2025 (9) TMI 1505 - HC - Income Tax

Income from production and sale of hybrid seeds held agricultural under s.10(1) due to contractual control over cultivation

High Court held that income from production and sale of hybrid seeds qualified as agricultural income under s.10(1) because the company, though not ... Exemption u/s 10(1) - income earned from production of sale of seeds - agricultural activity - direct and indirect involvement in agricultural activity - HELD THAT:- Admittedly, the assessee herein is a company engaged in the business of research, production and sale of agricultural seeds. The activity which is carried out by the assessee was for the purpose of research and development activity which involves scientific study of the parent seed and hybridization of different varieties of the parent seeds so as to evolve the high yielding of hybrid seeds. The hybrid seeds are generated by certain involved process, which the farmer cannot perform suo moto and that the hybrid seeds are sold in the market different varieties of the parent seeds so as to evolve high yielding variety of hybrid seeds. It is also stated that the assessee would enter into agreements with the farmers for utilization of lands owned by them, wherein the farmer agreed to perform certain agricultural operations including but not limited to normal agronomic practices required for raising a good crop like irrigation, fertilization, pest/disease combat, weeding, harvesting, threshing etc, for the purpose of production of seeds from the said foundation seeds. As evident from the terms and conditions imposed on the farmers that the farmers raised crops as desired by the assessee and the whole process is in the nature of production through contract. The parent seeds are produced by way of agriculture and cultivation. As the company gets the cultivation done under its supervision and at its own costs and risks, the production of these seeds, and the farmer wherein under the supervision, technical guidance and control of the company is in agreement for the production of the Hybrid seeds, since they have direct nexus with the land owned by it or on the leased lands by supplying seeds to the farmers and getting them cultivated under its supervision and control and the company plays an active role of action of monitoring and nurturing the plants by the assessee cultivated by the farmers. Though the assessee may not be directly involved in the activity of cultivation but it is being involved through farmers for production of hybrid yielding seeds for different types of hybridization and which are used for the purpose of agriculture for deriving high yielding seeds. Therefore, this bench is of the opinion that though the assessee is not directly involved into the agricultural activity, but indirectly they are involved in the said activity. Tribunal was justified in allowing disallowance u/s 10(1) of the Act by taking the income of the assessee as an a agricultural income - Assessee appeal allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether the income from production and sale of hybrid seeds is agricultural income exempt under Section 10(1) of the Income-tax Act, 1961, when the assessee undertakes research, development, supervision and uses contract farming arrangements with land-owning farmers. 2. Whether the character of the activity as commercial (involving scientific research, hybridization, processing and marketing) excludes it from the definition of 'agricultural income' under Section 2(1A) and thus from exemption under Section 10(1). 3. Whether the assessee's use of farmers' lands under agreements, where farmers perform agricultural operations under technical guidance and reimbursement, renders the income agricultural in nature or is merely procurement of produce by contract (non-agricultural for the company). 4. Whether disallowance under Section 14A read with Rule 8D in respect of expenditure attributable to exempt income (and interest) was correctly deleted/retained by the Tribunal and lower authorities. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Characterisation of income from hybrid seeds as 'agricultural income' under Section 10(1) and Section 2(1A) Legal framework: 'Agricultural income' is defined in Section 2(1A) (sub-clauses (a), (b)(i)-(iii)) and exemption is provided by Section 10(1). The statutory test looks to rent/revenue from land used for agricultural purposes; income derived from such land by agriculture or by processes ordinarily employed by a cultivator to render produce fit for market; and sale by a cultivator of produce where only such ordinary processes have been performed. Precedent treatment: The Court relied on authoritative exposition in Raja Benoy Kumar Sahasroy (Supreme Court) describing 'agriculture' in its primary sense as cultivation of the field (tilling, sowing, planting) and that subsequent operations form agricultural operations only if in conjunction with the basic operations. The Tribunal and earlier benches (referred decisions) held that production of foundation/basic seeds, including under contract farming, can be agricultural income (cases cited by the Tribunal and relied upon by the assessee and earlier benches). Interpretation and reasoning: The Court examined the factual matrix: the assessee conducts research, develops parent/germplasm and foundation seeds, supplies foundation seeds to farmers under seed production agreements, reimburses and supervises farmers who perform agronomic operations (irrigation, fertilization, pest control, weeding, harvesting, etc.), and bears costs/risks. The Court treated the farmers' operations as being carried out under the assessee's supervision and control and closely connected with cultivation on land owned or leased for the purpose. The Court accepted that though advanced scientific methods and processing are used, the parent/foundation seed production arises out of agricultural operations on land; contract farming arrangements do not strip the activity of its agricultural character where the company remains integrally involved and the operations are effectively agricultural operations performed in relation to the land. Ratio vs. Obiter: Ratio - where a company supplies foundation seeds, enters into seed production agreements, bears costs/risks, supervises and controls cultivation on land (including leased land or land of farmers), and the seeds produced are derived from agricultural operations on that land, the income from sale of such basic/foundation seeds is agricultural income under Section 2(1A)(b) and exempt under Section 10(1). Obiter - observations on the role of research and technology generally not displacing the statutory test, and remarks distinguishing purely laboratory activities from cultivation. Conclusion: The Tribunal's allowance of exemption under Section 10(1) for income generated from sale of basic/foundation seeds produced pursuant to cultivation under agreements with farmers (under supervision and at assessee's cost and risk) was justified and correctly treated such income as agricultural income exempt under Section 10(1). Issue 2 - Effect of scientific research, hybridization, processing and commercialization on agricultural character Legal framework: The statutory test does not preclude use of technology; it requires that the process be agriculture or 'a process ordinarily employed by a cultivator' to render produce fit for market (Section 2(1A)(b)(ii)-(iii)). Precedent treatment: Supreme Court authority establishes that subsequent operations may be agricultural if taken in conjunction with basic operations. Tribunal decisions hold that use of scientific methods/technology does not automatically convert agricultural operations into non-agricultural/commercial activities for tax characterisation. Interpretation and reasoning: The Court distinguished between (a) laboratory R&D and purely commercial processing divorced from land/cultivation, and (b) activities where research supports cultivation and the resulting seeds are produced through agronomic operations on land. The Court found that the assessee's R&D and technical inputs supported agricultural operations on land; the final production of parent/foundation seeds involved cultivation steps performed on land and therefore fell within the statutory contours of agricultural operations. The Court noted the hybrid seeds' complex nature but emphasised the statutory focus on linkage to land and ordinary processes performed by cultivators or those acting in their stead under supervision/control. Ratio vs. Obiter: Ratio - advanced scientific inputs and commercialization do not per se disqualify income from being agricultural where the statutory elements (derivation from land/agricultural operations or processes ordinarily employed by a cultivator) are satisfied. Obiter - comments addressing the proprietary nature of hybrid seed technology and dependency of farmers on producers for subsequent seasons. Conclusion: The presence of research, hybridization and commercial marketing does not, by itself, preclude classification as agricultural income where the production of seeds arises from agricultural operations on land under the assessee's supervision and control; hence the Tribunal was correct to treat qualifying seed income as exempt agricultural income. Issue 3 - Character of operations performed by farmers under agreements: agricultural operations vs procurement/contract farming Legal framework: Whether a person is a 'cultivator' or whether processes are those 'ordinarily employed by a cultivator' (Section 2(1A)(b)(ii)-(iii)); contract farming principles where landowner/farmer performs operations but under direction/supervision and at the cost/risk of another party. Precedent treatment: Earlier decisions have held that contract farming does not necessarily strip an operation of its agricultural character where the operations on the land amount to cultivation and are intimately connected with production of seeds, even if manpower/land is provided by others. Interpretation and reasoning: The Court examined seed production agreements and found effective control, supervision and technical guidance by the company while farmers retained ownership/possession of land. The company bore costs/risks and directed agronomic operations. The Court held that such arrangements amount to the company getting cultivation carried out under its supervision and therefore the resulting basic/foundation seed income is agricultural in character rather than mere procurement of produce by contract. Ratio vs. Obiter: Ratio - where a company arranges for cultivation on farmers' lands under agreements, provides technical control, bears costs/risks and the operations performed on land amount to agricultural operations, income from resulting basic/foundation seeds is agricultural. Obiter - distinctions between true job work/procurement and supervised cultivation in seed production context. Conclusion: The Tribunal rightly treated seeds produced under the described agreements as resulting from agricultural operations attributable to the assessee's activities and therefore as agricultural income eligible for exemption under Section 10(1). Issue 4 - Application of Section 14A and Rule 8D; disallowance of expenditure attributable to exempt income Legal framework: Section 14A permits disallowance of expenditure incurred in relation to exempt income; Rule 8D provides a formulaic mechanism to determine disallowable amount, including attribution of interest and common expenses. Precedent treatment: The Tribunal and lower authorities applied and interpreted Rule 8D and precedents (including decisions of coordinate benches and High Court of Bombay) concerning attribution of interest and common expenses where investments generate exempt income. Interpretation and reasoning: The Tribunal, on facts, concluded that investments of substantial amounts (approx. Rs.20.30 crores) were presumably from the assessee's own funds and therefore no disallowance on account of interest was justifiable; however, certain common administrative expenses reasonably attributable to investment activity were disallowable under Clause (iii) of Rule 8D, producing a limited disallowance (specific figure restored by CIT(A) and Tribunal). The Court upheld this fact-based differentiation: deletion of large interest disallowance was correct; modest proportionate disallowance of common expenses under Rule 8D(iii) was proper. Ratio vs. Obiter: Ratio - Rule 8D must be applied to facts; interest disallowance cannot be mechanically imposed where investments are from own funds; common expenses may be apportioned and disallowed to the extent formula permits. Obiter - general remarks about Board circulars and broader applicability of Rule 8D. Conclusion: The Tribunal's approach-deleting disallowance of interest under Section 14A read with Rule 8D on the facts and sustaining a limited disallowance of common expenses under Clause (iii) of Rule 8D-was correct and affirmed. Overall Disposition The Court answered the substantial questions in favour of the assessee: income from cultivation-linked production of basic/foundation seeds under the described supervision/control/agreements is agricultural income exempt under Section 10(1); scientific processes and commercialization did not negate agricultural character; contract farming arrangements did not convert the activity into mere procurement; and the Tribunal's treatment of Section 14A/Rule 8D disallowances on the facts was correct. The appeal was dismissed accordingly.