SALE OF AGRICULTURAL PRODUCE LIKE GREEN TEA LEAVES WILL RESULTS INTO PURELY AGRICULTUAL INCOME NOT LIABLE TO APPORTIONMENT

[Uma Kothari]

Union of India V. Belgachi Tea Co. Ltd. [2008 -TMI - 3950 - SUPREME COURT]

Relevant provisions:

Income tax Act- sections 2 (1A) ,10 (1) and 28.

Income Tax Rules - Rules 7, 7A,7B and 8.

And provisions of Indian constitution and agricultural income tax laws of state governments.

Sale of agricultural produce will result into deriving agricultural income even if the owner of estate is normally engaged in combined agricultural and manufacturing activities. For example in a tea estate tea leaves are cultivated, manufactured and sold- this results into combined income consisting of agricultural and business income. As per Rule 8 40% of such combined income is chargeable to tax under the income-tax Act and balance 60% is considered as agricultural income on which the state government may impose tax as tax on agricultural income. When a tea estate sell some green tea leaves, the income is not mixed income but purely agricultural income.

Therefore, when a tea estate, rubber estate or coffee estate sell green tea leaves, raw rubber or raw coffee etc. purely agricultural income will be derived and the rules of computing composite income and then allocating it in two segments will not apply.

In case agricultural produce like green tea leaves are purchase, processed and sold purely business income is derived and Rule 8 is not applicable.

The Rule 7A for Rubber and 7B for Coffee are also similar to Rule 8, therefore, law laid down in relation to rule 8 relating to tea will be equally applicable to Rubber estates and Coffee Estates.

 Tea, rubber or coffee estates:

In this write-up tea/ rubber/ coffee estate' is considered as an organization having tea/ rubber/ coffee garden/ plantation as well as factory to process agricultural produce grown and then selling processed agricultural produce like black tea, cured rubber or processed coffee. Income from such combined activities is considered as mixed income, it is computed as if total income is business income and then certain portion of such composite income (e.g. 40% in case of tea) is chargeable to tax under the income-tax Act,1961. Balance of such income is considered as 'agricultural income' within the meaning of S. 2(1A) and is therefore exempt u/s 10 (1) of the income-tax Act,1961. As per the provisions of the Indian Constitution, the income from business can be taxed by the Central Government and any agricultural income can be taxed by the state government in which the agricultural land is situated, whereon the agricultural produce is grown.

The legal position is settled by several judgments of the supreme Court.

Rubber and Coffee:

W.e.f. 01.04.2002 that is assessment year 2002-03 new Rules 7A and 7b have been inserted. These rules are on the same line as Rule 8 relating to tea. The ratio of chargeable profit are different in different situations as laid down in the respective rules.

Thus, by framing of the Rules 7A, 7B and 8 the definition of agricultural income stands modified for the purpose of ascertainment of agricultural income for the purpose of Income-tax Act and as a consequence for the purpose of Indian Constitution.

As the Rules for rubber and coffee are similar (except ratio of chargeable income) to rule for tea, the law laid downs in the case of tea are equally applicable for rubber and tea. Therefore, constitutional validity, meaning of agricultural income in different circumstances, extent of chargeable income under central income tax, and state's agricultural income tax laws will be governed similarly.

Agricultural produce sold without processing:

Some time a tea estate, rubber estate or a coffee estate may sell its agricultural produce that is tea, rubber or coffee, as the case may be to other parties. The reasons for such may be of varied nature for example:

a. lesser quantity of agricultural produce, which is not considered economical to process. This happens at the beginning or during last days of season.

b. Problems in factory - break downs or labor unrest etc.

c. Financial problem.

d. Getting better price of agricultural produce in comparison to manufactured produce- this may happen when another manufacturer is having stronger order position and is able to sell produce in his brand at a better price due to value addition made by marketing efforts, and brands popularity.

In all above cases, the selling of agricultural produce is undoubtedly incidental to the entire activities of the estate. But the fact remains that the agricultural produce (tea, rubber or coffee) is sold in its raw form without any processing in factory. Therefore, the condition of 'selling agricultural produce which was cultivate, and manufactured by the organization' are not satisfied. What is sold is agricultural produce therefore in such a case income from sale of such raw agricultural produce will be purely agricultural income and will not have an element of income chargeable to tax under the income-tax Act. The Rule 7A, 7B and 8 will not apply.

Incidental buying of agricultural produce by estate:

In some circumstances an estate may purchase agricultural produce and process it in its factory along with own agricultural produce. In relation to goods manufactured from bought out agricultural produce, the estate does not carryout any cultivation activity, and therefore, income from sale of final product made out of bought out agricultural produce will be fully chargeable income under the Income-tax Act and it will not contain any element of agricultural income.

An analysis of Rules:

Rule 8 is an old rule, which has been interpreted by the Supreme Court and its validity vis a vis the Indian Constitution has been upheld and it has also been held that the provision of the Rules is to be considered as integral part of the Act and accordingly agricultural income has also to be determined as per the Rule, even for the purpose of India Constitution and for determining agricultural income for the purpose of tax by state government. Therefore, the meaning of agricultural income, for the purpose of Indian Constitution is also to be ascertained according to the Rule 8, wherever it is applicable. That is the case computing income derived from selling tea which was grown and manufactured by the assessee. The new rule 7A and 7B for rubber and coffee are also on the same lines except the ratio of taxable income. Three rules also provide for allowability of some costs of re plantations.

