Karnataka H.C : the income derived by the assessee from manufacturing of seeds and sale of the same would amount to agricultural income which would be exempt under Section 10(1)

High Court Of Karnataka

CIT, Central Circle, Bangalore vs. Namdhari Seeds (P.) Ltd.

Assessment Years : 2003-04, 2004-05 And 2006-07

Section : 2(1A)

Mrs. Manjula Chellur And Aravind Kumar, JJ.

IT Appeal Nos. 75, 76 And 284 Of 2007, 19, 387 To 389, 474, 739, 740 And 748 Of 2008

October 24, 2011

JUDGMENT

Mrs. Manjula Chellur, J – ITA 75/2007 and ITA 284/2007 arise out of common order dated 14.7.2006 passed by the Tribunal in ITA No.3102/Bang./2004. Before the Tribunal, alongwith ITA No.3102/Bang./2004, ITA No. 1040/Bang./2002 pertaining to Indo American Exports came to be disposed of ITA No.3102/Bang./2004 pertains to the assessment year 2001-02 in respect of an assessee by name Namdhari Seeds Private Limited.

2. So far as ITA 76/2007, the assessee – Indo American Exports filed return of income claiming the entire amount as agricultural income seeking exemption under Section 10(1) of the Income Tax Act (‘Act’ for short) for the assessment year 1998-99. The Assessing Officer holding that the entire amount of profit was liable to tax under the provisions of the Act, denied the claim of the assessee that the entire income was agricultural income. An appeal came to be filed before the first appellate authority and the first appellate authority set aside the order of assessment and held that the entire income should be treated as agricultural income giving exemption under Section 10(1) of the Act. As against this, the Revenue went up in appeal before the Tribunal. The Tribunal opined that 10% of the net profit should be treated as business income and the balance 90% of the net profit as agricultural income exempting the same from tax.

3. So far as ITA 75/2007 and ITA 284/2007, the assessee – Namdhari Seeds Private Limited filed its income for the assessment year 2001-02 declaring an income of Rs. 7,68,860/- as taxable income and also declared Rs. 7,27,25,130/- as agricultural income generated by sale of hybrid seeds said to be obtained from agricultural operations. The assessment order came to be passed on 29.3.2004 treating a sum of Rs. 3,84,13,288/- as non-agricultural income stating that income generated from the lands taken on lease for the purpose of agricultural activity in the State of Karnataka as not eligible to be treated as agricultural income. So far as lands taken on lease situated outside the State of Karnataka, as Assessing Authority has accepted the contention of the appellant that income generated therefrom was agricultural income.

4. Aggrieved by the order of assessment, an appeal came to be filed before the Commissioner of Income-Tax (Appeals), who by his order dated 11.8.2004 allowed the claim of the assessee holding that abovestated income of Rs. 3,84,13,288/- as agricultural Income and accordingly exempted the same under Section 10(1) of the Act. So far as treating the income from agriculture in respect of lands situated outside the State of Karnataka by the Assessing Officer, Revenue had not filed any appeal. It contested the appeal filed by the assessee before the first appellate authority.

5. When the first appellate authority accepted the claim of the appellant assessee – Namdhari Seeds Private Limited that even the agricultural income of the assessee within the State of Karnataka is exempted under Section 10(1) of the Act, Revenue preferred appeal before the Tribunal and the same is numbered as ITA 3102/Bang./2004. As similar issues were also raised in ITA No. 1040/Bang./2002, both matters came to be clubbed and decided on 14.7.2006. The Tribunal while disposing of both the appeals, held that the foundation seeds or hybrid seeds produced by the appellant-assessee on contract farming is on account of agricultural operations and therefore profit arising from such activity will be treated as agricultural income, However in order to make these seeds as certified seeds, it has to be treated with insecticides and chemicals by a process. To consider the income from such activity as agricultural income, it should satisfy the requirement of Section 2(1A)(b)(ii) of the Act. As the process of converting hybrid seeds to certified seeds is not an ordinarily employed process by cultivator or receiver of rent-in-kind, profit arising out of such activity cannot be treated as agricultural income. However, looking to the expenses debited relating to such activity, the Tribunal held that 10% of net profit has to be treated as non-agricultural income. In other words, 90% of the income derived from the profit was treated as agricultural income and 10% of the net profit was treated as business income.

6. Aggrieved by the order of the Tribunal, the Revenue has filed ITA 75/2007 pertaining to M/s Namdhari Seeds Private Limited and assessee has filed ITA 284/2007. ITA 76/2007 is filed by the Revenue so far as Indo American Exports. These three appeals are against the common order in ITA 3102/Bang./2004 and ITA 1040/Bang./2002 dated 14.7.2006.

7. So far as appeals pertaining to the assessment years 1998-99, 1999-2000, 2000-01, 2002-03, 2003-04 and 2004-05, the Tribunal following the order passed in ITA 3102/Bang./2004 dated 14.7.2006, disposed of the appeals. ITA Nos.389/2008, 388/2008, 748/2008, 739/2008, 387/2008 and 740/2008 had been filed by the Revenue challenging the order of the Tribunal opining 90% of the income derived by the assessee as agricultural income for the above mentioned years.

8. In respect of the abovementioned assessment years, the assessee has also filed ITA Nos. 19/2008 and 474/2008 apart from ITA 284/2007.

9. As similar questions are arising in all the above appeals, we are disposing of these appeals by a common judgment.

10. In the appeals filed by the Revenue except in ITA No.75/2007, the following substantial question of law came to be formulated by this Court:

Whether the Appellate Authorities were correct in holding that the activity carried on by the assessee by trading in processed seeds would amount to agricultural activity on land taken on lease and is contract farming considered as agricultural income exempt under Section 10(1) of the Income Tax Act (‘Act’ for short) by following the view expressed in earlier cases ?

11. This Court admitted ITA No.75/2007 on the following substantial questions of law:

“(1) Whether the Tribunal was right in holding that the income derived by the assessee from manufacturing of seeds and sale of the same would amount to agricultural income which would be exempt under Section 10(1) of the Act?

(2) Whether the Tribunal was right in not taking into consideration of the fact that the assessee could not have had agricultural land in view of the provision of section 79-A of Karnataka Land Reforms Act ?

12. The appeals filed by Namdhari Seeds Private Limited – assessee for the assessment years 1998-99, 1999-00 and 2003-04 in ITA No.19/2008 came to be admitted on the following substantial question of law:

Whether the Tribunal having held that hybrid seeds produced by the appellant was agricultural produce and income therefrom is agriculture income, was right in law in holding the process of certification of hybrid seeds produced by the appellant to make it marketable could not be held to be a process ordinarily employed by the cultivator and to that extent the income derived could not be treated as agriculture income as defined under section 2(1A) of the Act ?

13. ITA No.474/2008, which pertains to assessment years 2000-01, 2002-03 and 2004-05 came to be admitted on the following substantial questions of law:

(1) Whether the Tribunal was right in law in holding that the process of certification of hybrid seeds produced by the appellant was not a process ordinarily employed by a cultivator to render the produce raised by him fit to be taken to market ?

(2) Whether the Tribunal having held that hybrid seeds produced by the appellant was agricultural produce and income therefrom is agricultural income, was right in law in holding the process of certification of hybrid seeds by the appellant to make it marketable could not be held to be a process ordinarily employed by the cultivator and to that extent the income derived, could not be treated as agricultural income as defined under Section 2(1A) of the Income Tax Act ?

14. ITA No.284/2007 for the assessment year 2001-02, came to be admitted on the following substantial question of law:

Whether the Tribunal having held that hybrid seeds produced by the appellant was agricultural produce and income therefrom is agriculture income, was right in law in holding the process of certification of hybrid seeds produced by the appellant to make it marketable could not be held to be a process ordinarily employed by the cultivator and to that extent the income derived could not be treated as agriculture income as defined under section 2(1A) of the Act ?

15. Before the Assessing Officer, the claim of the appellants assessees – Namdhari Seeds Private Limited and Indo American Exports was that the assessees were cultivating the lands which were taken either on lease or as per the ‘contract farming agreement’. The Assessing Officer held that income derived by the assessees under the agreement referred to above is not agricultural income and should be treated as income from business. As already stated above, the Tribunal has treated 90% of the income of the assessees as income from agriculture and gave exemption under Section-10(1) of the Act and insofar as balance 10% of the income, it was treated as income from business.

