Amendments relating to taxation of Charitable Trusts

Provisions relating to taxation of charitable trusts or exemption provided to charitable trusts have been fine tuned in recent times for plugging many unaddressed issues.

Brief BackgroundThe term “charitable purpose” is defined in Section 2(15) in an inclusive manner. The objectives for which a charitable trust or institution is created deserves tax relief and there is no dispute about it. However, it is the last limb of the definition that is “advancement of any other object of general public utility is yet to be free from litigations.

The exemption to trusts or institution is available under the following two regimes:

Regime One: Any fund, institution, trust, any university, other educational institution, any hospital or other medical institution approval under sub-clauses (iv), (v), (vi) and (via) of Section 10(23C), and

Regime two: The trusts registered under Section 12AA/12AB

Section 11 provides for an exemption to trusts or institutions registered under Section 12AA/12AB. Similarly, Section 10(23C) provides an exemption to certain funds or institutions is approved under this provision.

An organization cannot simultaneously have approval / registration under both the sections and has to opt only for anyone form of approval / registration under Section 12AB.

Amendment to Section 12A(1)(b) and tenth proviso to Section 10(23C)Following tenth proviso shall be substituted for existing tenth proviso to clause (23C) of Section 10 by Finance Act, 2022 with effect from 1.4.2023.

Tenth proviso to Section 10(23C) provides that where the total income of the fund or institution or trust or any university or other educational institution or any hospital or other medical institution under both the regimes, without giving effect to Section 10(23C) or Section 11 and 12 exceeded maximum amount which is not chargeable to tax, such trust or institution or institution shall:

  • keep and maintain books of account and other documents in such form and manner and at such place, as may be prescribed, and
  • get its accounts audited in respect of that year before the specified date and furnish by that date, the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed.

It is to be noted that this condition to maintain books of account is in addition to the conditions requiring the trust or institutions to get registration, audit of books of account and filing of the return of income. Thus, if the trust fails to comply with any of these conditions, the benefit of exemption under Section 10(23C) or Section 11 shall not be available.

Section 10(23C) is independent of Section 11 to 13. The objective is to amend Section 10(23C) to limit its scope and merge rest of the provisions contained therein with Section 11 to 13. 

Section 10(23C)(iiiad), University or other educational institutionIt applies to any university or other educational institution with effect from assessment year 2022-23. Any University or other educational institution existing solely for educational purposes and not for the purposes of profit and which is solely for educational purposes and not for the purposes of profit if the aggregate annual receipts from such University or Universities or educational institution or institutions do not exceed five crore rupees; or

Section 10(23C)(iiiae): Hospital or other institution providing medical relief for philanthropic purposes and not purposes of profitThis section applies to any hospital or other institution for the reception and treatment of persons suffering from illness or mental defectiveness or for the reception and treatment of persons during convalescence or of persons requiring medical attention or rehabilitation, existing solely for philanthropic purposes and not for the purposes of profit, if the aggregate annual receipts of the person from such hospital or hospitals or institution or institutions do not exceed five crores. 

Explanation

For the purposes of sub-clauses (iiiad) and (iiiae), it is clarified that if the person has receipts from University or Universities or educational or educational institution or institutions as referred to in sub-clause (iiiad), as well as from hospital or hospitals or institution or institutions as referred to in sub-clause (iiae), the exemptions under these clauses shall not apply, if the aggregate of annual receipts of the person from such University or universities or educational institution or institutions or hospital or hospitals or institution or institutions exceed five crore rupees.

Wholly or substantially financed by the  GovernmentThe term “wholly or substantially financed by the Government” would mean that the Government grant to such University or such other educational institution, hospital or other institution mentioned above exceeds 50% of the total receipts including any voluntary contributions received by it during the relevant previous year (Rule 2BBB).

These amendments have been brought to nullify the interpretation given in Children’s Education Society’s case [2013] 358 ITR 373 (Kar.) wherein it was held that each educational institution is a separate entity controlled under various statutes for various purposes. Similar view was found held in Vivekanand Society of Education and Research vs. CIT [IT Appeal No. 23 of 2014 dated 29th December, 2007 of Jammu and Kashmir]. The monetary limit and tax exemption of the income thus was applied with reference to each education institution. This amendment has been brought to nullify the interpretations given in the aforesaid cases.

