Tax-Free Income Need Not Grow On Trees

In the past three years, many schemes offering high, tax-free interest under the tax shelter of Section 10 (1) of the Income Tax Act, on income deemed to be agricultural in nature or some similar shelter, have dawned on the horizons of the wonderland of investment. Some of these are from respected houses but we often hear about fly-by-night operators joining the bandwagon only to dupe investors. For a lay investor, it is difficult to weed out the bad from the good.

The theme of these schemes is more or less identical. The income is taxed. The company will produce and market, on behalf of the investors, agricultural products like teakwood, rosewood, vegetables, bamboo, etc. Depending on the size and number of units bought by the investor, interest in a piece of land will be allotted to him for 15 years or thereabouts. The amount the company receives from selling these products is paid to the investor in due course.

 

Agricultural income is free from tax. To be entitled to this exemption, the assessee must have it as an effective and immediate source of income and not as an indirect and secondary source. When agricultural income is derived indirectly, it loses its agricultural character. For instance, dividend paid by a company out of its agricultural income cannot be considered agricultural income as the effective source is shareholding and not the landholding [Bacha F Guzdar v CIT (1955) 27ITR1, Supreme Court]. To circumvent this decision, such agro-based companies allocate interest in land or a number of trees or few plants to the investor, instead of shares or debentures.

Will the income tax department accept this as agricultural income of the unitholder (sorry, treeholder)? Columns of valuable space have been and are still being occupied by various experts but no effective answer has yet been found. I am not an expert, but I strongly hold a negative view.

Where literal interpretations of statutory provisions produce manifestly absurd and unjust results that could never have been intended, the court may modify the language used by the legislature or even do some violence to it, so as to achieve the obvious intention and a rational construction. [K.P. Varghese v ITO (1981)7Taxman13 SC)].

The perpetrators of this claim (that agricultural income is free from income tax), conveniently forget that it has to be taken into account for rate purpose.

The ruse of calling someone who is essentially a shareholder a landholder or a treeholder is certainly an infraction of law. It is difficult to understand why CBDT is mutely watching and is neither amending the legislation nor issuing a suitable clarification. Or is it waiting for yet another CRB scam to surface before taking much-needed action?

All said and done, I like these schemes, if they are handled by professionally managed companies of good repute. Even if the income is taxable in the hands of the unitholders, orchards, green earth and vegetables appear to be much more attractive than the mundane debentures or bonds. The promised returns from these schemes range from 19 to 24 per cent-plus.

The Securities and Exchange Board of India (Sebi), the watchdog of investor protection, does not allow any mutual fund to promise any minimum return for more than a year. Greenfield companies do not come under the purview of Sebi. It appears that there is no current legislation that brings such companies under the regulatory net of any authorities! How do I know which company is good and which is bad? There is no credit rating available, whatever be its worth. No, I am afraid to touch these schemes, even if I like them.

A word of caution

When an accountant prepares a feasibility report on a prospective project, he is expected to make most conservative estimates to ensure that the project is viable, even under adverse conditions. I only hope that the promoters, in their zeal, have not been over-optimistic in answering the following questions before throwing the doors open for the small investor:

Is the spacing between the trees adequate?

Will the tree grow to the expected girth?

Will it give quality timber?

Will the special irrigation system develop water blisters?

Will the fertilisers used to accelerate growth of trees, result in high sap wood contents?

Are the trees adequately insu-red against acts of God as well as fungal infections?

Will the timber sell at the target price?

Even if the answer to one of these questions is in the negative, it would be risky to invest in such a project.

The following extract from the letter of one of my valued readers, Awani Kumar, is most illustrative of the damage caused by nebulous advertisements.

I am aware that you are against investing in companies not governed by SEBI or RBI. I am enclosing the brochure and other documents of Anubhav Group, offering 21 per cent returns and still claiming to abide by the RBI rules! Please go through these and comment.

Mr. Awani Kumar did not understand the difference betw-een abiding by the rules and coming under the purview of the rules.

Recently, I had made a representation to S P Talwar, Deputy Governor of RBI, against the misguiding advertisements by banks and he was kind enough to instruct all the banks to desist from such publicity. I think some controlling authority should have a look at these greenfield projects as well.

If income from holding a tree is not to be treated as dividend, then the taxability thereof is still riddled with doubts in spite of the dividend income from shares having now become tax-free. I only hope that these so-called treeholders are not left holding only the paper of the deed.

There is no law that brings such greenfield companies under the regulatory net of any authorities.