16. So far as the appeals filed by the Revenue and to the appeals filed by the assessees, learned counsel Mr. M.V. Seshachala appearing for Revenue contends that none of the activities carried on by the assessee would fall within the ambit of the provisions of Section-2(1A) of the Act as the main activity of the assessee-company is trading in processed seeds. None of the terms of the agreement according to him would indicate the character of the assessees as agriculturist or a cultivator who would derive any rent or revenue from the land which is situated in India. According to him, none of the terms of the agreement would indicate that assessees have undertaken agricultural activity as a fixed price is paid for the seeds grown by the cultivator or the farmer or the owner of land. Therefore at the end of the day, the seeds grown by the farmer are sold at a fixed price if they withstand the test that has to be employed on seeds grown by the cultivator and such of the seeds which do not qualify the process of testing employed by the assessee will not be returned to the cultivator or the owner of the land, but the assessee-company itself would market the said rejected seeds on behalf of the farmer and pays only the sale price of such rejected seeds. Therefore according to Mr. Seshachala, none of the activities carried on by the appellant -assessee could be described as activities relating to agriculture or cultivation as is normally done by cultivator or an agriculturist. He relies upon the decision of the Hon’ble Apex Court in the case of Malabar Industrial Co. Ltd. v. CIT [2000] 243 ITR 83/ 109 Taxman 66 to contend that amount received by the assessee from purchaser of rubber estate in consideration for modification or relaxation of payment could not be treated as agricultural income.

17. According to Mr. Seshachala, Explanation to Section-37 of the Act clearly bars any benefit being extended to an assessee if the derivation of the income concerned is on account of violation of any law or contravention of any provision. He relies upon the decision in the case of Maddi Venkataraman & Co. (P.) Ltd. v. CIT [1998] 229 ITR 534/ 96 Taxman 643 (SC) to contend that the purpose must be lawful purpose.

18. According to the learned counsel for the Revenue, the entire activity of agriculture carried on by the farmers concerned would only involve research and scientific method of growing quality hybrid seeds for trading business of the appellant-assessee and this assistance of research and scientific method adopted by the staff of the appellant assessee will not make such assistance done on the land of the farmer or cultivator an activity of agriculture. An activity of agriculture starts from basic cultivation right from cleaning the land and making the land ready for sowing the seeds and it is done only by a farmer and the remote chance of appellant-assessee entering such land would be only in case of non-cooperation by the farmer as indicated in terms of the agreement and this would not give the assessee a status of agriculturist. According to the Revenue, neither the basic activity nor the subsequent activity carried on at the land either in terms of Section 2(1A)(b)(i) or (ii) is carried on by the assessee. Therefore question of any income by sale of certified seeds derived by the assessee will not attract any exemptions contemplated under Section 10. According to the Revenue, when no basic activity of agriculture is done on the land in question, subsequent so-called activity of the appellant-assessee by converting the foundation seeds to certified seeds cannot form part and parcel of agricultural activity of the farmer. According to him, by the process of converting the seeds either manually or mechanically, it looses the basic nature of the product and the process of conversion cannot be an agriculture activity so far as the appellant’s business trading in seeds. He places reliance on the decision in the case of Aspinwall & Co. Ltd. v. CIT [2001] 251 ITR 323 / 118 Taxman 771 (SC).

19. Learned counsel for the Revenue also places reliance on the following decisions in support of his contentions:

(1) CIT v. Raja Benoy Kumar Sahas Roy [1957] 32 ITR 466 (SC)

(2) Tarai Development Corpn. v. CIT [1979] 120 ITR 342 /2 Taxman 359 (All.)

(3) CIT v. E.I.D. Parry (India) Ltd. [1996] 218 ITR 713 (Mad.)

(4) CIT v. Jalna Seeds Processing & Refrigeration Co. Ltd. [2000] 246 ITR 156/[2001] 118 Taxman 725

20. According to the learned counsel Parthasarathy appearing for Indo American Exports and Shankar appearing for Namdhari Seeds Private Limited, the relevant provisions of the Act to decide the real question of controversy are Sections 2(1A) and 10(1) of the Income Tax Act; Rules 7, 7A, 7B & 8 and Rules 1 and 2 of Part-IV of the Finance Act. According to him, the Tribunal has partly confirmed the order of the Commissioner of Income Tax (Appeals) by disallowing 10% of the net profit as agricultural income. According to the learned counsel appearing for the appellants-assessees, so far as Namdhari Seeds Private Limited, they are recognised as growers and cultivators of fruits and vegetables and the Department of Commercial Taxes, Government of Karnataka has also recognized the same as growers and sellers of fruits, vegetables and seeds and so far as Indo American Exports, they are also recognized as growers of plants and seeds. Even the agricultural banking division of the bank has lent loan to the assesse-company as agriculturist considering the activities of the company. Therefore the assessees-companies by performing agriculture activity on lands owned by the company or lands taken on lease or on lands taken by way of agreement is indulging in activity of agriculture. According to them, main contention raised by the Revenue was that entire activity of the assessees is in the nature of business and not agriculture, but however the Revenue itself has accepted a part of the income as agricultural income insofar as the income derived from the agricultural operations outside the State of Karnataka for the assessment year 2000-01. According to the learned counsel Mr. Shankar, when concurrent finding of both the appellate authorities point out the activity of the assessees as agriculture, in the absence of assailing the orders of the appellate authorities on the ground of perversity by the Revenue, this Court cannot entertain the controversy as it would be nothing but finding of fact.

21. According to the learned counsel for the assessee, Section 2(1A) of the Act does not envisage that in order to derive income from lands by an assessee, assessee should own the land. As long as the activity performed by the assessee has agriculture in nature, income derived from said activity on the agricultural lands qualifies as agricultural income. According to him, the three parts of Section 2(1A)(b) of the Act clarifies the position as Section-2(1A)(b)(iii) refers to ownership and the word, ‘ownership’ is absent in Sections 2(1A)(b)(i) and 2(1A)(b)(ii). According to him, when production of products like jute, hemp trees etc. are considered as agriculture in nature, seeds which are also grown on land irrespective of whether it is fit for consumption or not amounts to agriculture produce. The Explanation to Section 2(1A) of the Act according to him, includes the cultivation of sapling and seedling as agriculture activity and the income from said activity when consequently qualifies as agriculture income, the seeds produced on the agricultural land deserves to be treated as agriculture produce as in the case of seedling. According to him, Explanation-3 of Section-2(1A) ought to be taken as clarificatory as it only explains the existing position of law and generally such explanations have retrospective effect clarifying the existing position. He relies on the decision of the Apex Court in the case of CIT v. Podar Cement (P.) Ltd. [1997] 226 ITR 625/ 92 Taxman 541 which has been reiterated by the Bombay High Court in the case of CIT v. Glenmark Pharmaceuticals Ltd. [2010] 191 Taxman 455 / 324 ITR 199 (Bom.)

22. While contending that a person who offers the agricultural income need not be absolute owner or tenant of the land, the learned counsel for the assessee further presses on the point as long as the activity on the land is recognised as agriculture and that activity is on the land meant for the purpose of agriculture and if a person has derivative interests in the land and he actually cultivates the land, then the income earned would attract the definition of agricultural income.

23. According to the learned counsel for the assessee, the agreement is not in contravention of the Land Reforms Act and the clauses-1, 8, 11 and 15 of the agreement definitely indicate the agricultural produce raised on the lands under the agreement belongs to the assessee and entire cultivation is done by the assessee and the farmer gets in return only the rent or revenue from the land and this income will fall within the ambit of Section 2(1A)(ia) of the Act. He alternatively contends that even if there is contravention of Land Reforms Act, as contended by the Revenue, the character of the income derived by the assessee from the agricultural operations will not change. He contends if at all there is any contravention, it is for the authority concerned to decide as to whether there was any contravention of the Land Reforms Act and the consequences of such contravention. Hence, according to him Assessing Officer cannot travel beyond the ambit of the Income Tax Act and decide regarding the contravention of other Acts. In the absence of any authorised authority opining that there has been a violation of some other law, Income Tax Officer lacks inherent jurisdiction to decide such issue. He places reliance on the decision in the case of Manasa Housing Co-operative Society Ltd. v. Marikellaiah AIR 2006 Kar. 273.