The term hospital or other institution has not been defined hence the question would arise whether pharmacy and / or chemist shop would be considered as a part of the “hospital or other institution”. Similarly, educational institution has not been defined hence the question would arise when books and uniforms are sold by a store run by educational institution would be considered as “educational institution”.

Section 10(23C): Income of certain funds, trust or institutions (Clause 4): Existing Provision: Section 10(23C) exempts the income of certain funds, trust or institutions which fulfill various criteria. Once, such criteria is trusts or institutions which are approved by the prescribed authority. The said prescribed authorities will be Principal Commissioner or Commissioner. The amendment will be effective from 1st April, 2021.

Voluntary Contribution received by the temple, mosque, gurudwara etc. for repairsExplanation 1A: For the purposes of this  proviso, where the property held under trust or institution referred to in clause (v) includes any temple, mosque, gurudwara, church or other place notified in clause (b) of sub-section  (2) of Section 80G, any sum received by such trust or institution as a voluntary contribution for the purposes of renovation or repair of such temple, mosque, gurudwara, church or other place, may, at its option, be treated by such trust or institution as forming part of the corpus of the trust or institution as forming part of the corpus of that trust or institution, subject to the condition that the trust or institution.

  • Applies such corpus only for the purpose for which voluntary contribution was made;
  • Does not apply such corpus for making contribution or donation to any person;
  • Maintains such corpus separately identifiable; and
  • Invests or deposits such corpus in the form and modes specified under Section 11(5).

Explanation 1B:

For the purposes of Explanation 1A, where any trust or institution referred to in sub-clause (v) of Section 10(23C) has treated any of the conditions specified in clause (a) to (d) of the above Explanation is violated, such sum shall be deemed to be the income of such trust or institution of the previous year during which violation takes place.

Explanation 3 to Section 10(23C) amended with effect from 1.4.2023:

For the purposes of determining the amount of application under this proviso, where 85% of the income is not applied wholly and exclusively to the objects during the previous year but is accumulated or set apart, either in whole or in part, for application to such objects in subsequent years, such accumulated income shall not be included in the total income, if the following conditions are complied with:

  • Furnish a statement to the Assessing Officer stating the purpose for which the income is being accumulated or set apart, which shall in no case exceed five years; in computing due to an order or injunction of any Court, shall be excluded.
  • The money so accumulated or set apart is invested or deposited in the forms or modes specified is Section 11(5); and
  • The statement referred to in clause (a) is furnished on or before the due date specified under Section 139(1) for furnishing the return of income of the previous year.

Explanation 4:

Any income referred to in Explanation 3, which

  • is applied for purposes other than the objects for which the fund or institution or trust is established or ceases to be accumulated or set apart for application thereto, or
  • Ceases to remain invested or deposited in any of the forms or modes specified in sub-section (5) of Section 11; or
  • Is not utilized for the purpose for which it is so accumulated or set apart during the period referred to in clause (a) of Explanation 3, or,
  • Is credited or paid to any trust or institution or trust or university or other educational institution or any hospital or other medical institution referred to in sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via), shall be deemed to the income of the previous year;
    • In which it ceases to remain so invested or deposited under clause (a); or
    • In which it ceases to remain so invested or deposited under clause (b); or
    • Being the last previous year of the period, for which the income is accumulated or set apart under clause (a) of Explanation 3, but not utilized for the purpose for which it is so accumulated or set apart under clause (c); or
    • In which is it is credited or paid to any fund or institution or trust or any University or other educational institution or any hospital or any other medical institution under clause (d). 

Amount not deductible:

Section 40(a)(ia) and 40A(3) shall, mutatis mutandis, apply in computing the income chargeable under the head “profit and gains” of business or profession.

No deduction in respect of expenditure or allowances or set-off of any loss shall be allowed:

New 23rd proviso provides that for the purposes of computing income chargeable to tax under twenty second proviso, no deduction shall be allowed to the assessee under any other provisions of this Act.

