I. ISSSUE OF DEPRECIATION

1. The claim of the Department is that the Charitable Trust (hereinafter referred as assessee) is claiming double deduction which is in violation of the law laid down by the Supreme Court in the case of Escorts Ltd. v. union of India 199 ITR 43 (SC). The department is also relying upon the decision in the case of JK Synthetics Ltd. v. UOI 1992 65 Taxmann 420 (SC) where the Supreme Court has laid down the law regarding the non-admissibility of double deduction. Needless to say that the ruling of the Apex Court would prevail over the judgment pronounced by the High Court.

2. Reliance by the Department on the two judgment of the Supreme Court in the case of Escorts Ltd. and JK Synthetics (supra) is that the law lays down that in no circumstances the benefit of double deduction can be claimed and allowed.

3. It is entirely incorrect to deny the claim of depreciation to the assessee. This is based on the facts that there are various judgment that supports the assessee’s view directly on the subject while the decision of the Supreme Court are not directly on the issue but are by virtue of inference and analogy on the issue of double deduction and therefore the Supreme Court judgments would not apply. In fact, the following judgments would support the stand that depreciation would be allowed. These judgments being:

(i) CIT v. Seth Manilal Ranchhoddas Vishram Bhawan Trust [1992] 198 ITR 598 (Guj.);

(ii) CIT v. Institute of Banking Personnel Selection (IBPS) (2003) 131 Taxmann 386 (Bom.);

(iii) CIT v. Rao Bahadur Calavala Cunnan Chetty Charities [1982] 135 ITR 485 (Mad.);

(iv) CIT v. Society of the Sisters of St. Anne [1984] 146 ITR 28 (Kar.); and

(v) CIT v. Raipur Pallottine Society [1989] 180 ITR 579 (MP).

4. The judgment of the Supreme Court in the case of Escorts Ltd. v. Union of India 199 ITR 43, in my opinion has no application to the situation where depreciation as claimed by a charitable institution in determining the percentage of fund applied for purpose of charitable objects and the question concerning depreciation. In this connection, attention is invited to the judgment of CIT v. Tiny Tots Educational Society (2011) 330 ITR (P&H).

5. Courts have repeatedly held that in ascertaining the income of a trust or charitable institution liable to be either applied or accumulated, depreciation on capital assets in use would have to be charged. However, this law was sought to be treated as superseded by the decision in Escorts’ Ltd. v. Union of India 199 ITR 43 (SC) overlooking the vital fact that the decision in Escorts’ case was rendered in the context of section 35(1) (iv), which barred depreciation for an equipment acquired for research, the cost of which had been allowed as a deduction.

6. In the case of charities, the amount of expenditure incurred for acquiring capital assets is not deducted from his income, so that depreciation could not have been denied even otherwise.

7. In CIT v. Market Committee, Pipli (2011) 330 ITR 16 (P&H) have pointed out this distinction with the facts of Escorts Ltd.’s case and upheld the order of the Tribunal allowing depreciation. This was followed in CIT v. Tiny Tots Educational Society 330 ITR 21 (P&H).

8. Based on the above, I am of the view that the claim of depreciation is justified on law as well as on facts.

9. CASE LAWS IN SUPPORT OF THE PROPOSITION THAT DEPRECIATION TO BE ALLOWED TO THE TRUST

9.1. BOMBAY HIGH COURT

9.1.1 CIT v. Institute of Banking (2003) 264 ITR 110 (Bom.):

The Tribunal was right in law in directing the Assessing Officer to allow depreciation on the assets, the cost of which had been fully allowed as application of income under section 11 in the past years.

Income of the Trust is required to be computed under section 11 on commercial principle after providing for allowance for normal depreciation and deduction thereof from the gross income of the Trust.

9.1.2. DIT Exemption v. Framjee Cawasjee Institute (1993) 109 CTR 463 (Bom.):

In the case, the facts were as follows: The assessee was the trust. It derived its income from depreciation assets. The assessee took into account depreciation on those assets in computing the income of the trust. The Income-tax officers held that depreciation could not be taken into account because, full capital expenditure had been allowed in the year of acquisition of the assets. The assessee went in appeal before the Appellate Assistant Commissioner. The appeal was rejected. The Tribunal, however, took the view that when the Income Tax Officer stated that full expenditure had been allowed in the year of acquisition of the assets, what he really meant was that the amount spent on acquiring those assets had been treated as “application of Income” of the trust in the year in which the income was spent in acquiring those assets. This did not mean that in computing income from those assets in subsequent years, depreciation in respect of those assets cannot be taken into account. This view of the Tribunal has been confirmed by the Bombay High Court Institute of Banking case. Hence, question No. 2 is covered by the decision of the Bombay High Court in the above judgment. Consequently, question No. 2 is answered in the affirmative i.e. in favour of the assessee and against the Department.

