Agricultural Income and Exempt Income under Income Tax

Agricultural income is exempt from Union income tax because the Constitution gives the power to tax it to the States. The difficult questions are what counts as agriculture, how to split income that is partly agricultural, and how agricultural income still affects the rate on other income. This note answers them and then surveys the other main categories of exempt income.

1. Why Agricultural Income Is Exempt

• Constitutional basis. Entry 82 of List I covers taxes on income other than agricultural income; taxes on agricultural income fall under Entry 46 of List II (Topic 3)
• Consequence. Parliament cannot tax agricultural income, so the Income-tax Act exempts it (s.10(1) of the 1961 Act, carried into the exemption schedules of the 2025 Act)

2. What Agricultural Income Is

Figure 1: When an activity is agriculture

• Section 2(5). Rent or revenue derived from land in India used for agricultural purposes; income from such land by agriculture, or by processes that make the produce fit for market, or by sale of the produce; income from certain farm buildings; and income from saplings or seedlings grown in a nursery.
• Raja Benoy Kumar Sahas Roy (1957). The Supreme Court held that agriculture requires basic operations on the land, such as tilling, sowing and planting; subsequent operations like weeding and harvesting are agricultural only when they follow basic operations. Income from a forest of spontaneous growth is not agricultural income, but income from trees planted and nursed may be.
• Exclusions. Income from land or buildings used for non-agricultural purposes, and gains from transferring urban agricultural land, are not agricultural income.

3. Partial Integration

Figure 2: Agricultural income and the rate of tax

Agricultural income remains exempt, but for an individual, HUF, AOP or BOI with net agricultural income above Rs 5,000 and non-agricultural income above the basic exemption limit, it is added for working out the rate. Tax is computed on the aggregate, then on agricultural income plus the basic exemption limit, and the second figure is deducted from the first. The effect is to push the non-agricultural income into a higher slab.

4. Composite Income and Agricultural Land

Figure 3: Apportionment of composite income

• Composite income. Where produce is grown and also manufactured, the income is split on a fixed basis under the Income-tax Rules: for tea, 60 per cent is agricultural and 40 per cent business income; for rubber, 65 and 35; for coffee grown and cured, 75 and 25; and for coffee also roasted and ground, 60 and 40.
• Rural agricultural land. Agricultural land outside specified distances from a municipality or cantonment (from 2 to 8 km depending on population) is not a capital asset, so gains on its sale are not taxed.
• Urban agricultural land. Agricultural land within those limits is a capital asset, and gains on its transfer are taxable as capital gains (Topic 16)

5. Other Exempt Income

• Common exemptions. Sums received by a member from the income of an HUF; a partner's share of profit from a firm; certain allowances and retirement benefits of employees; interest on specified bonds and deposits; income of specified funds, institutions and authorities.
• Where they sit. The 1961 Act listed most exemptions in s.10; the 2025 Act moves them into schedules and tables.
• Disallowance of related expenditure. No deduction is allowed for expenditure incurred in relation to exempt income (s.14A of the 1961 Act). In Maxopp Investment v CIT (2018), the Supreme Court held that the disallowance applies even where shares yielding exempt dividends are held as stock in trade.

6. Frequently Asked Questions

Can Parliament tax agricultural income?

No. Entry 82 of List I excludes agricultural income, and the power to tax it lies with the States under Entry 46 of List II. Agricultural income only affects the rate on other income through partial integration.

What share of income from growing and manufacturing tea is taxable?

Forty per cent is treated as business income and taxed; sixty per cent is agricultural income and exempt.

7. Related Topics

• Topic 3: Distribution of Taxing Powers. Entries 82 and 46.
• Topic 7: Interpretation of Taxing Statutes. Construing exemptions.
• Topic 16: Capital Gains. Urban agricultural land.