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Tax on farm income

September 17, 2013

ALTHOUGH Pakistan has a combined federal and provincial tax-to-GDP ratio of less than 10pc, the income of one segment — farmers — seems to escape taxation.

This causes anger among regular taxpayers, especially since legislation was promulgated at the provincial level way back in 2000/01 to tax agricultural incomes. Provincial governments haven’t been collecting revenue from this source, primarily because the bulk of the political, civil and military bureaucratic leadership has rural connections.

Moreover, large landowners oppose taxation of agricultural activities citing three main reasons: agriculture is already overtaxed; there’s a ceiling on land holdings; and there’s a lack of crop insurance to cover losses on account of drought or floods.

The most common method employed by those arguing for or against taxation of agricultural incomes is to show how the agriculture sector is under-taxed or overtaxed compared with, say, the industrial sector. However, the concept of a sector being under-taxed or overtaxed (the ratio of taxes paid as a percentage of the sector’s contribution to national income as against the same ratio for other sectors) confuses the issue.

From the fiscal standpoint, the sector is neither an income-earning nor a tax-paying unit. The entire value-added in a sector belongs to individuals, families or companies operating in the sector, who are the taxpaying entities.

Only the income earned by a taxpaying entity is relevant for determining its tax liability. Thus, the identity of the activity or sector as the source of income is irrelevant. Those earning equal incomes should be treated equally irrespective of income sources. People own businesses and are liable to taxation. Therefore, a sector is under-taxed or overtaxed only in the sense that those in a particular income group, on the basis of income earned from the sector, pay less or more taxes than those falling in the same income bracket in other sectors.

We know that those in the upper-income segments of the agricultural community pay far less taxes than their counterparts, or those in comparable segments, in non-agricultural sectors. The incidence should be roughly the same on similar amounts of income, irrespective of the source from which the income is derived. Hence, it’s pointless estimating the tax burden of a sector to evaluate the equity of a fiscal system.

The argument generally made about exempting farmers with small holdings from taxation is similarly flawed. How do we define a small-sized holding? The assumption underlying this contention is that small farmers only have low levels of earnings. But then the earnings of a five-acre farmer growing strawberries or apples is several times that of one growing wheat, making the foundation of this line of reasoning for exempting or taxing incomes derived from agricultural pursuits shaky, if not untenable.

Yet more confusion is created by the claim that since there’s a ceiling on land holdings there’s no justification for tax. However, the ceiling applies to ownership and not to holdings operated (ignoring for now the issue of land held benami to get around legislation restricting the holding of land, a limited resource). Land rented in adds to incomes substantially without these earnings being liable for taxation. Moreover, as the issue revolves around taxation of incomes generated, such arguments fail to impress.

Although under the Constitution the taxation of agricultural incomes is a provincial subject, the term ‘agricultural income’ is actually defined in Section 41 of the Income Tax Ordinance. Under the Ordinance even rental incomes derived from agriculture escape assessment. This is because while exempting the taxation of agricultural incomes it defines agricultural incomes as “any rent or revenue from land … which is used for agricultural purposes”.

But then can it be logically argued that the rental income derived from leasing out agricultural land to a tenant is in any way, form or nature different from the rent derived from leasing out land in urban areas? Whereas the latter income is considered taxable (correctly) as rental income, the income from the former activity is, under some convulated logic, exempt.

There’s certainly an anomaly in the tax law under which income earned from leasing out agricultural land is not covered because, logically, income cannot be categorised on the basis of the sector from which it originates. Incomes have to be identified on the basis of the activities from which they accrue.

If this were not so and rental income from agricultural land were deemed to be agricultural income then, by the same reasoning, should interest earned from loans given for agricultural activities or dividends derived from shares in a company engaged in agri-business be exempt from taxation?

This definition can be altered without requiring sympathetic changes in the Constitution. Rental income from agriculture can legitimately, and legally, be treated as non-agricultural income by redefining agricultural income in the Income Tax Ordinance as merely “revenue derived from land” without having to amend the Constitution and the income tax can be levied on it and collected by the Federal Board of Revenue.

As regards the need for crop insurance, while supporting the demand for such a faulty option, lest we forget, no similar option exists for salaried employees or industrial and commercial entrepreneurs. A salaried employee can lose his job but would still be liable for tax on earnings for the year, while businesses can carry forward their losses without being allowed to adjust them against taxes paid in previous years.

Finally, to simplify the process of assessing agricultural incomes liable for taxation, while simultaneously minimising interaction between taxpayers and revenue authorities, provincial governments can use a ‘proxy’ by either:

a) the federal government levying something like an ‘excise duty’ on cash crops sold by farmers to government agencies (eg wheat and rice) or the private sector (eg wheat, rice, cotton, sugarcane, etc.); or

b) estimating taxable incomes on the basis of land lease rent (the patta rate) in the area — information that is readily available and easy to compile.

The writer is a former governor of the State Bank of Pakistan.