9.2 CALCUTTA HIGH COURT

9.2.1 CIT vs. Public welfare Trust (1999) 240 ITR 513 (Cal.):

While Computing Income of Charitable Trust, income is to be arrived at in commercial manner and, therefore, depreciation claimed in accounts by assessee-trust was an outgoing for purpose of determination of income in terms of section 11(1) of the Act. In the Computation of Income of the Trust, Depreciation is deductible.

9.2.2 CIT v. Birla Janahit Trust (1994) 208 ITR 372 (Cal.):

Computation of Income for purpose of section 11. Expenditure on salary and miscellaneous expenditure for carrying out the purpose of the trust must be considered as application for Charitable Purposes. Central Board of Direct Taxes Circular dated 19th May, 1968.

9.3 GUJARAT HIGH COURT

CIT v. Seth Manual Ranchhoddas Vishram Bhavan Trust (1992) 198 ITR 598 (Guj.):

Allowance of Depreciation in Computing Income of a Charitable Trust. Mode of Computation of Income. Income to be computed in normal commercial manner.

9.4 KERALA HIGH COURT

9.4.1 CIT v. Society of Sisters of St. Anne (1984) 146 ITR 28 (Ker.)

Depreciation on its assets is to be allowed to a Charitable Trust. It is not right to contend that depreciation being a notional expenditure cannot be allowed to be the expenditure account of the Trust.

9.4.2 CIT v. St. George Forana Church (1988) 170 ITR 62 (Ker.)

The assessee trust spent certain amount for the construction of additional to its buildings which had been let out and income by way of rent from those building was used for religious purposes. Held that the word ‘applied’ occurring in section 11 is wider in import than the word ‘Expenditure’. The word ‘Expenditure’ means ‘Disbursement’. ‘Expend’ means ‘to pay out or distribute; to spend’. Considering these two words, the word ‘applied’ is of wider import. The money or amount will not to go out irretrievably, when it is ‘applied’ to a purpose. Hence, the said expenditure was as application of income by the assessee for religious or charitable purposes.

9.5 MADRAS HIGH COURT

CIT v. Rao Bahadur Calavala Cunnan Chetty Charities (1982) 135 ITR 485 (Mad.):

Income from properties held under trust would have to be arrived at in normal commercial manner without classification under various heads set out in section 14 and 25% thereof will have to be ascertained. If the assessee has accumulated more than 25%, the consequences in section 11 will have to follow.

9.6 MADHYA PRADESH HIGH COURT

In respect of the assets owned, a charitable trust is entitled to depreciation allowance CIT v. Raipur Pallottine Society (1989) 180 ITR 579 (MP)

Depreciation is the exhaustion of the effective life of a fixed asset owing to “use” or obsolescence. It may be computed as that part of the cost of the asset which will not be recovered when the asset is finally put out of use. The object of providing for depreciation is to spread the expenditure incurred in acquiring the asset over its effective lifetime and the amount of provision made in respect of an accounting period is intended to represent the proportion of such expenditure which has expired during that period. If depreciation is not allowed as a necessary deduction in computing the income of a charitable trust, then there would be no way to preserve the corpus of the trust. A charitable trust is, therefore, entitled to depreciation in respect of the assets owned by it.

CIT v. Society of the Sisters of St. Anne (1984J 146 ITR 28 (Kar.) followed.

9.7 Recent Tribunal’s judgment of Chennai Tribunal also confirms with the same principle having distinguished Escort’s case. In Shri Rengalatchumi Education Trust v. ITO (OSD) Exemptions (2012) 137 ITD 318 (Chennai), assessee was entitled to depreciation on capital assets even if the cost of acquisition of such assets was earlier allowed as application of income while computing income u/section 11. Facts: Assessee trust claimed depreciation while computing its income for the respective assessment year. The AO held that as the cost of addition to assets was claimed by the assessee as application of income for the respective assessment years, assessee could not further claim depreciation on the very same assets and hence disallowed the claim of depreciation.

