Agricultural Land & Capital Gains Tax: Supreme Court’s Landmark SLP and Legal Interpretation

By CA Surekha

Law, Interpretation & Supreme Court Perspective 

Statutory Framework – Section 2(14) of the Income Tax Act, 1961

Under the Income-tax Act, the charging of capital gains under Section 45 hinges on the transfer of a “capital asset”. Section 2(14) defines capital asset to exclude certain agricultural lands in India, subject to location and population criteria.

Key legislative provisions:

• Section 2(14)(iii) specifically excludes from the definition of capital asset:

  • Agricultural land in India not situated:

    1. Within the jurisdiction of a municipality or cantonment board having a population of not less than 10,000, or

    2. Within such distance (measured aerially) from the local limits of any such municipality or cantonment board, as notified:

       • Up to 2 km for population between 10,000 and 1,00,000

       • Up to 6 km for population between 1,00,000 and 10,00,000

       • Up to 8 km for population exceeding 10,00,000

If agricultural land falls outside these limits, it is not a capital asset, and its sale is outside the scope of capital gains taxation.

Nature of Land – Agricultural or Not? Judicial Tests

Merely calling land "agricultural" is not enough; courts have evolved objective tests:

1. Actual Use – Whether the land was being used for agricultural purposes at the time of transfer.

2. Intention of the Owner – Whether the owner intended to continue agricultural operations or was holding it for commercial purposes.

3. Revenue Records – Classification in land revenue records as “agricultural land” is strong but not conclusive evidence.

4. Location & Surroundings – Whether the land is in the midst of developed areas or retains rural characteristics.

5. Physical Characteristics – Presence of irrigation facilities, crops, farmhouses, etc.

Judicial Precedents

(a) Supreme Court – SLP Dismissal in Favour of Assessee

In a recent matter, the Supreme Court dismissed the SLP of the Revenue where lower authorities had concurrently held that land, though within municipal limits, retained its agricultural character due to actual cultivation, revenue classification, and lack of development.

• Significance: The dismissal strengthens the principle that agricultural character is determined by facts, not by location alone.

• Implication: Even if within notified limits, if the land has not lost its agricultural character and is not intended for non-agricultural use, exemption under Section 2(14)(iii) can still be claimed.

(b) Sarifabibi Mohmed Ibrahim vs. CIT (1993) 204 ITR 631 (SC)

The Supreme Court laid down multi-factor tests and clarified that intention, coupled with actual use, governs the classification.

(c) CIT vs. Manilal Somnath (1977) 106 ITR 917 (Guj.)

It was held that surrounding developments alone are not decisive unless there is a change in user.

Analytical Interpretation

From a law and fact synthesis:

• Step 1: First, determine if the land is within the population-distance thresholds under Section 2(14)(iii).

• Step 2: Even if it is, examine if actual agricultural use and absence of conversion for non-agricultural purposes are proven.

• Step 3: Judicially, the Revenue’s onus is to prove loss of agricultural character.

Key takeaway – Location triggers statutory inclusion, but factual character can still provide exclusion if supported by strong evidence.

Practical Compliance & Documentation

To safeguard exemption claims:

• Maintain Khasra/Khatoni or equivalent land revenue records showing agricultural classification.

• Retain proof of crops grown (photographs, mandi receipts, agricultural income in ITR).

• Avoid applying for conversion to non-agricultural purposes before sale.

• In sale deeds, clearly state that land is sold as agricultural land.

Visual Decision Matrix

Is Agricultural Land Sale Taxable under Capital Gains?

Step	Test	Yes → Next Step	No → Conclusion
1	Within municipal/notified limits & population threshold?	Go to Step 2	Not a capital asset – No capital gains tax
2	Actually used for agriculture till sale?	Go to Step 3	Capital asset – Capital gains taxable
3	Evidence supports agricultural character (revenue records, crops, no conversion)?	Not a capital asset – No tax	Capital asset – Taxable

Conclusion – Law Backed Guidance

The combined statutory and judicial reading confirms:

• Rural agricultural land is fully exempt from capital gains by definition.

• Urban/peri-urban agricultural land may still escape taxation if factual agricultural character is proven.

• The recent Supreme Court SLP dismissal reinforces that facts prevail over presumption, and Revenue cannot tax merely on municipal limits if agricultural nature is intact.

For high-value transactions, legal due diligence and documentary preservation are critical to defend against litigation.