24. While repelling the arguments of the learned counsel for the Revenue that Explanation to Section-37 of the Act would come in the way of the assessee because the income derived from the so-called agricultural operations is prohibited by law, Mr. Shankar submits that Section-37 refers to expenditure in general which is not in the nature of capital expenditure or personal expenditure of the assessee and relevant section is 28 of the Act. Section-37 deals with allowance of expenses. In the present case, it is not a question of claiming any expenditure, but the Revenue treating the income earned under Section 28 as non-agricultural income. Hence, Explanation to Section 37 cannot be read into the provisions of Section 28 of the Income Tax Act. He refers to the decision in the case of Dr. T.A. Quereshi v. CIT [2006] 287 ITR 547 / 157 Taxman 514 (SC).

25. Learned counsel for the assessee also refers to the decision in the case of CIT v. Williamson Financial Services [2007] 297 ITR 17 / 165 Taxman 638 (SC) to contend that agricultural income is outside the purview of total income unlike other exemptions under Chapter-VI of the Act and the above said decision also proposes that contravention of any other law could not be invoked as the constitutional mandate is to treat the definition of agricultural income as per Income Tax Act for all purposes.

26. Then coming to third issue, whether the activity of the assessee in making the hybrid seeds as marketable is an activity ordinarily carried on to make the produce marketable in order to treat such income as income from agriculture, learned counsel for the appellant-assessee contends that income from an integrated activity to make the produce grown on the land marketable, necessarily it has to be treated as agricultural income. According to him, the process of making the produce marketable by manually or mechanically is immaterial as long as the process is necessary for marketability of the produce. He further contends by advanced technology, the method of cultivation itself has undergone change and hence modern method used either for agricultural operations or processing the agricultural produce as marketable goods, cannot be held against assessee to hold that portion of the income as not agricultural income. He refers to the case of CIT v. B. Suresh [2009] 313 ITR 149 / 178 Taxman 457 (SC).

27. By placing reliance on the decision in the case of Raja Benoy Kumar Sahas Roy (supra) learned counsel for the assessee contends that as Section 2(1A) of the Act includes cultivation of seedlings and saplings as part of agricultural activity, the activity of the assessee in cultivating the land for the purpose of obtaining seeds for sale in the market is also an agricultural activity and the income generated by selling the said commodity in the market is nothing but income from agriculture. Hence, the same deserves to be exempted from tax.

28. Learned counsel for the assessee also places reliance on the decision in the case of A.T. Parthasarathiah & Bros. v. CIT [1963] 48 ITR 830 (Mys.) as well as decision in the case of K. Lakshmanan & Co. v. CIT [1999] 239 ITR 597 /[2000] 108 Taxman 167 (SC) to contend that the hi-tech activity in the present case has to be treated as an ordinary activity either due to acquaintance by the massess or by mandate of law. According to the assessee, a small section of the growers are engaged in process of converting the crop to be sold as seeds in the market and the process undertaken by them is normal process carried on in agricultural activity. What is normal and ordinary in one part of the country may be a rare process or not ordinary in the other part. This alone will not change the character of the income earned by employing process to convert agricultural produce into marketable produce.

29. Learned counsel for the assessee places reliance on Section-7 of the Seeds Act with reference to certain prohibitions for sale of seeds to contend that certain activity has to be done by an assessee to make the seeds marketable in accordance with law to have certification. The Tribunal ought to have made enquiry to know exact activity of the assessee for conversion of the hybrid seeds or foundation seeds to certification seeds. It had to understand whether there was necessity for the assessee to adopt this process to convert the seeds produced by him as per the mandate of law under the Seeds Act. In the extreme situation also the process contemplated under Section-2(1A) of the Act ought to be decided keeping in mind the law under Seeds Act. Therefore the Tribunal ought to have remanded the issue to the file of the Assessing Officer for determination.

30. Alternatively, learned counsel for the assessee contends that without prejudice to his contention that 10% of the income is also agricultural income, the apportionment made by the Tribunal is justified in view of the law laid down in Continental Construction Ltd. v. CIT [1992] 195 ITR 81 / 60 Taxman 429 (SC), CIT v. Best & Co. (P.) Ltd. [1966] 60 ITR 11 (SC) and Williamson Financial Services case (supra). Learned counsel to substantiate his challenge to the arguments of the learned counsel for the Revenue contends that for the assessment year 2001-02, the Assessing Officer himself has given the relief insofar as the land classified as leased lands situated outside Karnataka. Having accepted such position for one year, the Revenue cannot challenge that portion of the order which has attained finality in view of the decision in the case of Mcorp Global (P.) Ltd. v. CIT [2009] 178 Taxman 347/ 309 ITR 434 (SC).

31. With these arguments, learned counsel for the assessee placing reliance on several other decisions contends firstly that the appeal filed by the Revenue challenging the orders of the Tribunal treating 90% of income as agricultural income is not justified. According to him, there is no contravention of Land Reforms Act and even if such contravention is indicated, Income Tax Officer has no jurisdiction to import other laws while making assessment. He contends that so far as appeals of the assessee, according to him, the activity or the process done by the assessee for converting the seeds grown by cultivating the land as marketable produce, becomes an integrated part of the same agricultural activity done by assessees. Therefore according to him, both activities contemplated under Section 2(1A)(b)(i) and so also 2(1A)(b)(ii) are attracted to the above appeals and seeks for dismissal of the appeals filed by the Revenue while seeking for allowing the appeals filed by the assessee.

32. The terms of the agreement are required to be referred in order to examine whether Section 2(1A) applies to the facts of the present case or not. Agreement and Annexure-1 of the agreement reads as under:

“AGREEMENT

This agreement entered into between Namdhari Seeds Pvt. Ltd., hereinafter referred to as the company and Sri Mahadevappa Mallappa Chikkalli s/o Mallappa Chikkalli aged about 30 years residing at Hirehali hereinafter referred to as farmer.

WHEREAS the company is in the business of cultivation, production and marketing of open-hybrid seeds both for domestic and international market and desires to take up the production of open-hybrid tomato seeds for its own benefit or/on behalf of its overseas principals.

WHEREAS the farmer is the person owning land suitable for cultivation of hybrid tomato seeds for and on behalf of the company or the Company’s overseas principals by sowing the stock/foundation seeds to be supplied by the company.

Now therefore this deed witnesseth, the terms and conditions agreed to between the parties for their mutual advantage.

(1) The farmer agrees to place at the total disposal of the company in terms of this agreement one acre of land, earmarked for the purpose of cultivation of hybrid tomato seeds, out of the land belonging to him and more particularly described in the schedule herebelow for the period from June 2000 to 2001. During the said period the farmer shall have only the right to enter the land so earmarked for fulfilling his obligations in terms of this agreement and for none other.

(2) The Farmer agrees that he will undertake for and on behalf of the company, cultivation of the open hybrid tomato seeds in the land so earmarked under the guidance, specifications and supervision of the company.

(3) The farmer assures the Company that the land, more particularly described in the schedule hereinbelow, belongs to the farmer in his own right as Owner/Term Lessee and is in his possession and cultivation.

(4) The farmer further assures the company that the land is suitable for cultivation of open-hybrid tomato seeds.

(5) The farmer agrees to observe, all the conditions regarding the cultivation and other incidental matters, as set out in these presents including Annexure hereto, connected with the preparation of land, sowing of male female seeds, fertiliser application, weeding, irrigation, pollination, harvesting, seed extraction, seed cleaning and other agricultural operations connected with open pollinated/hybrid seed production. The farmer agrees to allow the personnel of the company to operate on the above land, machinery, implements and accessories towards the achievement of better results envisaged under this agreement and also agrees to use such machinery.

Implements, accessories etc. when provided by the company on such land selected for the production of seeds. The farmer agrees to abide by other conditions or advice which the Company may give from time to time directly or through the company staff or farm supervisors.

(6) The Farmer agrees that if during the operation of this agreement the company is not satisfied with the manner in which the farmer conducts himself or conducts the cultivation, the company will be at liberty at any stage to enter upon the land, so set apart for open pollinated/hybrid seed cultivation and take over the agricultural operations, with full right even to exclude entry of the Farmer himself into the said area.

(7) Appoint another licencee on similar terms & conditions and until the particular operations are fulfilled and culminated. The grower shall not exercise any right in respect of that land.