Held: For the purpose of determining the income of trust eligible for exemption u/section 11, income should be construed strictly in commercial sense (i.e. normal accounting principles), without reference to the heads of income specified in section 14. The income to be considered is the book income and not the total income as defined in section 2(45). The concept of commercial income necessarily envisages deduction of depreciation on the assets of the trust. This position is as confirmed by the CBDT vide its circular No. 5-P (LXX-6), dated 19-5-1968. Normal accounting principles clearly provide for deducting depreciation to arrive at income. Income so arrived at (after deducting depreciation) is to be applied for charitable purpose. Capital expense is applicable of income so determined. Hence, there is no double deduction or double claimed of the same amount as application.

Thus, depreciation is to be deducted to arrive at income and it is not application of income.

Note:

(i) Supreme Court decision in case of Escorts Ltd. v. Union of India (1993) 199 ITR 43 was distinguished;

(ii) Readers may refer two decision of Hon’ble Bombay High Court viz.:

• DIT (Exemption) v. Framjee Cawasjee Institute (1993) 109 CTR 463;

and

• CIT v. Institute of Banking Personnel Selection (IBPS) (2003) 264 ITR 110.

10. Since the Department is relying upon Escort’s judgment, in my opinion, the said judgment has no application and my analysis of depreciation in Escorts’ judgment is made hereunder:

(i) Since the income of a charitable institution should be computed under ordinary Principles of commercial accounting, depreciation has to be allowed for depreciable assets held by a charitable institution to arrive at the income of 85%, which is required to be applied for charitable purposes. But where an acquisition of an asset is treated as income which has been applied for the objects of the trust or institution, it was inferred that such application gets the income correspondingly reduced, so that in respect of such assets, there can be no further deduction by way of depreciation in view that any such deduction would amount to double deduction. This was understood to be the view taken by the Supreme Court in Escorts Ltd. v. Union of India {1993} 199 ITR 43 (SC), so that was followed by the Kerala High Court in Lissie Medical Institutions v. CIT {2012} 348 ITR 344 (Ker). There is considerable confusion on the subject.

(ii) Accordingly to the Guidance Note issued by the Institute of Chartered Accountants of India in Audit of Public Charitable Institution under the IT Act, even where the whole capital expenditure has been treated as application of income towards charitable or religious purposes for exemption u/section 11, the trust or institution can claim depreciation in respect of the assets used by it for its purposes on the basis of normal commercial principles following Circular No. 5-P (LXX-6) of 1968 dated 19th June 1968 issued by the Central Board of Direct Taxes. But in a publication by the institute of Chartered Accountants of India on debatable issues (page 121), it was opined that three could be an inference of double deduction in following the cost as well as depreciation purportedly with reference to the decision of the Supreme Court in Escorts’ case (supra). The Guidance note issued by the Institute of Chartered Accountants of India has correctly understood that depreciation can be claimed on all assets applied for charitable purposes.

(iii) This view cannot be subject matter of any debate on the basis of Escorts Ltd v. Union of India {1993} 199 ITR 43 (SC)’s case, which relates to a case of full deduction of the cost of asset used for research since capital expenditure on scientific research is deductible in recognition of income, so that depreciation was inadmissible. The doubt overlooks the difference between computation of income and utilisation of such income.

(iv) This distinction has been pointed out in CIT v. Manav Mangal Society {2010} 328 ITR 421 (P&H) at 423 as under:

“The amount spent on construction of school building at Panchkula is a capital expenditure but for the purpose of Section 11 it is an outgoing which is application of the income of the appellant for charitable purpose. The appellant shall also be entitled to claim depreciation on the school building.”

(v) Special Leave Petition (“SLP”) filed by the Income Tax Department against this case has also since been dismissed by the Supreme Court (see Income Tax Reports {2010} 328 ITR (St.) 9). The decision in Manav Mangal Society’s case was cited before the High Court but it was dismissed by the High Court along with other citations in a sweeping statement that “we do not find in any of these decisions this aspect is considered and discussed by any of the High Court’s”, while in Manav Mangal’s case, this was the sole issue, which was discussed.

