Understanding Sub-clause (iii): Agricultural Land under Indian Income Tax Law

Navigating the complexities of income tax in India often requires a detailed understanding of specific clauses and sub-clauses. One such critical area involves the taxation of agricultural land, particularly addressed under sub-clause (iii) of Section 2(14) of the Income Tax Act, 1961. This article aims to provide a comprehensive and legally accurate explanation of this sub-clause, clarifying its implications for taxpayers involved in agricultural activities.

Defining Capital Asset and the Exclusion of Agricultural Land

At its core, the Income Tax Act levies taxes on capital gains arising from the transfer of a "capital asset." Therefore, it's crucial to understand what constitutes a capital asset and, importantly, what is excluded from that definition. Section 2(14) of the Act defines "capital asset" as property of any kind held by an assessee, whether or not connected with their business or profession. However, this definition includes several exceptions. Sub-clause (iii) of Section 2(14) specifically excludes certain types of agricultural land from being classified as a capital asset. This exclusion is highly significant because it means that any profit arising from the sale or transfer of such agricultural land is not subject to capital gains tax.

The Specific Exclusion: Sub-clause (iii) Explained

Sub-clause (iii) of Section 2(14) carves out an exception for agricultural land in India from being treated as a capital asset, provided it meets specific conditions. The wording of the sub-clause focuses on the location of the land concerning municipal limits and cantonment boards. This is a crucial determining factor for taxability. The exemption applies if the land satisfies either of the following location-based criteria:

1. Land within Municipal Limits/Cantonment Board Limits: The land is situated in an area which is comprised within the jurisdiction of a municipality (by whatever name called) or a cantonment board and which has a population of not more than ten thousand according to the last preceding census.

2. Land Outside Municipal Limits/Cantonment Board Limits: The land is situated in a specified area outside the limits of a municipality or cantonment board. This specification is based on the land's proximity to the local limits of a municipality or cantonment board, depending on the population of that municipality or cantonment board:

   • Population not exceeding 10,000: If the population of the municipality or cantonment board is not more than 10,000 according to the last preceding census, then there is no distance limit for the agricultural land. It is automatically considered as not being a capital asset.

   • Population exceeding 10,000 but not exceeding 1 lakh: If the population of the municipality or cantonment board is more than 10,000 but does not exceed 1 lakh, then the agricultural land must be situated at a distance of not more than two kilometers from the local limits of such municipality or cantonment board.

   • Population exceeding 1 lakh but not exceeding 10 lakhs: If the population of the municipality or cantonment board is more than 1 lakh but does not exceed 10 lakhs, then the agricultural land must be situated at a distance of not more than six kilometers from the local limits of such municipality or cantonment board.

   • Population exceeding 10 lakhs: If the population of the municipality or cantonment board is more than 10 lakhs, then the agricultural land must be situated at a distance of not more than eight kilometers from the local limits of such municipality or cantonment board.

In essence, the farther the agricultural land is from a more densely populated urban area, the more likely it is to be classified as outside the scope of "capital asset" and thus exempt from capital gains tax.

Key Terms and Definitions for Clarity

To fully understand the application of sub-clause (iii), it is vital to define key terms:

• Agricultural Land: This refers to land that is used for agricultural purposes or activities incidental to agriculture. While the Income Tax Act does not comprehensively define "agricultural purpose," it's generally understood to include activities like cultivating crops, fruits, vegetables, flowers, and rearing livestock. Case laws often play a significant role in determining whether land is truly agricultural. Mere ownership of land, without any agricultural activity, might not qualify for the exemption.

• Municipality (by whatever name called): This refers to any local authority constituted under any law for the time being in force for the purpose of local self-government. This encompasses municipal corporations, municipal councils, and other similar urban local bodies.

• Cantonment Board: These are local authorities established under the Cantonments Act, 2006, for the administration of cantonment areas (military areas).

• Local Limits: These refer to the defined geographical boundaries of the municipality or cantonment board.

• Population: This refers to the population as per the last preceding census of which the relevant figures have been published before the date of transfer. For example, if land is sold in 2024, and the 2021 census figures have been published, then the 2021 census data will be used.

• Transfer: Under the Income Tax Act, transfer includes sale, exchange, relinquishment, extinguishment of any rights therein, or compulsory acquisition under any law. Therefore, the exemption applies not only to outright sales but also to other forms of transfer.

Determining Agricultural Use: A Crucial Factor

Even if the land satisfies the location criteria outlined in sub-clause (iii), it must also be used for agricultural purposes to qualify for the exemption. The assessing officer may inquire into the actual use of the land. Factors considered include:

• Whether the land is actually cultivated.
• The type of crops grown (if any).
• Whether any agricultural operations are carried out.
• Entries in revenue records.
• Proximity to agricultural areas.