(8) During the period stipulated in para one above or any extension thereof, the company shall have all rights to possession, cultivation and harvesting of hybrid seeds on the land earmarked in terms of this agreement, as if the company is a Lessee although all parties agree that no lease is created in terms of this agreement. The terms of this contract to the extent that is not consistent with the Karnataka Land Reforms Act shall be considered as null and void.

(9) The farmer while agreeing to abide by the terms and conditions contained in the Annexure hereto more particularly, assures the company that the foundation seeds supplied by the company would be fully sowed for cultivation and none of them would be misused, or parted with to others not entitled to it. Any unutilised foundation seeds would be returned to the company.

(10) The farmer further assumes that he would hand over to the company at such place/s as may be specified all the hybrid seeds cultivated by him and not sell or part with or retain for himself any portion of the seeds cultivated by him.

(11) Foundation seeds/stock seeds, and seeds derived out of this are the property of the company/company’s overseas principals. The farmer only undertakes multiplication of this material using his land and labour. The multiplication is done under the technical supervision of the company at the mutually agreed price and will deliver the seeds to the specified person at specified place.

(12) The farmer further agrees that all information relating to the foundation seeds/stock seeds, as also the cultivation of open pollinated/hybrid seeds are confidential in nature and he would not part with any of the property or information relating to the company to outsiders or competitors. The farmer undertakes, to pay such damages as may be determined by the company for breach of these covenants.

(13) The company agrees to pay the farmer compensation at the rate of Rs. 3200/ per kg/quintal for hybrid tomato seeds which answer to the specifications relating to moisture contents, physical purity, germination, hybridity, quality etc. as set out in the Annexure.

(14) The farmer agrees that the amount due as compensation as per clause 11 shall be determined by the company after the seeds are duly tested by the company at its Bangalore unit or by the overseas principals on whose behalf the production is undertaken. The farmer further agrees that for the purpose of ensuring quality and purity, the company may subject the seeds to further cleaning and processing. The final quality of seeds so arrived at, after such cleaning, processing, and testing shall be deemed to be the produce for which the farmer would be entitled for compensation. The farmer hereby specifically agrees and accepts unconditionally the judgment as to quality and measurement as to eight of the produce, arrived at by the company or its overseas principals. The company may withhold from such payment, the registration fee, advances and the other inputs if any, paid to him.

(15) The farmer further agrees that the farmer would not, during validity of this agreement, create any rights by way of lease or licence, mortgages or sale to others. The company shall have uninterrupted and unquestioned right to enter upon the land without any let or hindrance and he shall not in any way question the right of the company for cultivation of open hybrid tomato seeds during the validity of the agreement.

(16) The contents of this agreement have been explained to the farmer in Kannada and I have fully understood the terms and conditions of this agreement.

SCHEDULE

Property earmarked for one acre cultivation.

Land measuring Village-Hirohalli Survey No. 15 Sub-Division District
Bounded on the 4 sides as under:

East – Malashappa-Hulihalli

West – Malarayappa Kassambi

South – Maralangappa Govorapur

North – Suresh Vasanada

For Namdhari Seeds Pvt. Ltd.
(1) -sd-
(M.S. Subramanya)
(2) -sd-
(M.M. Chikkalli)
(Name of the Farmer)

Witness:

(1)

(2)

 

ANNEXURE-1

Conditions forming part of the agreement for cultivation of open pollinated/hybrid

seeds.

(a) The farmer will carry out all instructions of the company in the matter of hybrid seed cultivation. Whether herein contained or conveyed/communicated separately from time to time by the company or through its representative/s orally or in writing.

(b) He will ensure that there is sufficient water for raising the

crops.

(c) He will ensure that the land should have not been used for Tomato crops cultivation during the previous season. Preferably the land should have been used for cultivation of

crops or
crops during the previous season.

(d) He will ensure that within a radius of 800 mts./

__ -ft. there would not be any other variety of
crops raised either for seed or for commercial production.

(e) He will ensure that the land is prepared for sowing by applying 5-10 cart loads of farmyard manure per acre and the land ploughed thoroughly. He undertakes to apply soil amendments like lime, gypsum, etc., as per the company’s recommendation.

(f) He will inform the company officials the locations and his requirements of foundation seeds one day in advance of sowing.

(g) He shall ensure that the foundation seeds supplied by the company are sown for cultivation in the specified field, in the presence of the representative of the company and none of them are misused or parted with to others not entitled to it. Any unutilised foundation seeds shall be returned to the company.

(h) From the time of sowing the seeds to the time of harvesting the crop, the farmer undertakes to cultivate the farm as per the instructions of the Company and its representative.

(i) Final payment: The hybrid seeds which pass the tests and conform to the following quality parameters viz.,

(a) Moisture content less than 8%

(b) Germination 90% and above

(c) Hybridity 98% and above

(d) Physical purity 98% and above

Will entitle the farmer to receive payment at the rate of Rs. 3,200/- per quintal of processed seeds of such rate as may be fixed by the company. Normally testing and processing is likely to take about 4 to 5 months time.

(j) Any undersized seeds which pass through the sieve while processing shall remain as property of the company, the same will be sold in the market after due process and the amount if any realised will be paid to the farmer in due course.”

33. It is useful to refer Section-37 of the Act with its Explanation and it reads as under:

“37. (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”

Explanation: For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by ‘law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.

(2) omitted

(2B) Notwithstanding anything contained in sub-section (1), no allowance shall be made in respect of expenditure incurred by an assessee on advertisement in any souvenir, brochure, tract, pamphlet or the like published by a political party.”

34. Section-2(1A) of the Act is relevant for the purpose of understanding and analyzing whether the income derived by the assessee-company is from agriculture operations and it amounts to agricultural income. Section-2(1A) reads as under:

“Agricultural income” means –

(a) any rent or revenue derived from land which is situated in India and is used for agricultural purposes;

(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;

(c) ** ** **

Explanation-1 ** ** **

Explanation-2 ** ** **

Explanation-3 For the purposes of this clause, any income derived from saplings or seedlings grown in a nursery shall be deemed to be agricultural income.”

35. So far as the above definition, it is exhaustive and it refers to three kinds of income:

36. Section 2(1A)(a) refers to any rent or revenue derived from agricultural land which is situated in India and is used for agricultural purposes. Section 2(1A)(b)(i) refers to income derived from such land by agriculture. Section 2(1A)(b)(ii) refers to any income derived from such land by the performance of 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. We are not concerned with the third type of income as the same is attributable to a building and the facts of the present case do not warrant consideration as to whether such income is a agricultural income or not.

37. An Income can become agricultural income only if such income is derived from land which is situated in India and when such land is put to agricultural use. When a land is used for agriculture purpose, different types of operations can be carried on such land and two operations which are relevant are basic operations and subsequent operations. Basic operations involve cultivation of the land like tilling of the land, sowing of the seeds, planting and similar operations which can be termed as basic operations warranting and demanding human labour and the skill upon the land itself, which is a direct link to make the crop sprout from the land. After the crop sprouts from the land, subsequent operations have to be resorted to by the agriculturists for the efficient production of crop such as removing the weeds, cleaning and loosening soil around crop, prevention of crops from insects and pests etc. Therefore both the basic and subsequent operations together form the integrated activity of an agriculturist. In order to call basic and subsequent activity as integrated activity of a farmer, the subsequent activity should be in conjunction with or in continuation of the basic operation i.e. preparation of land and sowing of the seeds or such similar activity. It is well-settled that preparation of the soil and sowing of the seeds need not necessarily be by tilling of the land using a plough and it could be by use of mechanical apparatus also. The basic operation should be on the land itself and it cannot be outside the land.

38. One has to understand why agricultural income was kept outside the purview of income tax. Section-10(1) of the Act totally exempts agricultural income from income tax. However, no agricultural income subsequent to 1974-75 has to be added to the total non-agricultural income for the purpose of determining the tax on non-agricultural income of an individual although the agricultural income will remain fully exempted. While Section-10(1) of the Act exempts agricultural income from income tax, one has to see why it is so. Constitution of India gives exclusive powers to the State Legislature to make laws with reference to tax on agricultural income. Entry-82 of List-I of 7th Schedule further clarifies this position by empowering the Parliament to levy taxes on income other than agricultural income. Central Government is not empowered to fax this source of income under Income Tax Act.