11. When capital expenditure has been treated as application of income, whether depreciation can be deducted in respect of those assets? In other words, while computing taxable income whether both depreciation and capital expenditure be deducted?

Ans: Yes, as already discussed above on the issue of depreciation and the various explanations.

II CARRY FORWARD OF DEFICIT

12. Another issue is concerning deficit arising on a/c of excess of expenditure over the revenue. When the expenditure incurred is more than the revenue generated, which are credited to income and expenditure account, the deficit occurs. The issue that arises is what is the source of excessive expenditure over the revenue generated. The view of the department is that the funds can come from three sources either by expenditure from corpus, accumulation or loans raised. The Department’s contention is that in such circumstances, the issue is which such deficit and expenditure due to which deficit has occurred can be termed as applicable of income for availing of expenditure. In this connection, the Department is relying upon the decision of Escorts and JK Synthetics (supra) on the ground that deficit cannot be allowed since no double deduction can be allowed, unless it is specifically sanctioned by the statute.

In my opinion, the stand regarding carry forward of deficit is misplaced and the Charitable Trust (hereinafter referred as assessee) is entitled to carry forward of the deficit.

In this connection, my analysis of deficit is as under :

In this connection, reliance is placed on (i) 279 ITR 659 (Del.); (ii) 185 CTR 492 (Bom.); (iii) 60CTR (Raj.) 40; and (iv) 211 ITR 293 (Guj.) that the excess expenditure in earlier years can be adjusted against the income of subsequent years.

The amount incurred out of corpus is an amount applied for the objects of the trust and, therefore, the said amount is claimed as deduction u/section 11(1)(a) of the IT Act. The IT Act allowed a trust/ institution to carry forward losses and claim set off against the future income. These are based on benevolent provisions of the Act and such debits to corpus accounts are only account presentations. Reliance is placed on the decision of the Kerala High Court in case of George Forma Church 170 ITR 62 where the word “apply” occurring in section (11)(1)(a) is of wider import than the word “expenditure”, where the “expenditure” means “disbursements”. Hence, the said expenditure was application of income of the assessee for the objects of the trust.

The amounts spent on acquisition of capital assets of a trust are exempt as held in the case of Devine Mission 279 ITR 659 (Del). Reliance is also placed on the decision of Institute of Banking Personnel 185 CTR 492 (Bom.) for the proposition that carry forward of deficit of earlier years and set off against subsequent years is allowable. Also the decision of the Rajasthan High Court in the case of Maharana of Mewar Charitable Foundation 60 CTR 40 (Raj.) lends support to the proposition that there is nothing in the language of section 11(1)(a) which lends support to the contention that the expenditure incurred in the earlier year cannot be met out of the income of the subsequent years. Result of such income for meeting expenditure of earlier years will amount to such income being applied for charitable or religious purpose. Reference is also made to the decision of the Gujarat High Court in Shri Plot Swetamber Murti Pujak Jain Mandal 211 ITR 293 that excess expenditure in earlier years can be adjusted against the income of the subsequent years. In the light of the above judgments, the carry forward of deficits would be allowed.

III The Charitable Trust (hereinafter referred as assessee) is writing the following note in the statement of total income

“If for whatever reason, the deficit turns out to be surplus and if that surplus figure, after setting off the brought forward deficits to earlier years, if any, is taxable than the taxable portion of it should be deemed to have been applied under clause (2) of the explanation section 11(1). That this return may be treated as if we are exercising the option under clause (2) of the explanation of section (1)”.

Whether such a note will be sufficient for deemed application for surplus arising on assessment ?

Ans.: Yes. The note filed by the Charitable Trust (hereinafter referred as assessee) in my opinion is absolutely correct :

“1. Deemed application under explanation 2 to section 11(1):

The Explanation 2 to section 11(1) refers to two circumstances under which the income applied to charitable or religious purpose in India may fall short of eighty-five per cent of income derived during the relevant year from property held under trust, or as the case may be, held under trust in part and still it will be deemed to have been applied., Firstly in case the whole or any part of income has not been received during that year, then so much of the income applied to such purposes in India during the previous year in which the income is received or during the previous year immediately following; the year of accrual as does not exceed the said amount, may be deemed to have been applied provided the option and conditions stated below are availed of and satisfied. Secondly, where the shortfall from 85 per cent application is for any other reason, then so much of the income applied to such purposes in India during the previous year immediately following the previous year in which the income was derived as does not exceed the said amount, would be deemed to have been applied for the purposes of exemption provided the option provided for is availed of and conditions met.

