Court excludes agricultural land from capital gains tax, upholds state's power to tax agricultural income

Manubhai A. Sheth And Others Versus ND Nirgudkar, 2nd Income-Tax Officer, A-II Ward, Bombay And Another

Manubhai A. Sheth And Others Versus ND Nirgudkar, 2nd Income-Tax Officer, A-II Ward, Bombay And Another - [1981] 128 ITR 87, 22 CTR 41, 4 TAXMANN 381 Issues Involved:
1. Constitutionality of sub-clause (iii) of clause (14) of section 2 of the Income Tax Act, 1961.
2. Legislative competence of Parliament to impose capital gains tax on agricultural lands.
3. Violation of Article 14 of the Constitution.
4. Delegation of legislative power to the executive authority.
5. Whether capital gains tax on transfer of agricultural land is a tax on land or income.

Analysis of the Judgment:

1. Constitutionality of sub-clause (iii) of clause (14) of section 2 of the Income Tax Act, 1961:

The petitioners challenged the constitutionality of sub-clause (iii) of clause (14) of section 2 of the Income Tax Act, 1961, which defined 'capital asset' to include certain agricultural lands. They argued that the definition infringed upon the State's power to tax agricultural income and was thus unconstitutional. The court examined the legislative history and the definitions of 'agricultural income' and 'capital asset' in various Income Tax Acts. It was concluded that capital gains arising from the transfer of agricultural land used for agricultural purposes are 'revenue derived from land' and thus constitute 'agricultural income' under section 2(1)(a) of the Income Tax Act, 1961. Therefore, Parliament lacks the legislative competence to tax such income.

2. Legislative competence of Parliament to impose capital gains tax on agricultural lands:

The court held that profits or gains arising from the transfer of agricultural land used for agricultural purposes fall within the State's legislative field by virtue of entry 46 in List II of the Seventh Schedule to the Constitution. The court read down the impugned sub-clause (iii) to exclude agricultural land used for agricultural purposes from the definition of 'capital asset,' thereby preserving the State's power to tax agricultural income.

3. Violation of Article 14 of the Constitution:

The petitioners argued that the classification made by sub-clause (iii) between lands situated in urban areas and rural areas was arbitrary and violated Article 14 of the Constitution. The court found that the classification was based on an intelligible differentia with a rational nexus to the object sought to be achieved by the Act. The distinction between urban and rural areas was justified, given the differences in land use and potential for urbanization. Therefore, the court held that sub-clause (iii) did not violate Article 14.

4. Delegation of legislative power to the executive authority:

The petitioners contended that sub-clause (iii) involved excessive and unguided delegation of legislative power to the executive authority, particularly in allowing the Central Government to notify areas within a certain distance from municipalities. The court found that the delegation was not excessive or unguided, as the guidelines and principles for such notifications were laid down in the sub-clause itself. The court held that the delegation was permissible and necessary for the practical implementation of the Act.

5. Whether capital gains tax on transfer of agricultural land is a tax on land or income:

The court clarified that capital gains tax is not a tax on land but a tax on the profits or gains arising from the transfer of a capital asset. The court rejected the State's argument that such a tax fell within the State's power to tax land under entry 49 in List II of the Seventh Schedule. The court held that capital gains tax is a tax on income, not on land.

Conclusion:
The court declared that sub-clause (iii) of clause (14) of section 2 of the Income Tax Act, 1961, read with other relevant sections, does not operate to levy a tax on the profits or gains arising from the transfer of lands used for agricultural purposes. The court quashed the assessment orders that included such profits or gains in the total income and directed fresh assessments to be made, excluding the profits or gains from the sale of lands used for agricultural purposes. The court granted a certificate under Articles 132(1) and 133(1) of the Constitution to enable the parties to appeal to the Supreme Court.