38A. With this background, one has to see what exactly happens if the activity of the nature claimed by the assessee is carried on in the lands of the owner/farmer in these matters by virtue of the agreement entered into between the parties. In order to understand different parts of Section-2(1A), one has to understand the terms of agreement to know who gets what ? Sub-section (a)(i) refers to rent or revenue derived from the land and such land should be situated in India and the land must have been used for agricultural purpose. The rent could be paid either in cash or in kind or in money or money’s worth. To know the nature of any income or revenue received as rent which is payable either in cash or in kind, definitely it should be with reference to relationship of landlord and tenant or lessor and lessee between the parties. If cash is paid for carrying out agricultural operations, it would amount to rent received. On crop share basis, if crop produced from the land is given to the landlord in kind, it is deemed to be rent. Therefore either way it would attract sub-section (a) of Section 2(1A). The words, ‘any rent or revenue’ used under Section 2(1A)(a) do not refer to any income which has no connection to the land. Therefore, unless the immediate and effective source is land, such income cannot be termed as agricultural income. It is well settled principle that if interest has to be paid on arrears of land rent payable, though the rent payable is agricultural income, but the interest cannot be agricultural income. Similarly by agreement if a person buys the standing crops, the profit earned from the sale of standing crops cannot be claimed as agricultural income. Therefore every amount accrued to a person in whose hands the agricultural produce passes through cannot become agricultural income. It would lead to conclusion that only the owner, landlord or farmer or persons having derivative interests in such land receives income from the above persons, then the income from the land by the performance of agricultural operations on it can be termed as agricultural income.

39. Learned counsel for the appellant-assessee challenging the appeals of the Revenue regarding the opinion of the Tribunal that 90% of the income of the assessee is agricultural income refers to the following decisions on different aspects of the matter like nature of income, interest in land and nature of produce:

(i) Raja Benoy Sahas Roy’s case (supra )

(ii) CIT v. K.E. Sundara Mudaliar [1950] 18 ITR 259 (Mad.)

(iii) CIT v. Associated Metals Co. [1989] 177 ITR 428 (All.)

(iv) Jugal Kishore Arora v. Dy. CIT [2004] 269 ITR 133 / 141 Taxman 187 (All.)

(v) CIT v. Soundarya Nursery [2000] 241 ITR 530 /[2002] 123 Taxman 372 (Mad.)

(vi) Consolidated Coffee Estates Ltd. [1943] v. CAGIT [1970] 76 ITR 29 (Mys.)

(vii) Williamson Financial Services case (supra )

(viii) CIT v. Green Gold Tree Farmers (P.) Ltd. [2008] 299 ITR 262 / 167 Taxman 151 (Uttarakhand)

(ix) A.S. Karachi v. Commissioner of Agricultural Income-tax [1978] 115 ITR 629 (Ker.)

(x) U.P. Krishi Utpadan Adhiniyam [2004] (13) ILD 1144 (sic)

(xi) Havakkal Estate Co. v. CIT [1977] 109 ITR 59 (Mad.)

(xii) CIT v. Maddi Venkatasubbayya [1951] 20 ITR 151 (Mad.)

40. The gist of the above citations is as under:

In considering the connotation of the term “agriculture”, we have so far thought of cultivation of land in the wider sense as comprising within its scope the basic as well as the subsequent operations, regardless of the nature of the products raised on the lands. These products may be grain or vegetables or fruits which are necessary for the sustenance of human beings including plantations and groves, or grass or pasture for consumption of beasts (livestock) or articles of luxury such as betel, coffee, tea, spices, tobacco etc, or commercial crops like cotton, flax jute, hemp, indigo etc. When such products could be raised from the land, the term, agriculture cannot be confined merely to the production of grain and food products for human beings and beasts. Therefore the term, ‘agriculture’ has to be understood as comprising of oil products of the land which have some utility either for consumption or for trade and commerce and would also include forest products such as timber, sal piyasal trees, casurina plantation, tendu leaves, horra nuts etc. If the term agriculture is understood as above, the basic as well as subsequent operations in the process of agriculture and the raising on the land of products which have some utility either for consumption or for trade and commerce, it will be seen that the term, agriculture receives a wider interpretation both in regard to its operations as well as the results of the same. The operations put forth on the land could be divided into two, the initial one is all the operations carried on by the agriculturist which are absolutely necessary for the purpose of effectively raising the produce from the land. There are certain other operations to be performed after the produce sprouts from the land like cleaning the land around the plants, weeding and protecting the same from pests and insects. Sometimes it may also need tending, pruning, cutting, harvesting so as to make the produce fit for market. In such a situation the later operations also can be termed as agricultural operations. As long as integrated activity is between the two operations, it would mean the income derived from the land is agricultural income. This distinction between basic and subsequent operations is not so important in cases where the agriculturist performs these operations as a part of his integrated activity in cultivation of the lands.

Irrespective of the nature of the produce or product of the land, whatever is grown on the land with the assistance of human labour and effort whatever does not grow wild or spontaneously on the soil without human labour and effort would be an agricultural product and the process of producing it would be ‘agriculture’ within the meaning of the expression in Section-2(1A) of the Act.

Agriculture would also include horticulture, floriculture, arboriculture and sylviculture. Cultivation of flora and fauna which has artistic and decorative value can be termed as agricultural activity.

The seeds were clearly a product of agriculture and the income derived from the sale of seeds can be agriculture income.

Agricultural income not only exempted from taxable income but also from the total income of the assessee. These incomes are different from the tax-free incomes under Chapter VI-A. The definition of agricultural income in Article-366(1) indicates that it is open to the income-tax enactments in force from time-to-time to define agricultural income in any particular manner and that would be the meaning not only for tax enactments but also for the Constitution. Rule 8(1) of the Income Tax Rules states that composite integrated income shall be computed as if it was income derived from business. The composite income had an element of agricultural and business incomes which need to be separated by applying the rule of apportionment under Rule-8. That is because Agricultural income has no linkage with any of the enumerated heads in Section 14 of the Act though the non-agricultural element has such linkage. When income is derived from composite activity, such income shall be chargeable to income tax as business income. Here legal fiction comes into play and chargeability is assigned only to the non-agricultural part of the composite income which has linkage with one of the enumerated heads in Section-14 viz., business income.

Mere fact that some of the operations required for raising the crop in question has been carried on by the farmer lessee up to certain date and subsequently carried on by the assessee would not make the income derived by the assessee by selling the produce a non-agricultural income because without continuing the agricultural operations stopped by the farmer, the assessee would not have got the income in question.

The definition of seed includes seedlings as well. Therefore the Seeds Act and Agricultural Produce Act have to be construed harmoniously.

When a person takes a tea estate on lease for a period of ten years or five years and during the said period, he carries out nursing of the plantation for proper growth of tea leaves, which ultimately manufactured into tea in the commercial sense, such persons will be entitled for the benefit of Rule-8 of the Income Tax Rules.

The profit earned by the assessee by the sale of standing crop is different in its character from income derived by way of rent or revenue or by the performance of agricultural operations by a person having an interest therein as owner, tenant or mortgagee with possession etc. The profit in such a case is derived by entering into a contract of purchase of a commodity and by resale of that commodity at a higher price and it is not agricultural income.

41. As against this, the learned counsel for the Revenue relies upon the following decisions to show when an income from land could be treated as agricultural income and when it would not amount to agricultural income.

1. Malabar Industrial Co. Ltd.’s case (supra)

2. Raja Benoy Kumar Sahas Roy’s case (supra)

42. The gist of the above citations is as under:

The amount received by the assessee (vendor) from purchaser of rubber estate in consideration for modification/relaxation of payment schedule which was not fixed or quantified as loss of agricultural income could not be treated as agricultural income. Therefore it has to be an income from other sources.

The term ‘agriculture’ cannot be confined merely to production of grain and food products for human beings and beasts. It needs further activity which is useful for the land. Therefore certain activities which are necessary and are in connection with the land would come within the term, ‘agriculture’. Therefore other operations which are absolutely necessary for an agriculturist for effective raising of the produce on the land are also called agricultural operations.

