COMPOSITE TEA INCOME UNDER RULE 8 - INCIDENTAL INCOMES ARE PART OF COMPOSITE INCOME BUT MAY NOT BE TAXABLE AS AGRICULTURAL INCOME

[CA DEV KUMAR KOTHARI]

COMPOSITE TEA INCOME UNDER RULE 8 - INCIDENTAL INCOMES ARE PART OF COMPOSITE INCOME BUT MAY NOT BE TAXABLE AS AGRICULTURAL INCOME

Relevant links and references:

Sections 2(1A), 10(1), 28 -43D, 145 and 145A on the Income Tax Act, 1961(ITA).

Rules 7, 7A, 7B and 8 of the Income Tax RTules, 1962 (ITR)

Recent judgment in case of MC LEOD RUSSEL INDIA LTD VERSUS COMMISSIONER OF INCOME TAX AND ANR 2013 (10) TMI 98 - GUWAHATI HIGH COURT.

Other related judgment (not referred to or considered by Guwahati High Court)

Commissioner Of Income-Tax Versus Kothari Plantations And Industries Limited 1993 (4) TMI 59 - CALCUTTA HIGH COURT

Tata Tea Ltd. v. State of West Bengal 1988 (5) TMI 6 - SUPREME Court

CIT v. Nandlal Bhandari Mills Ltd. 1965 (12) TMI 30 - SUPREME Court

CIT v. Bipinchandra Maganlal and Co, Ltd. 1960 (11) TMI 13 - SUPREME Court

CIT v. Maharashtra Sugar Mills Ltd. 1971 (8) TMI 14 - SUPREME Court

General discussion:

Composite income means composite/ mixed or total income from sale of products manufactured by the cultivator himself in case of rubber, coffee and tea plantations having own factories. Section 2(1A) of the Income-tax Act 1961(ITA) prescribed a meaning of Agricultural Income, and Rules 7A,7B and 8 provide method of computation for composite income for rubber, coffee and tea as if it is business income and then provide that a certain percentage of such composite income will be taxable under the ITA.

Agricultural Income- on reading of the Rules we find that there is nothing in the Rules to suggest that balance of composite income is taxable under Agricultural Income Tax Act of concerned state. For this purpose we need to look at charging provisions of the State Act and also definition of agricultural income u/s 2(1A) because certain receipts may be included in composite income but they may not be agricultural income as per S.2(1A) of ITA and charging section of state legislation for tax on agricultural income. Therefore,It cannot definitively be said that balance of composite income which includes all incidental incomes is necessarily agricultural income.

Calcutta High Courts judgment:

In Commissioner Of Income-Tax Versus Kothari Plantations And Industries Limited 1993 (4) TMI 59 - CALCUTTA HIGH COURT more than twenty years ago Calcutta High Court has held that composite income in case of tea will include incidental incomes/ balancing charge etc. falling under section 41 and than 40% of composite income will be taxable under ITA. In that case the court noted that “ There is no dispute that the income arising from its tea business is a composite income which is required to be taxed under the Act to the extent of 40 per cent. with reference to rule 8(1) of the Income-tax-Rules, 1962 (in short, "the Rules"), and the balance 60 per cent. income is to be assessed as agricultural income.”

The Court has considered that as per S. 29 business income is to be computed as per S. 30-43D. Now we find that many types of receipts have been included in scope of business income u/s 28. We also find that business sincome is to be computed as per the accounting method regularly followed by assessee. Therefore, we can say that stock of tea and other incidental incomes , receipts and credits which falls under section 28 ,41 and other receipts or credits which falls under category of income as per method of accounting for ascertaining income chargeable under Income-tax Act will also be covered in composite income of tea if they relate to composite activity.

As per Rule 8 in case of tea 40% of composite income is taxable under ITA. There is nothing more to read in the Rule that balance 60% is agricultural income, but generally it is so considered.

Before discussing the judgment in case of Mcleod Russle, it is necessary to have a recap of fundamental and related provisions.

Tax on income:

In the context of this article and particularly mixed or composite income derived from sale of agricultural produce after manufacturing a different finished product, we need to note that there are two types of income on which tax in nature of income is levied. One is agricultural income on which concerned State Government can impose tax; another is income other than agricultural income on which the Central Government can levy as tax by way of tax on income as income-tax, excess profit tax and corporation tax.