If the land is lying barren or is being used for non-agricultural purposes (even if it is located in a rural area), the exemption may be denied.

Burden of Proof

The onus of proving that the land qualifies as agricultural land and meets the conditions specified in sub-clause (iii) lies with the assessee (the taxpayer). The assessee needs to provide adequate evidence to substantiate their claim, including:

• Revenue records showing the classification of the land as agricultural.
• Evidence of agricultural activities carried out on the land.
• Census data to determine the population of the relevant municipality or cantonment board.
• Documents showing the distance of the land from the local limits of the municipality or cantonment board.

Practical Implications and Examples

Let's illustrate the practical implications of sub-clause (iii) with a few examples:

Example 1: Mr. A owns agricultural land located within the municipal limits of Village X. According to the 2011 census (the last preceding census), the population of Village X is 8,000. Mr. A sells the land. Since the population of the municipality is less than 10,000, the land is not a capital asset, and the sale is not subject to capital gains tax.

Example 2: Mrs. B owns agricultural land situated 3 kilometers away from the municipal limits of Town Y. The population of Town Y, according to the relevant census, is 50,000. Because the population exceeds 10,000 but is less than 1 lakh, and the land is within 2 kilometers of the municipal limits according to the provisions of sub-clause (iii), this should not be considered agricultural land and would be taxable. However, Mrs. B's land is 3 kilometers away. Therefore, her land would be considered agricultural land and not a capital asset. The sale proceeds would not be taxable as capital gains.

Example 3: Mr. C owns land situated 7 kilometers away from the municipal limits of City Z. The population of City Z is 5 lakhs. Because the population exceeds 1 lakh but is less than 10 lakhs, and the land is within 6 kilometers of the municipal limits according to the provisions of sub-clause (iii), this should not be considered agricultural land and would be taxable. However, Mr. C's land is 7 kilometers away. Therefore, his land would be considered agricultural land and not a capital asset. The sale proceeds would not be taxable as capital gains.

Example 4: Mr. D owns land situated 5 kilometers away from the municipal limits of Metropolitan City W. The population of Metropolitan City W is 15 lakhs. Because the population exceeds 10 lakhs, and the land is within 8 kilometers of the municipal limits according to the provisions of sub-clause (iii), this should not be considered agricultural land and would be taxable. Because Mr. D's land is 5 kilometers away, it would not be considered agricultural land and would be taxable.

Example 5: Mr. E owns land situated within the municipal limits of a Village P. The population of Village P is 5,000. However, Mr. E has converted the land into a commercial building and runs a shop. Even though the population criteria are met, the land is not used for agricultural purposes. Therefore, the sale of the land would be subject to capital gains tax.

Relevant Case Laws

Several court decisions have further clarified the interpretation and application of sub-clause (iii). Some notable cases include:

• CIT v. Kamalini Khatau (1978) 113 ITR 913 (Bom): This case emphasized the importance of actual agricultural operations in determining whether land qualifies as agricultural land. The Bombay High Court held that merely possessing land near agricultural areas is insufficient; there must be evidence of actual cultivation or agricultural activity.

• Sarifabibi Mohmed Ibrahim v. CIT (1993) 204 ITR 631 (Bom): This case highlighted that the revenue authorities have the right to inquire into the actual use of the land, even if it is classified as agricultural in revenue records.

• CWT v. Officer-in-Charge (Court of Wards) (1976) 105 ITR 133 (SC): This Supreme Court case provided guidance on determining whether land is being used for agricultural purposes, considering factors like the nature of the land, its proximity to agricultural areas, and the activities carried out on it.

These are just a few examples, and the specific facts of each case are crucial in determining the outcome.

Impact of Amendments and Notifications

The Income Tax Act and related rules are subject to amendments and notifications issued by the Central Board of Direct Taxes (CBDT). Taxpayers should stay updated on any changes that may affect the interpretation or application of sub-clause (iii). These changes can be found on the official website of the Income Tax Department and through reputable tax advisory services.

Conclusion

Sub-clause (iii) of Section 2(14) provides a significant exemption from capital gains tax for agricultural land in India, subject to specific conditions related to location and usage. Understanding these conditions, along with relevant definitions and case laws, is crucial for taxpayers involved in agricultural activities to accurately determine their tax liabilities. Consulting with a qualified tax professional is always recommended for personalized advice based on individual circumstances. By carefully considering these factors, taxpayers can ensure compliance with the Income Tax Act and optimize their tax planning.