The above decisions relied upon by the learned counsel for the assessee as well as Revenue would show, when income of a particular nature becomes agricultural income. According to the learned counsel for the assessee, the agreement between the parties (contract farming) not only indicates the assessee having some derivative interest from the land, but also derivative interest in growing the foundation seeds on the land. According to him, by virtue of terms of agreement, the assessee having some interest in the land in question, after employing a particular process ordinarily employed by a cultivator makes the produce raised or received by him fit to be taken to market. In other words, according to Mr. Shankar, the assessee not only produces foundation seeds by undertaking cultivation in the land under the agreement, but also converts the foundation seeds to certified seeds by a process so as to make the foundations seeds marketable. Hence according to the learned counsel for the assessee, the total activity of the assessee carried on by raising the foundation seeds and also making the foundation seeds marketable is an integrated activity carried on by them by virtue of terms of contract-farming agreement.

43. Learned counsel for the assessee relies upon the following decisions as well to substantiate his argument that the activity carried on by the assessee-company is activity ordinarily carried on to make the produce marketable:

1. K. Lakshmanan & Co.’s case (supra)

2. A.T. Parthasarathiah & Bros. case (supra)

3. Dooars Tea Co. Ltd. v. CAIT [1962] 44 ITR 6 (SC)

4. B. Suresh’s case (supra)

5. CIT v. Maharashtra Sugar Mills Ltd. [1971] 82 ITR 452 (SC)

6. Thiru Arooran Sugars Ltd. v. CIT [1997] 227 ITR 432/ 93 Taxman 579 (SC)

44. The gist of the above citations is as under:

The produce must retain its original character in spite of the process, unless there is no market for selling it in that condition. If there is no market to sell the produce, then any process which is ordinarily employed to render it fit to reach the market, where it can be sold would be covered by the definition. The process ordinarily employed by the cultivators of any particular locality to render the produce raised by them fit for market has to be decided. The process adopted in one locality may not be adopted in another locality. In some places, paddy as such is sold, but in other places usually it is converted into rice before it is sold. In other words, the market referred to in the provision is a ready and willing market and not a market where the produce has to be dumped.

For the purpose of making a produce marketable or fit for sale, some process may have to be undertaken. The section does not contemplate the sale of an item or a commodity which is different from what is cultivated and processed. If mulberry leaves are subjected to some process and sold in the market as such, then certainly income derived therefrom would be regarded as agricultural income.

Section-2(1b) includes instances of income derived from performance of some process. The process must be one which is usually employed by the cultivator or receiver of rent in kind; it may be simple manual process or it may involve the use and assistance of machinery. The first requirement is the process must be one which is usually employed by the cultivator and the second requirement is said process must have been employed with the object of making the produce marketable.

The basic requirement of section 80HHC is earning in foreign exchange and retention of profit for export business. Earning of income depends on sale of goods and services. The difference between the two is getting blurred with globalization and cross- border transaction. With technological advancement, one has to change our thinking regarding concept like goods, merchandise and articles.

The cultivation of sugarcane and the manufacture of sugar by the assessee constituted one single and indivisible business. The question was whether a part of the managing agency commission paid by the company could be disallowed on the ground that that part related to management of sugarcane cultivation, income from which was exempted from tax as agricultural income. The entire managing agency commission was laid out or expended for the purpose of the business carried on by the assessee and was allowable under section 10(2)(xv) of the Act.

When a question arose for consideration what exactly was the market value of agricultural produce would mean, it was held that the value of a property will be the price which it will fetch if sold in the open market. It is a well-known method of valuation adopted in the large number of statutes in England and also in India. There may or may not be an actual market where buyers and sellers congregate to purchase and sell goods. Therefore the word, ‘market’ would not mean actual market where there would be sellers and buyers to sell and buy the goods. It would mean if the agricultural produce is taken to a market after making it as a marketable produce, it would also be considered as agricultural produce.

45. Learned counsel for the Revenue relies upon the following decisions to substantiate his argument that every activity in relation to land and the income from such land cannot be an activity carried on to make the produce marketable.

(1) Aspinwall & Co. Ltd. v. CIT [2001] 118 Taxman 771 (SC)

(2) Tarai Development Corpn.’s case (supra)

(3) State of Rajasthan v. Rajasthan Agriculture Input Dealers’ Association [1996] 5 SCC 479

(4) E.I.D. Parry (India) Ltd.’s case (supra)

(5) Maddi Venkataraman & Co. (P.) Ltd.’s case (supra)

46. The gist of the above decisions is as under:

The assessee after plucking or receiving the raw coffee berries makes it undergo nine processes to give it the shape of coffee beans. The net produce is absolutely different and separate from the input. The change made in the article results in a new and different article which is recognized in the trade as a new and distinct commodity. The coffee beans have an independent identity distinct from raw material from which it was manufactured. If commercially a different article or commodity results after processing, then it would be a manufacturing activity.

The assessee distributes foundation seeds to farmers, who are none other than the shareholders in the company. After the seeds are sown by the shareholders, the seed production assistants of the company inspect the fields and advise the farmers regarding the mechanical use, pesticides etc. After the produce is harvested, seed samples are collected by the officers of the company, and tested for purity, viability and moisture content in the laboratory of the University. On the samples meeting the required standard, the farmers are asked to supply their produce. The seeds supplied are again tested, and if found suitable, approved for processing. The seeds are then graded and cleaned by mechanical processes, and sorted out in three categories. The assessee on the sale of these seeds derived income in respect of which deduction under Section 80J has been claimed. In such situation, the process or converting foundation seeds to certified seeds amounts to manufacture or production of the article sold by the assessee.

By process of coating and applying insecticides, other chemicals and poisonous substances to the foodgrain meant to be utilised as seeds, one of its basic character i.e. its consumption as food by human beings or animals or for extraction for the like purpose, gets irretrievably lost and such processed seeds become a commodity distinct from foodgrains as commonly understood.

The raw seeds after processing the same were converted into seeds for cultivation. Such processed seeds would not be fit for human consumption or edible. The new article is different from raw material used. Then assessee is entitled for relief under Section 80-J.

Processing of raw seeds through multiple stages resulting in a different commodity which is no longer edible and can be used only for cultivation amounts to manufacture or production entitling deduction under Section 80HH.

47. With the above case laws and arguments, one has to see the terms of the agreement between the parties in order to understand whether the so-called two activities of the assessee viz., supplying foundation seeds and in turn getting the foundation seeds from the farmer and later on making it as a marketable commodity amounts to integrated activity of agriculture.

48. The terms of agreement indicates that the company is in the business of cultivation, production and marketing of open-hybrid seeds both for domestic and international market and it enters into the agreement with the farmer for production of open hybrid tomato seeds for its own benefit or/on behalf of its overseas principals. The farmer is the person owning land suitable for cultivation of hybrid seeds and agrees to cultivate the hybrid seeds specified by the assessee company. The foundation seeds are supplied by the Company. By virtue of this agreement, the farmer agrees to demarcate a particular acreage of land earmarked for the purpose of cultivation of particular seeds. The seeds are grown in the land belonging to the farmer during the fixed period.

49. During this term, the farmer has to do all acts on the land in order to fulfil his obligations in terms of the agreement. The farmer agrees that he will carry on the cultivation of open-hybrid seeds in the land so earmarked under the guidance, specifications and supervision of the company. The farmer assures the company that the land belongs to the farmer in his own right as owner/term lessee and is in his possession and cultivation. He must assure the assessee-company that his land is fit for cultivation of open-hybrid tomato seeds The farmer undertakes to observe all the conditions regarding the cultivation and other incidental matters as set out in the agreement with reference to preparation of land, sowing of male and female seeds, fertiliser application, weeding, irrigation, pollination, harvesting or seed extraction, seed cleaning and other agricultural operations necessary for the cultivation of hybrid-seeds. The farmer agrees to allow the personnel of the company to operate on the land, machinery, implements and accessories in order to achieve best results envisaged under the agreement. The farmer also agrees that if during the operation of the agreement, the company is not satisfied with the manner in which the farmer conducts himself or conducts the cultivation, the assessee-company is entitled to enter upon the land, so set apart for open pollinated/hybrid seed cultivation and take over the agricultural operations. Company is also entitled to appoint another licences on similar terms and conditions.