2. Effect of exercise of option available under explanation 2:

On exercise of option in writing by the person in receipt of income in the first circumstance may, at the option of the person in receipt of the income (such option to be exercised in writing before the expiry of the time allowed under sub-section (1) of section 139 for furnishing the return of income) be deemed to be income applied to such purposes during the previous year in which the income was derived; and the income so deemed to have been applied shall not be taken into account in calculating the amount of income applied to such purposes during the previous year in which the income is received or during the previous year immediately following, as the case may be.

Similarly on exercise of option in writing by the person in receipt of income in the second circumstance mentioned above, so much of the income applied to such purpose in India during the previous year immediately following the previous year in which the income was derived as does not exceed the said amount to be deemed to be income applied to such purposes during the previous year in which the income was derived; and the income so deemed to have been applied shall not be taken into account in calculating the amount of income applied to such purposes during the previous year immediately following the previous year in which the income was derived.

3. According to Trustees of Tulsidas Gopalji Charitable & Chaleshwar Temple Trust v. Cit (1994) 207 ITR 368 (Bom), if a return is filed within the time specified in section 139(4) and the option contemplated by Explanation 2 to section 11(10) is exercised in writing along with such return, the requirements of that Explanation would stand satisfied.

4. The assessee charitable trust accumulated more than 25 per cent of its income. The option for accumulation was exercised by furnishing a statement along with the return. The Assessing Officer held that the assessee had not filled Form No. 10 giving notice for accumulation; the entire amount was therefore, taxable. Commissioner (Appeals) and Tribunal allowed the assessee’s appeal holding that the disputed income would be deemed to be applied for charitable purpose. It was held by the High Court that mere mentioning in the total income statement that the amount had been set apart to be utilised for charitable purpose in subsequent year amounts to exercising option under Explanation 2(i) or (ii) to Section 11(1)(a) and such amount set apart for application under section 11(1)(a). Further, when an assessee claims exemption under section 11(1), no notice of accumulation need be give and a statement along with the return would serve the purpose. Thus, section 11(2) does not operate to whittle down or to cut across exemption provisions contained in section 11(1)(a) so far as such accumulated income of the previous year is concerned. – Vide CIT v. G. R. Govindarajulu & Sons Charities (2005) 1 (I) ITCL 378 (Mad. – HC): (2005) 271 ITR 145 (Mad.): (2005) 144 Taxmann 300 (Mad.).”

In this connection, attention of the querist is invited to the recent decision of CIT v. Moti Ram Gopal Chand Charitable Trust (2014) 360 ITR 598 (All.). In this case, the issue was accumulation of income and the information to be furnished to the AO in prescribed form within the prescribed time. The Court held that it was a matter of form and not of substance and information furnished in form of a letter with full details as required in Form 10 for setting apart and carried forward of unspent amount for spending in the next year would be full compliance of section 11 and the assessee would be entitled to the exemption u/section 11.

In CIT v. Nagpur Hotels Owners’ Association 247 ITR 201 (SC), it was held that notice of accumulation must be given to the AO u/section 11 before the assessment is concluded. That the AO must have information at the time of completion of the assessment. That in the absence of any such information, it is not possible for the AO to give assessee the benefits of such exclusion and once the assessment is completed it would be futile to find fault with the assessing authority for having included such income in the assessable income of the assessee. Thus it is reasonable to presume that intimation required u/section 11 has to be furnished before the assessing authority completes the concerned the assessment.

In CIT v. Moti Ram Gopalchand Charitable Trust, the Allahabad High Court held that even if application u/section 11(2) is not filed with the return, but information is given during the process of assessment and before the completion of assessment, then in such circumstances, the assessee has given notice u/section 11(2)(a) read with Rule 17 of the Rules of 1962 for accumulation of income. In my opinion, the assessee has already given the note which forms part of the total income, and therefore there is full compliance and the recent judgment of the Allahabad High Court squarely supports the note as sufficient for deemed application of surplus arising on assessment.

Tushar Doctor and Zankhana Pranjal Mehta