Recent judgment of the Supreme Court:

In Union of India V. Belgachi Tea Co. Ltd. [2008 -TMI - 3950 - SUPREME COURT] decided on May 9, 2008 the Supreme Court

Considered provisions relating to business income under section 28(i) of the Income-tax Act,1961 read with rule 8 of the Income-tax Rules, 1962 and also section 8(1A) of the Bengal Agricultural Income-tax Act, 1944 in relation to agricultural income derived from lands situated in the state of West Bengal. The Court reiterated its earlier decision that income from 'tea grown and manufactured' shall be computed in accordance with provisions of 1961 Act and thereafter 40 per cent of that income is taxable under 1961 Act and remaining 60 per cent income is taxable under 1944 Act by State,as income from agriculture. This is as per already settled legal position.

In fact the new controversy that arose was whether , income from green tea leaves sold without any processing to make into black tea, as an incidental activity in the tea estate can also be considered under Rule 8 and 40% can be considered as business income and only 60% can be considered as agricultural income. The Supreme Court held that when assessee directly sells green tea leaves resulting into an income from agricultural products, it cannot be taken as incidental income to business and whatever income is derived from sale of green tea leaves will be assessed by Agricultural Income-tax Officer under 1944 Act.

The assessee, inter alia, claimed and submitted that the sale proceeds of green tea leaves be treated as incidental to business and income there from should also be computed under the provisions of the 1961 Act. However, the revenue was of the view that the income from sale of green tea leaves was taxable as income from agriculture under the Bengal Agricultural Income-tax Act, 1944. The Court also held that the income derived from sale of green tea leaves was agricultural income assessable under the 1944 Act of the State Government.

The observations and ruling of the Supreme Court are analyzed below:

a. There was no dispute on the fact that from the composite income from composite activities computed , 60 per cent was taxable by the State as agricultural income and 40 per cent was taxable by the Centre as business income.

b. The apportionment of 60 per cent and 40 per cent share of the composite income is that there are common expenses on establishment and staff for two different activities, that is, tea grown and tea manufactured. There can be independent income from sale of green tea leaves and by sale of tea, that is, after processing of green tea leaves when green tea leaves become tea for use. Income from agriculture is taxable by the State and sale of tea after manufacturing is taxable by the Union of India as business income.

c. Though segregation of income and expenses from two combined activities of the assessee is not possible, but at the same time, there cannot be two assessments of income by two different authorities. Therefore, there can be only one assessment of income from the tea business.

d. The combined reading of rule 8 of the Income-tax Rules, 1962 and section 8 of the 1944 Act and its amendment by insertion of sub-section (1A) in section 8 of the 1944 Act leaves no doubt in that the income from 'tea grown and manufactured' business shall be computed in accordance with provisions of the 1961 Act by the Assessing Officer under the 1961 Act and 40 per cent of the income is taxable under the 1961 Act and remaining 60 per cent income is taxable under the 1944 Act by the State, treating it as income from agriculture.

e. According to the assessee, agricultural income derived from the sale of green tea leaves is incidental income from its business and could not be taxed separately by the 1944 Act.

f. Mixed income means the income derived by an assessee from the combined activities, i.e., growing of tea leaves and manufacturing of tea to which Rule 8 apply. Therefore, for the purpose of computation of income under the 1961 Act, it should be the mixed income from 'tea grown and manufactured' by the assessee.

g. If the income is by sale of green tea leaves by the assessee, it cannot be called income assessable under the 1961 Act for the purpose of 40:60 share between the Centre and the State. In both the provisions, i.e., rule 8 of the Income-tax Rules, 1962 and section 8 of the 1944 Act, the words used are 'income derived from the sale of tea grown and manufactured'. Therefore, when there is restricted activity of growing and selling tea leaves, without manufacturing, then these provisions are not applicable.

h. The income from sale of green tea leaves is purely income from the agricultural product. There is no question of taxing it (or any part of it - added by the author) as incidental income of the assessee when there is a specific provision and authority to tax that income, i.e., the State, under the 1944 Act. Thus, the agricultural income cannot be taxed under the 1961 Act.

i. It was also pertinent to mention that the Assessing Officer had assessed the income of tea manufactured by the assessee from 1977-78 to 1980-81 at a very low amount as compared to the assessee's income from the sale of green tea leaves. In that view of the matter, the income of the assessee from the sale of tea leaves could never be incidental to its business.

j. In the instant case, the assessee could process only 10 per cent of green tea leaves and 90 per cent of green tea leaves were sold directly in the market. That income from sale of green tea leaves could not be treated incidental to the business.

k. In case, the assessee directly sells the green tea leaves resulting into an income from agricultural products, it cannot be taken as income incidental to the business and whatever the income is derived from the sale of the green tea leaves can be assessed by the Agricultural Income-tax Officer under the 1944 Act.

l. The conclusion arrived at by the Division Bench of the High Court was in consonance with the judgment of the Supreme Court in Tata Tea Ltd.'s

m. The view, which had been taken by the Division Bench of the High Court in the impugned judgment, was to be upheld.

n. The Assessing Officer was to be directed to frame the assessment order in the case of the assessee on the principle of law laid down by the Supreme Court in the case of Tata Tea Ltd. (supra) and followed by the Division Bench of the High Court in the impugned judgment.