50. According to the agreement, during the term of the agreement, Company has all rights to possession, cultivation and harvesting of hybrid seeds on the land earmarked in terms of the agreement, as if the company is a Lessee although all parties agree that no lease is created in terms of the agreement. It specifically says the terms of the agreement would bind both the parties except such terms which are inconsistent with the Karnataka Land Reforms Act and such terms shall be considered as null and void. The farmer undertakes to use the foundation seeds supplied by the assessee-company for cultivation and further assures that none of them would be misused or parted with to others not entitled to it and further undertakes to return to the assessee unutilised foundation seeds. The farmer further undertakes to hand over all the hybrid-seeds cultivated by him and not to sell or part with or retain for himself any portion of the seeds. It further makes clear all the seeds derived out of the foundation seeds by cultivation belongs to the company and the farmer has to undertake only multiplication of foundation seeds using his land and labour. However this multiplication of seeds is done under the technical supervision of the company at the mutually agreed price and the farmer has to deliver the seeds to the person specified at specified rate. Farmer also undertakes to keep all the information relating to the foundation seeds/stock seeds as also the cultivation of open pollinated/hybrid seeds as confidential and will not reveal it to any person. Farmer also undertakes to pay damages if he violates any of the terms.

51. The company agrees to pay the farmer compensation at the rate of Rs. 3,200/- per quintal for hybrid tomato seeds which answer to the specifications relating to moisture contents, physical purity, germination, hybridity, quality etc. The farmer agrees that the amount due as compensation will be determined by the company after the seeds are duly tested by the company at its Bangalore unit. Farmer also agrees that the company can subject the seeds to further cleaning and processing to ensure quality and purity. The farmer would be entitled for compensation only after the entire process of cleaning, processing and testing is done on the seeds produced by him. He also agrees to accept unconditionally the judgment as to quality, measurement and as to weight of the produce, arrived at by the company. Company is entitled to withhold from such payment, the registration fee, advances and the other inputs, if any paid to him. Farmer also undertakes not to create any third party right during the subsistence of the agreement.

52. Apart from the above agreement, farmer also executes Annexure-1 and it contains conditions forming part of the agreement and they are as under:

That the farmer will carry out all instructions of the company in the matter of hybrid seeds cultivation. That he would ensure that there is sufficient water for raising the crops. He would also ensure that land should not have been used for tomato crop cultivation during the previous season and he will ensure that within a radius of 800 meters/feet, there would not be any other variety crops raised either for seed or for commercial production. He will ensure that (and is prepared for sowing by applying 5- 10 cart loads of farmyard manure per acre and the land ploughed thoroughly. He undertakes to apply soil amendments like lime, gypsum etc. He also undertakes to intimate the company officials the locations and his requirements of foundation seeds one day in advance of sowing. He will ensure that the foundation seeds supplied by the company are sown for cultivation in the specified field, in the presence of representative of the company. He further undertakes to cultivate the farm as per the instructions of the company right from sowing the seeds to the time of harvesting the crop. He undertakes to conform to the quality parameters mentioned in the annexure. He undertakes to receive payment at the rate of Rs. 3,200/-per quintal of processed seeds or at such rate as may be fixed by the company. Normally testing and processing would take 4 to 5 months. He further undertakes that any undersized seeds which pass through the sieve while processing shall remain as property of the company and the same will be sold in the market after due process and the amount if any realised will be paid to the farmer in due course.

53. In the present case, the argument of the assessee is not only initial operations, but also subsequent operations having nexus with the initial operations, are carried on by the assessee on the lands belonging to the farmer or other owners. What exactly means, agriculture, agricultural operations, basic operations & subsequent operations, agricultural purposes, agricultural income etc. came up for consideration before the Apex Court as long back as in 1957 in Raja Benoy Kumar Sahas Roy’s case (supra). Important paragraphs of the said judgment which are relevant for appreciating the facts of the present case are necessarily to be mentioned and they are as under:

The term “agriculture” cannot be confined merely to the production of grain and food products for human beings and beasts. The mere fact that an activity has some connection with or is in some way dependent on land is not sufficient to bring it within the scope of the term and such extension of the term “agriculture” is unwarranted. The term “agriculture” cannot be dissociated from the primary significance thereof which is that of cultivation of the land and even though it can be extended in the manner we have stated before both in regard to the process of agriculture and the products which are raised upon the land, there is no warrant at all for extending it to all activities which have relation to the land or are in any way connected with the land. The use of the word agriculture in regard to such activities would certainly be a distortion of the term.

If the term “agriculture” is thus understood as comprising within its scope the basic as well as subsequent operations in the process of agriculture and the raising on the land of products which have some utility either for consumption or for trade and commerce, it will be seen that the term “agriculture” receives a wider interpretation both in regard to its operations as well as the results of the same. Nevertheless there is present all throughout the basic idea that there must be at the bottom of it cultivation of land in the sense of tilling of the land, sowing of the seeds, planting, and similar work done on the land itself. This basic conception is the essential sine qua non of any operation performed on the land constituting, agricultural operation. If the basic operations are there, the rest of the operations found themselves upon the same. But if these basic operations are wanting the subsequent operations do not acquire the characteristic of agricultural operations.

11. The terms “agriculture” and ‘agricultural purpose” not having been defined in the Indian IT Act, we must necessarily fall back upon the general sense in which they have been understood in common parlance. “Agriculture” in its root sense means ager a field and culture, cultivation, cultivation of a field which of course implies expenditure of human skill and labour upon land. The term has, however, acquired a wider significance and that is to be found in the various dictionary meanings ascribed to it. It may be permissible to look to the dictionary meaning of the term in the absence of any definition thereof in the relevant statutes. As was observed by Lord Coleridge in R v. Peters (1886) 16 QBD 636.

80. We have, therefore, to consider when it can be said that the land is used for agricultural purposes or agricultural operations are performed on it. Agriculture is the basic idea underlying the expressions “agricultural purposes” and agricultural operations and it is pertinent therefore to enquire what is the connotation of the term “agriculture”. As we have noted above, the primary sense in which the terms agriculture is understood is ager—field and cuitra— cultivation, i.e., the cultivation of the field, and if the term is understood only in that sense agriculture would be restricted only to cultivation of the land in the strict sense of the term meaning thereby, tilling of the land, sowing of the seeds, planting and similar operations on the land. They would be the basic operations and would require the expenditure of human skill and labour upon the land itself. There are however other operations which have got to be resorted to by the agriculturist and which are absolutely necessary for the purpose of effectively raising the produce from the land. They are operations to be performed after the produce sprouts from the land, e.g., weeding, digging the soil around the growth, removal of undesirable undergrowths and all operations which foster the growth and preserve the same not only from insects and pests but also from depreciation from outside, tending, pruning, cutting, harvesting, and rendering the produce fit for the market. The latter would all be agricultural operations when taken in conjunction with the basic operations above described, and it would be futile to urge that they are not agricultural operations at all. But even though these subsequent operations may be assimilated to agricultural operations, when they are in conjunction with these basic operations could it be said that even though they are divorced from these basic operations they would nevertheless enjoy the characteristic of agricultural operations? Can one eliminate these basic operations altogether and say that even if these basic operations are not performed in a given case the mere performance of these subsequent operations would be tantamount to the performance of agricultural operations on the land so as to constitute the income derived by the assessee therefrom agricultural income within the definition of that term?

We are of the opinion that the mere performance of these subsequent operations on the products of the land, where such products have not been raised on the land by the performance of the basic operations which we have described above would not be enough to characterise them as agricultural operations. In order to invest them with the character of agricultural operations, these subsequent operations must necessarily be in conjunction with and a continuation of the basic operations which are the effective cause of the products being raised from the land. It is only if the products are raised from the land by the performance of these basic operations that the subsequent operations attach themselves to the products of the land acquire the characteristic of agricultural operations. The cultivation of the land does not comprise merely of raising the products of the land in the narrower sense of the term like tilling of the land, sowing of the seeds, planting and similar work done on the land but also includes the subsequent operations set out above all of which operations, basic as well as subsequent, form one integrated activity of the agriculturist and the term “agriculture” has got to be understood as connoting this integrated activity of the agriculturist. One cannot dissociate the basic operations from the subsequent operations and say that the subsequent operations, even though they are divorced from the basic operations can constitute agriculture operations by themselves. If this integrated activity which constitutes agriculture is undertaken and performed in regard to any land that land can be said to have been used for “agricultural purposes” and the income derived therefrom can be said to be “agricultural income” derived from the land by agriculture.