This amendment will take effect from 1st April, 2023 and will accordingly, apply in relation to assessment year 2023-24 and subsequent assessment years.

In my view this proviso is harsh. Any loss of the trust or instituted be allowed to set off against the income of the subsequent year.

Section 11(1): Explanation 4 and Explanation 5inserted by Finance Act, 2021 with effect from 1.4.2022

Explanation 4: For the purposes of determining the amount of application under clause (a) or clause (b):

  • Application for charitable or religious purposes from the corpus as referred to in clause (d) of this section shall not be treated as application of income for charitable or religious purposes.

    Provided that the amount not so treated as application, or part thereof, shall be treated as application for charitable or religious purposes in the previous year in which the amount or part thereof, is invested or deposited back, into one more of the forms or modes specified in sub-section (5) of Section 11 maintained specifically for such corpus, from the income of that year and the to the extent of such investment or deposit; and

  • Application for charitable or religious purposes, from any loan or borrowing, shall not be treated as application of income for charitable or religious purposes.

    Provided that the amount not so treated as application or part thereof, shall be treated as application for charitable or

     religious purposes in the previous year in which the amount or part thereof, is invested or deposited back, into one or more of the forms or modes specified in sub-section (5) maintained specifically for such corpus, from the income of that year and to the extent of such investment of deposit; and

  • Application for charitable or religious purposes, from any loan or borrowing, shall not be treated as application of income for charitable purposes.

    Provided that the amount not so treated as application, or part thereof, shall be treated as application for charitable or religious purposes in the previous year in which the loan or borrowing or part thereof, is repaid from the income of that year and to the extent of such repayment.

    Repayment of debt incurred for the purpose of the trust or loan advanced by educational trust to students for higher studies amounted to application of income. The Circular issued by CBDT and various High Court’s decisions in this connections are nullified and application for charitable or religious purposes from any loan or borrowing shall not be treated as application of income for charitable or religious purposes.

Explanation 5:

It clarifies that the calculation of income required to be applied or accumulated during previous year shall be made without any set- off or deduction or allowance of any excess application of any of the year preceding the previous year.

 Section 11(1A)For the purposes of sub-section (1)

  • Where a capital asset, being property held under trust wholly for charitable or religious purposes is transferred and the whole or any part of the net consideration is utilized for acquiring another capital asset to be so held, then the capital gain arising from the transfer shall be deemed to have been applied to charitable or religious purposes to the extent specified hereunder:
    • The whole of the net consideration is utilized in acquiring the new capital asset, the whole of such capital gain;
    • Where only a part of the net consideration is utilized for acquiring the new capital asset, so much of such capital gain as is equal to the amount, if any, by which the amount so utilized exceeds the cost of the assets transferred.

Explanation to this sub-section defines the meaning of “appropriate fraction”, cost of transferred asset” and the “net consideration”.

Section 11(1B)Where any income in respect of which an option is exercised under clause (2) of the Explanation to sub-section (1) is not applied to charitable or religious purposes in India during the period referred to in sub-clause (a) or, as the case may be, sub-clause (b) of the said clause, then, such income shall be deemed to be the income of the person in receipt thereof-

In the case referred in sub-clause (i) of the said clause of the previous year immediately following the previous year in which the income was received; or

  • In cases referred to in sub-section (ii) of the said clause of the previous year immediately following the previous in which the income was received.

Requirement for filing Income-tax ReturnClause (c) of Section 139(4C) mandates that a trust or institution which is otherwise eligible for blanket tax exemption under Section (23C) meaning thereby an educational institution or hospital not being run for the purposes of profit, have to file the return where the total income before giving effect to the provisions of Section to exceeds the basic exemption limit.

Failure to furnish the Return of Income Section 272A(2)provides that failure to furnish the income-tax return under Section 139(4C) is liable for penalty of Rs. 100/- for every day during which the failure continues.