Situations when significant or insignificant quantity is sold:

A. In the case before the Supreme Court, 90% of green tea leaves were sold in raw condition and only 10% was processed and then sold as black tea. Therefore, in such a situation on commercial principals and on the basis of quantitative analysis it can at best be said that growing and selling of green tea leaves was the main activity of assessee, and therefore, the assessee was principally engaged in purely agricultural activity. In such situation, the 10% quantity sold after processing cannot be considered as principal activity and with due respect it is felt that the assessee had raised patently wrong contention that the cultivation and selling of green tea leaves ( to the extent of 90%) was incidental to 'growing, manufacturing and selling made black tea ( which was only to the extent of 10%)

B. On the other hand, in many tea estates, as discussed earlier in some circumstances, some quantity of green tea leaves are sold in exceptional cases and on economic criterion. For example, suppose a tea estate cultivated fifty lakh Kg. tea leaves, out of which, during initial period of season it sold fifty thousand kg. tea leaves to a neighboring tea garden or a bought leaves factory and similarly at the fag end of season fifty thousand kg of tea leaves were sold without processing. In this case total green tea leaves sold without processing is only 2% of total green tea leaves grown. The action of selling green tea leaves is because at that time factory was not ready at beginning of season or early closure of factory was preferred to prepare the factory for new season or the quantity of green leaves was not enough to economically operate the factory. In such circumstances, it can be said that the selling of green tea leaves is incidental to the main activity of tea estate.

However, for computing income Rule 8 cannot be applied because in relation to one lakh kilograms of tea leaves, any manufacturing efforts are not made and tea leaves are sold in raw form and not in manufactured black tea form. Therefore, income is to be considered as purely agricultural income from the sale of one lakh Kilograms of tea leaves, though the quantity sold is insignificant. In such circumstances role of agricultural is 60% in comparison to composite activity on application of Rule 8.

Purchasing some green tea leaves:

Similarly, some times tea estates purchase green tea leaves as incidental activity. For example, in the beginning of season as well as at the end of season, green tea leaves are purchased from neighboring tea estates, the bought leaves are mixed and manufactured in tea along with own green tea leaves. In such activity, purely business activity is involved. As per Rule 8 role of such activities is considered as 40% in comparison of composite activities.

How to compute income:

Buying and selling some quantity of green tea leaves, in a tea estate, can be considered as an incidental activity of tea estate provided major quantity is processed by the tea estate. In the case before the Supreme Court 90% of green tea leaves were sold, therefore in this case factually processing only 10% of tea leaves can be considered as incidental to cultivation and sale of green tea leaves and not vice versa. Strictly speaking, howesever small quantity of agricultural produce be sold in relation to such raw produce like tea leaves grown and sold, the tea estate has only carried agricultural activity. On the other hand in relation to green tea leaves bought from others and then processed and manufactured and sold as black tea, only business activity is involved.

In a situation where only some quantity is sold in raw state, the problem of estimation can be solved by mathematical formulae. Generally tea companies allocate income in the ratio of green tea leaves sold and used in manufacture of tea, this is also accepted by the Assessing Officers. However, that formula is not perfect because the factor of activity is not considered. Therefore, a weightage of activity involved can be applied as follows:

A. Activity of cultivation, manufacture and sale of tea- full activity - weight 1.00

B. Activity of cultivation and sale of green tea leaves-agricultural activity- weight 0. 60

C. Activity of purchasing green leaves and manufacture and sale of tea - business activity - weight 0.40

Rule 8 vis a vis Rule 7A and 7B

Rule 8 is old one and has seen judicial scrutiny. Rule 7A and 7B are new. Principally rules are similar, therefore, interpretation prevailing for Rule 8 are equally applicable to situations when Rules 7A and 7B are applied. The difference will be only in relation to ratio of business and agricultural income, deductions actually allowed or allowable while computing taxable income under income-tax Act etc. For example in case of tea companies when Rule 8 is applied only 40% of depreciation taken into consideration of composite income is actually allowed under the income-tax Act and thus for computing written down value of assets only 40% of total depreciation is deductible from the cost vide CIT Vs Suman Tea and Plywood Ind. P. Ltd 204 ITR 719 (Cal) followed in 226 ITR 34 (Cal). Similarly in case of rubber and coffee also when rule 7A or 7B are applied, depreciation actually allowed will be in the ratio in which the composite income is considered taxable under the income-tax Act. In case of assets eligible for 100% depreciation allowance, full deduction may be considered against composite income but depreciation actually allowed against business income will only be in ratio of taxable income. Such assets will be eligible for additional depreciation allowance u/s 32 (1) (iia) and cannot be considered as not eligible merely because rate of 100% is prescribed.