81. In considering the connotation of the term “agriculture” we have so far thought of cultivation of land in the wider sense as comprising within its scope the basic as well as the subsequent operations described above, regardless of the nature of the products raised on the land. These products may be grain or vegetables or fruits which are necessary for the sustenance of human beings including plantations and groves, or grass or pasture for consumption of beasts or articles of luxury such as betel, coffee, tea, spices tobacco etc., or commercial crops like cotton, flax, jute, hemp, indigo, etc. All these are products raised from the land and the term “agriculture” cannot be confined merely to the production of grain and food products for human beings and beasts as was sought to be done by Bhashyam Ayyangar, J., in Murugesa Chetti v. Chinnathambi Gouden (supra) or Sadasiva Ayyar, J., in Raja of Venkatagiri v. Ayyappa Reddi (supra), but must be understood as comprising all the products of the land which have some utiliy either for consumption or for trade and commerce and would also include forest products such as timber, sale and piyasal trees, casuarina plantations, tendu leaves, horra nuts, etc.

83 …………. The term “agriculture” cannot be dissociated from the primary significance thereof which is that of cultivation of the land and even though it can be extended in the manner we have stated before both in regard to the process of agriculture and the products which are raised upon the land, there is no warrant at all for extending it to all activities which have relation to the land or are in any way connected with the land. The use of the word agriculture in regard to such activities would certain be a distortion of the term.

84. A critical examination of the definition of “agricultural income’ as given in s.2(1) of the Indian IT Act and the relevant provisions of the several Agrl. IT Acts of the various States also lends support to this position. In the first instance, it is defined as rent or revenue derived from land which is used for agricultural purposes; and it is next defined as income derived from such land by agriculture or by the activities described in cls.(ii) and (iii) of s.2(1)( b) of the Act. These activities are postulated to be performed by the cultivator or received of rent-in-kind of such land in regard to the products raised or received by him which necessarily means the produce raised on the land either by himself or by the actual cultivator of the land who pays such rent-in-kind to him. If produce raised or received by the cultivator or receiver of rent-in-kind is thus made the subject matter of cls.(ii) and (iii) in s. 2(1)( b) of the Act, the term “agriculture” used in cl.(I) of s.2(1)(b) must also be similarly restricted to the performance of the basic operations on the land and there is no scope for reading the term “agriculture” in the still wider sense indicated above.

54. From different terms and conditions of agreement, what we notice is except supplying the foundation seeds and giving scientific advice from time to time, either at the time of sowing or pollination or harvesting, none of the normal activities of agriculture are undertaken by the assessee-company. Except sowing the foundation seeds belonging to the assessee, farmer is not entitled to grow any other seeds in the land earmarked for the purpose of growing hybrid seeds and is not allowed to part with the seeds supplied to him to anyone else and so far as unused seeds, he had to give back the same to the company. Farmer conducts the cultivation and assessee-company only allots machinery and personnel for the purpose of achievement of better results in producing the quality hybrid seeds. Preparation of bed, sowing of the seeds, cultivation and harvesting of hybrid seeds is done by the farmer. He is entitled for the price fixed by the assessee per quintal for all such seeds which would qualify the specification indicated by the assessee. The seeds which do not qualify the specification are also not sold by the farmer, but by the company and the sale consideration, if any is given to the farmer. The farmer while multiplying foundation seeds, uses his land and labour. The input given by the assessee is only technical supervision of the company. Whatever seeds grown by the farmer whether qualifies the specification indicated by the assessee or not has to be given to the assessee and the assessee will pay a fixed price so far as the seeds which qualify the specification and other seeds will be sold in the open market by the assessee and there is no fixation of any price for the seeds which do not meet the specification. The farmer has to ensure fertility of the land, suitability of the land, cultivation of the land, watering of the land, use of the seeds supplied by the assessee and also has to sell the hybrid seeds at a price fixed by the assessee. Clause-8 of the agreement is an important condition and it reads as under:

“8, During the period stipulated in para one above or any extension thereof, the company shall have all rights to possession, cultivation and harvesting of hybrid seeds on the land earmarked in terms of this agreement, as if the company is a lessee although all parties agree that no lease is created in terms of this agreement. The terms of this contract to the extent that is not consistent with the Karnataka Land Reforms Act shall be considered as null and void.”

55. Though the company says it has all the rights of cultivation, possession and harvesting of the hybrid seeds on the land earmarked, both the parties agree that the terms and conditions which are inconsistent with the Karnataka Land Reforms Act shall be considered as null and void. The terms and conditions which are in violation of the provisions of Karnataka Land Reforms Act would not bind the farmer and the assessee can never call himself as cultivator or lessee of the land. Except one stray clause that assessee can enter the land if the conduct of the farmer is not satisfactory or if he violates the terms and conditions of the agreement, no other terms of the agreement, would indicate that the assessee is a lessee under the farmer or the owner as the case may be.

56. The assessee-companies neither have derivative interests in the land nor actually cultivate the land. Even if they cultivate the land, they are not lessees of the land in view of terms of agreement eliminating such relationship. At the most, they cultivate the land on behalf of the farmer or owner. Not only under the Karnataka Land Reforms Act such lease is prohibited but the terms specify so, therefore it is not open to the assessee to contend that it is for the concerned authorities to question the same and not under the Income Tax Act. Then explanation to Section 37 of the Act also comes in the way. Even if the assessee has benefits under Section 80J or 80HHC of the Act treating the conversion of foundation seeds to certified seeds as manufacturing activity, it would not enure to the benefit of the assessee so far as Section 10(1) of the Act (total exemption).

57. The assessee is not paying any rent per acre to the farmer and is not giving anything in kind like produce to the farmer. The assessee only pays a fixed price of Rs.3,200/- per quintal or any other price depending upon the terms of the agreement for foundation seeds grown by the farmer. Farmer has to agree that the seeds grown by him will be subjected to process of cleaning and grading. The assessee-company could have paid the rent or a particular amount per acre for the lease of the land. They are not paying farmer any other amount towards the labour or supplying any input. The only payment they are making is the so-called compensation at a specified rate per quintal as agreed. If the farmer has to arrange the labour and pay the labour charges and also spend money for other operations either basic or subsequent operations, he can only take advance amount from the assessee and such amount paid by the assessee would be deducted from the so-called compensation to be paid for the qualified foundation seeds at the end by the assessee. The entire terms of agreement would only indicate that the foundation seeds grown by the farmer would be purchased by the assessee at the end for a certain price provided seeds qualify the specifications as per the agreement. It is nothing short of a fertile womb being offered by a surrogate mother for the growth of child of someone else. The assessee supervises and oversees the sowing, cultivation right from the process of sowing till the end in order to get the qualified foundation seeds as per the specifications so as to carry on his trade in selling certified seeds. The main interest of the assessee is to see that good and healthy seeds are produced by the farmer meeting the requirement specified by it. Such input or scientific method in giving advice to the farmer cannot be termed as either basic agricultural operation or subsequent operations ordinarily employed by the farmer or agriculturist. If the basic operations of agriculture are not carried on by the assessee-company, then the harvested foundation seeds purchased by him and converting them to certification seeds cannot be termed as integrated part of the foundation activity of agriculture. Therefore even if we agree that the mechanical process of agricultural operations either basic operations or subsequent operations would not be an impediment to make such operations as agricultural operations, the question is whether such operations are conducted by the assessee or the farmer or someone else. The entire reading of the terms of the agreement would only indicate that assessee-company was interested only to have healthy foundation seeds grown for the process of converting the same as certified seeds.

58. Therefore the view of the first appellate authority that 100% of the operations up to conversion of the foundation seeds as agricultural activity conducted by the assessee-company and therefore .income deserves to be exempted from tax under Section 10(1) of the Act is erroneous. Similarly exemption given by the Tribunal for 90% of the income is also erroneous. We opine that that the Tribunal was justified in treating 10% of the income as business income which involved processing of foundation seeds to certified seeds. In that view of the matter, we hold that the entire income amounts to business income of the assessees and Assessing Officer was justified in treating the total income as business income. As a matter of fact for some of the assessment years based on the opinion of one of the senior counsel on taxation Mr. K.R . Prasad, the assessee-company offered its income as business income and even claimed deduction under Section 80 HHC of the Act.

[Citation : 341 ITR 342]

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