In the COI Agricultural income has been defined as agricultural income for the purposes of provisions for levy of tax on Income that is Income-tax Act, 1961 (ITA for short), and related Rules of the Income-tax Rules 1962 (ITR for short) at present.

Agricultural income:

Agricultural income has been defined in sub-section (1A) of section 2 of the ITA. For incomes which are partially agricultural income and partially non-agricultural income rules have been provided in ITR. The definition of agricultural income and relevant rules are considered as integral part for the purpose of ascertaining what is agricultural income. Relevant portions from them are reproduced below with highlights for easy analysis.

Income-tax Act, 1961

Definitions. [Clause (1) to Clause (15)]

     2. In this Act, unless the context otherwise requires,—

[(1A)] "agricultural income" means—

           (b) any income derived from such land by—

                (i) agriculture; or

                (ii) the performance by a cultivator or receiver of rent-in-kind of any process ordinarily employed by a cultivator or receiver of rent-in-kind to render the produce raised or received by him fit to be taken to market; or

                (iii) the sale by a cultivator or receiver of rent-in-kind of the produce raised or received by him, in respect of which no process has been performed other than a process of the nature described in paragraph (ii) of this sub-clause ;

           From above definition we can summarize that agricultural income is basically rent for agricultural land and also income derived from sale of agricultural produce raised by cultivation of land. In case cultivator has to carry other processes (other than usual minimum processes to render produce marketable) than income derived from sale of such manufactured produce is considered partially agricultural income and partially business income. For determination of such income, in the Income-tax Rules, 1962 in part II under sub-part D. Special cases , Income which is partially agricultural and partially from business Rules 7, 7A, 7B and 8 are provided.

On reading of Rule 7 we find that when agricultural produce raised or received as rent of agricultural land, the market price of agricultural produce is the basis of determination of agricultural income. In case market value is not ascertainable, then cost plus reasonable profit is applied for determining agricultural profit.

Rule 7A and 7B relates to Income from the manufacture of rubber and Income from the manufacture of coffee respectively. In principal these rules are similar to Rule 8 relating to composite and taxable income from tea. Rule 8 is reproduced below with highlights added:

Income from the manufacture of tea.

8. (1) Income derived from the sale of tea grown and manufactured by the seller in India shall be computed as if it were income derived from business, and forty per cent of such income shall be deemed to be income liable to tax.

(2)xxx about cost of re plantation which is not relevant for present study

Comments on Rule 7A,7B and 8:

As per headings these rules concern with determination of income from manufacture and not from cultivation of produces – rubber, coffee and tea.

These rules provide for determination of income when cultivator himself carries manufacturing processes and marketing activities and sell agricultural produce after carrying such processes that is when he sells manufactured produce of rubber, coffee and tea in which his own cultivated agricultural produce was used.

These rules prescribe different proportion in which composite income will taxable under ITA. There is nothing to say that balance will be agricultural income.

The prescribed proportions are for rubber 35% , for coffee of two types are 25% and 40% and for tea 40%. There is also provision to allow cost of re-plantation of plants in sub rule (2).

Agricultural income:

As noted with reference to definition of ‘agricultural income’, we find that agricultural income is basically sale value or market value of agricultural produce raised or received as rent of agricultural land less expenses incurred for cultivation of the crop and expenses for transportation and selling. In other words it is income from activity of cultivation and selling of agricultural produce after carrying out necessary processes to render the produce marketable.

When some extra processes are carried out for selling the produce, there is combination of manufacturing activities, in which case income from sale of manufactured agricultural produce is computed as if it is business income and certain percentage is considered as chargeable under Income-tax Act, 1961.

Whether balance of composite income is agricultural income?:

The general perception is that the balance of composite income which is left un-assessed under the Income-tax Act, is agricultural income. However, the same is not always true. This is because while computing composite income as if it were business income, many of receipts which are deemed to be business income under section 28 and 41, are taken into account. Many of such receipts have nothing to do with cultivation of agricultural land. Therefore, such receipts which are included in composite income will be business income to the extent of applicable percentage. However, such receipts which are not as a result of cultivation of land will have to be excluded from the agricultural income.

