Partial integration of agricultural income with non-agricultural income (as set, 1961 Act, AY 2016-17)

Agricultural income is exempt, but it affects the rate

Section 10(1) excludes agricultural income from total income, and section 2(1A) defines it: rent or revenue from land in India used for agriculture, income from agriculture on such land or from the cultivator's processes that make the produce fit for the market, and income from certain farm buildings. The exemption itself is in the Income-tax Act. The scheme of partial integration, however, is not: it is laid down each year in the Finance Act, in the section that fixes the rates of income-tax, so that agricultural income, though not taxed, pushes the non-agricultural income into a higher slab. For assessment year 2016-17 that is the Finance Act, 2016, section 2(2), applied with the rates of Part I of its First Schedule (Finance Act, 2016, First Schedule, Part I, Paragraph A).

Who the scheme applies to

For assessment year 2016-17 the scheme applies only when all three hold (Finance Act, 2016, section 2(2) and its provisos):

1. the assessee is an individual, a Hindu undivided family, an association of persons, a body of individuals or an artificial juridical person (it does not apply to a firm or a company);
2. the net agricultural income for the previous year is more than ₹5,000; and
3. the non-agricultural (taxable) income is more than the basic exemption limit: ₹2,50,000 for an individual below 60, ₹3,00,000 for a senior citizen and ₹5,00,000 for an individual of 80 or more.

If any condition fails, tax is computed on the non-agricultural income alone.

The method, step by step

(Finance Act, 2016, section 2(2)(b))

1. Add the net agricultural income to the non-agricultural income and compute tax on the total at the slab rates, as if the total were taxable.
2. Add the net agricultural income to the basic exemption limit of the assessee and compute tax on that sum at the same rates.
3. Subtract the tax of step 2 from the tax of step 1. The result is the tax on the non-agricultural income.
4. From it deduct the rebate under section 87A where it applies (for assessment year 2016-17, up to ₹2,000 for a resident individual whose total income is not more than ₹5,00,000; the footnotes to section 87A give these figures for that year), then add the education cess (Finance Act, 2016, section 2(11) and (12)).

Step 2 removes the slab benefit that the agricultural income would otherwise use up; what is left is tax on the non-agricultural income charged at the higher rate that the combined income attracts.

A worked example (our own figures)

An individual aged 45 has non-agricultural income of ₹6,00,000 and net agricultural income of ₹1,00,000 for the previous year 2015-16. Rates for assessment year 2016-17 (Finance Act, 2016, First Schedule, Part I, Paragraph A, item (I)): nil up to ₹2,50,000, 10% up to ₹5,00,000, 20% up to ₹10,00,000, 30% above; education cess 3% (2% and 1%, Finance Act, 2016, section 2(11) and (12)).

Without integration, tax on ₹6,00,000 alone would be ₹45,000 plus cess ₹1,350, that is ₹46,350. The agricultural income stays untaxed, but the non-agricultural income now bears a higher average rate. No section 87A rebate applies here, because total income is above ₹5,00,000.

Why the scheme exists

Because section 10(1) keeps agricultural income out of total income, a person with both kinds of income could, without the scheme, enjoy the lowest slabs on his non-agricultural income however large his farm income was. Partial integration keeps the exemption but makes the rate on the non-agricultural income depend on the person's combined income, so that two people with the same overall income bear a similar rate.