment board and the location of the agricultural land.
• Conjunction of Conditions: Both the population threshold and the distance criteria must be met for the land to be classified as a capital asset. If the population is less than 10,000, or if the land is located beyond the specified distance based on the population, the land will generally be considered agricultural land and exempt from capital gains tax (provided other conditions for agricultural land are met).
• Applicability: The applicability of this provision depends on the facts of each case. Determining the distance and population accurately is crucial.

Example Scenarios:

• Scenario 1: A farmer sells agricultural land located 3 kilometers away from the municipal limits of a town with a population of 50,000 according to the last census. Since the population is more than 10,000 but not exceeding 1 lakh, the distance limit is 2 kilometers. Since the land is 3 kilometers away (which exceeds the 2 km limit), the land is not considered a capital asset under item (b).
• Scenario 2: A landowner sells agricultural land situated 5 kilometers away from the municipal limits of a city with a population of 500,000. The population falls in the bracket of more than 1 lakh but not exceeding 10 lakhs, so the distance limit is 6 kilometers. Since the land is 5 kilometers away (which is within the 6 km limit), the land is considered a capital asset under item (b).
• Scenario 3: Agricultural land is 1 kilometer from the boundary of a cantonment board. The population of the cantonment board is 8,000. Even though the land is within a 2-kilometer range, because the population is less than 10,000, it's not a capital asset under Item (b).

Consequences of Land Being Classified as a Capital Asset

If the agricultural land falls within the ambit of either Item (a) or Item (b), it is treated as a capital asset under the Income Tax Act. This has the following consequences:

• Capital Gains Tax: Any profit or gain arising from the transfer (sale, exchange, etc.) of such land is subject to capital gains tax.
• Short-Term or Long-Term Capital Gains: The capital gains are classified as either short-term or long-term depending on the period of holding of the asset. The holding period is generally considered to be 24 months for immovable property (including land) to qualify as a long-term capital asset (as per Section 2(42A) of the Income Tax Act). Before 1st April 2017 it was 36 months.
• Tax Rates: Short-term capital gains are taxed at the applicable slab rate of the assessee. Long-term capital gains are generally taxed at a rate of 20% (plus applicable surcharge and cess) after indexation benefits (allowing for inflation adjustment of the cost of acquisition).
• Exemptions: Certain exemptions under Sections 54, 54F, etc., of the Income Tax Act may be available to reduce or eliminate the capital gains tax liability, provided the conditions specified in those sections are met. For example, Section 54 allows exemption from capital gains if the sale proceeds are used to purchase another residential house within a specified timeframe. Section 54F offers a similar exemption if the sale proceeds are used to purchase a new residential house, subject to specific conditions regarding investment of the entire net consideration.

Importance of Due Diligence

It is crucial to conduct thorough due diligence before engaging in any land transaction to determine the tax implications accurately. This includes:

• Verifying the Land's Location: Precisely determine the location of the land in relation to the nearest municipality or cantonment board.
• Determining the Aerial Distance: Measure the aerial distance accurately using reliable tools.
• Obtaining Census Data: Secure official census data for the relevant municipality or cantonment board for the year applicable at the time of transfer.
• Seeking Professional Advice: Consult with a tax advisor or chartered accountant to understand the specific tax implications based on the individual circumstances and explore potential tax-saving options.
• Checking Local Land Records: Confirm the land's classification in the local land records and any applicable land use regulations.

Conclusion

Items (a) and (b) of Section 2(14) of the Income Tax Act play a vital role in determining the taxability of agricultural land in India. Understanding the criteria related to location, population, and distance is essential for accurately assessing the capital gains tax implications of land transactions. Accurate determination, diligent documentation, and professional tax advice are vital to ensure compliance and optimize tax outcomes. Failure to comply with these provisions can result in penalties and legal issues. Therefore, thorough due diligence is of paramount importance when dealing with land within or in the vicinity of a municipality or cantonment board.