In this regard we also have to look into applicable provisions of the Agricultural Income Tax Act of concerned state. For example, in state of Assam insurance claims received for loss of crop is deemed agricultural income if the insurance premium was allowed. Other receipts (other than sale of tea) may not be regarded as agricultural income in state of Assam.    

Recent judgment of Guwahati High Court:

On 18^th June, 2013 Guwahati High Court has rendered a judgment in case of MC LEOD RUSSEL INDIA LTD VERSUS CIT 2013 (10) TMI 98 . In this case the assessee company was engaged in cultivation, manufacture and sale of tea. Besides sale of tea assessee had derived connected revenue by way of the following receipts , which all were concerned with composite activity of cultivation, manufacture and sale of tea:

Heads	Amount (Rs)
Premium on import Licence	1,20,25,812/-
Sale of Scrap	2,12,218/-
Misc. Garden Income	1,44,32,310/-
Excise duty	6,69,740/-

 The Central tax authorities that is the Assessing Officer, CIT(A) and Tribunal concurrently held that the above receipts are not part of sale of tea and cannot be considered as forming composite income from cultivation, manufacture and sale of tea.

In this case the learned Tribunal also took the view that in order to be composite income under Rule 8, the income has to be derived from the business of growing, manufacturing and selling of tea and, in the case at hand, though the miscellaneous receipts might be treated as ‘attributable to’ the business of tea of the appellant, the miscellaneous receipts cannot be treated, in law, as income ‘derived from’ the business of tea. On the basis of the conclusions, so arrived at, the learned Tribunal, by its order, dated 16-11-2010, aforementioned, dismissed the appeal. Therefore, the assessee preferred appeal under section 260A of the Income-tax Act, 1961 before the Guwahati High Court.

The High Court held that all these receipts are o be considered as part of composite income of sale of tea cultivated and manufactured by assessee company. While considering different receipts the court took view as given in the left column of the table below and in the right column the author had expressed his views:

From judgment	Views of author
17. From a bare reading of Rule 8, what becomes abundantly clear is that the rule making authority has prescribed that the income, which is derived from sale of tea grown and manufactured by a seller, shall be treated as if it were the ‘income derived from the business’ and 40% of such income shall be deemed to be income chargeable under the Income Tax Act, 1961. Extended logically, it would mean that the remaining 60% of the income has to be treated as agricultural income and would, obviously, be chargeable to tax under the Assam Agricultural Income Tax Act, 1939.	So far computation of income liable to tax under ITA is concerned, the author agrees that composite income will include all incomes related with sale of tea cultivated , manufactured and sold. And this will include incomes prescribed in section 28, 41 and what falls under method of accounting – that is receipts in nature of expenses recovered or recouped like sale of scrap. However, with due respect, author feels that the observations of honorable High Court that balance 60% will be treated as agricultural income liable to tax under Assam Agricultural Income Tax Act (AAIT) was not called for. Furthermore, the legal position is not as such. For taxability we need to check provisions of AAIT. Many of such incidental receipts are not agricultural income chargeable to tax under AAIT Act.
18. What, now, needs to be noted is that Section 28 of the Income Tax Act, 1961, embodies certain income chargeable to income tax under the head ‘profits and gains of business or profession’. Since Section 28 (iii a) and Section 28 (iii c) of the Income Tax Act, 1961, are relevant for the purpose of deciding this appeal, both these Rules are reproduced below:    “28. The following income shall be chargeable to income-tax under the head ‘Profits and gains of business or profession’ -    (iiia) profits on sale of a licence granted under the Imports (Control) Order, 1955, made under the Imports and Exports (Control) Act, 1947.    (iiic) any duty of customs or excise re-paid or re-payable as drawback to any person against exports under the Customs and Central Excise Duties Drawback Rules, 1971.”	Author agrees and further add that so far excise duty concessions are concerned, these are in nature of expenses recovered and thus also form part of business income u/s 41 as well as per general rules of accountancy that expenses are to be considered as net of recovery. However, sale value or profit of import license, though falling under composite income is not agricultural income liable to tax under AAIT Act.
19. From a bare reading of Section 28 (iii a), it becomes clear that the profits on sale of a licence, granted under the Customs and Central Excise Duties Drawback Rules, 1971, are to be treated as income derived from the sale of tea grown and manufactured. Similarly, Section 28 (iiic) provides that duty of customs or excise re-paid or re-payable as drawback to any person against exports under the Customs and Central Excise Duties Drawback Rules, 1971, has to be treated as an income chargeable, under the Income Tax Act, within the purview of the head of ‘profits and gains of business and profession’.
22. Turning to the sum of Rs. 2,12,218/-, claimed by the assessee-appellant as receipt from sale of scraps, it needs to be appreciated that sale of scraps, generated in a tea estate in the process of growing and manufacturing of tea, is, indisputably, an ancillary part of the business of growing and manufacturing of tea and, hence, the same form part of the composite income of the appellant as an assessee. More so, when the appellant, as an assessee, had made it clear that the receipt of Rs. 2,12,218/- was on account of sale of scraps, realized from regular sale of unused or unusuable goods of the tea estate, which were procured from time to time in course of running of the business of growing and manufacturing of tea and that the expenses, incurred from such items, formed composite income before apportionment thereof under Rule 8.	Sale of scrap as such will not be income from sale of tea, however, when it is in nature of recovery of expenses, it is considered as forming part of composite income falling u/s 28 rws 145 and s. 41 of ITA. When income is to be computed as if it were business income, this will definitely form part of composite income.
24. Turning to the assessee-appellant’s claim of miscellaneous garden income, amounting to Rs. 1,44,32,310/-, arising out of the amount received from insurance claim, lodged with the insurer on account of loss caused to the business of tea, finished plantation, etc., due to flood and heavy rains, it is noteworthy that the amount paid, in terms of the insurance claims, in the circumstances as indicated hereinbefore, and in respect of the items, as mentioned hereinbefore, ought to be treated as part of the composite income of the assessee-appellant before apportionment thereof under Rule 8.	With due respect author feels that the insurance claims for loss of tea plantations, cannot be regarded as income from sale of tea falling under Rule 8. Insurance claims received for loss of tea plantations or any other capital assets are capital receipts or are damages to capital assets and not revenue from sale of tea. Loss of tea business- this need to be examined further according to nature of loss. If this is claim for loss of standing crop of tea plantations, then in my view, this cannot form part of income under Rule 8. Whether 60% of these receipts will be agricultural income chargeable to tax under AAIT Act requires examination. Primafacie these receipts   appears not taxable under AAIT Act.

Observations about agricultural income:

In paragraph 17 of the judgment honorable High Court has observed, noted or held as follows:

             “Extended logically, it would mean that the remaining 60% of the income has to be treated as agricultural income and would, obviously, be chargeable to tax under the Assam Agricultural Income Tax Act, 1939.”

With due regards, author convey his view that this observation which can be regarded as an obiter dicta was not at all required by the honorable High Court for the following reasons:

1. The question in appeal before honorable High Court was in relation to Income-tax Act, 1961 and Rules made there under to determine income chargeable under the ITA.
2. Any of provisions of AAIT Act were not in question.
3. Any of the provisions of AAIT Act have not been considered by the Court, so far as appears from noting in the judgment.
4. The provisions of AAIT Act, need to be looked into to find out what out of composited income computed under ITA is taxable as agricultural income under the AAIT Act.
5. Extended logic as applied by honorable High Court is at best an observation and cannot be considered as judgment because in an appeal, generally the court is required to render judgment on question formulated for its decision.
6. The authorities under AAIT Act were not party in appeal, therefore, the judgment is not binding on them and cannot be enforced by them to hold that 60% of incidental receipts, though forming part of composite income will be agricultural income taxable under AAIT Act.

Therefore, with due regard to their lordships of Guwahati High Court, the author feels that the observations of the Court that 60% of all such incidental income (other than sale of tea) will be agricultural income taxable under the Assam Agricultural Income Tax Act seems to be uncalled for and thus superficial observations which revenue may try to consider as ruling. Therefore observations in this regard deserves reconsideration and deletion from the judgment.

The judgments of Guwahati High Court and Calcutta High Court:  

MC LEOD RUSSEL INDIA LTD VERSUS COMMISSIONER OF INCOME TAX AND ANR 2013 (10) TMI 98 No. - ITA 11/2011 Dated - 18 June 2013

Commissioner Of Income-Tax Versus Kothari Plantations And Industries Limited 1993 (4) TMI 59 - CALCUTTA High Court Dated - 30 April 1993