Requirement to maintain Books of Account – From A.Y. 2023-24Under the Income-tax Act, tax payers are required to maintain books of account and get them audited. The requirement to maintain books of account are prescribed under Section 44AA. However, there is no specific provision under the Act providing for the books of account to be maintained by trusts or institutions.

The Finance Bill, 2022 proposes an amendment to Section 12A(1)(b) and tenth proviso to Section 10(23C) to provide that where the total income of the trust or institution under both the regimes, without giving effect to exemption under Section 10(23C) or Sections 11 and 12 exceeds the maximum amount which is not chargeable to tax, such trust or institution shall maintain books of account and other documents in such form and manner and at such place, as may be prescribed.

The condition to maintain books of account is in addition to the conditions requiring the trust or institutions to get registration, audit of the books of account and filing of return of income. Thus, if the trust fails to comply with any of

these conditions, the benefit of exemption under Section 10(23C) or sections 11 and 12 shall not be available. 

Cancellation of Registration or approvalIt is the general law that registration once granted shall remain in force till the Commissioner cancels it. Under the existing provisions of the Income-tax Act, the registration can be cancelled if the Commissioner is satisfied that the activities of the trust or that the trust or institution has violated requirements of any other law which was material to achieve its objects. However, the Commissioner shall given an opportunity of being heard before the cancellation of registration of the trust. The following amendments to Section 12AB and fifteen proviso to Section 10(23C) to empower the authorities to cancel the registration. The registration or approval can be cancelled by the Principal Commissioner of Income-tax (Pr. CIT) or CIT can cancel the registration or approval can be cancelled.

  • Final registration or provisional registration granted under clause (a) or clause (b) of Section 12AB(1);
  • Final registration granted under clause (b) of Section 12AA(1);
  • Institute approval under clauses (iv), (v), (vi) and (via) of Section 10(23C).

Circumstances under which registration or approval can be cancelled.

  • PCIT or CIT has noticed one or more occurrence “specified violations” during any previous year;
  • PCIT or CIT has received a reference from the Assessing Officer under second proviso to Section 143(3) for any previous year.
  • Such a case has been selected in accordance with risk management strategy, formulated by the Board from time to time for any previous year.

Specified Violations: The following shall be considered as “specified violation”.

  • If any income, derived from property held under trust wholly or in part for charitable or religious purposes, has been applied other than for the objects of the trust or institution.
  • The trust or institution has income from profits and gains of business which is not incidental to the attainment of its objectives.
  • Separate books of account are not maintained by such trust or institution in respect of the business which is incidental to the attainment of its objectives.
  • The trust or institution has applied any part of its income from the property held under a trust for private religious purposes, which does not enure benefit of the public.
  • The trust or institution established for charitable purposes has applied any part of its income for the benefit of any particular religious community or caste.
  • Any activity being carried out by the trust or institution is not genuine or is not being carried out in accordance with the conditions subject to which it was registered.
  • The trust or institution has not complied with the requirement of any other law for the time being in force as is material to achieve its objects, and the order, direction or decree, by whatever name called, holding that such non-compliance has occurred, has either not been disputed or has attained finality.

PCIT/CIT to satisfy himself about the occurrence or otherwise of any specified violation:

  • The PCIT or CIT shall call for such documents or information from the Trust or institution or make such inquiry about the occurrence or otherwise of any specified violation. He shall pass an order in writing, cancelling the registration of such trust or institution after affording a reasonable opportunity of being heard for the previous year and all subsequent previous years, if he is satisfied that one or more specified violations have taken place.

    If the PCIT/CIT is not satisfied about the occurrence or more specified violations. In such as case, he shall pass an order in writing, refusing to cancel the registration of such trust or institution.

    PCIT/CIT shall forward a copy of the cancellation order or order refusing to cancel the registration, as the case may be, to the Assessing Officer and such trust or institution.

Time limit to pass cancellation order The cancellation order or order refusing to cancel the registration, as the case may be, shall be passed before the expiry of six months to be calculated from the end of the quarter in which the first notice is issued by PCIT or CIT, on or after 1st April, 2022 calling for any document or information or for making any inquiry.

Year of Taxability of unutilized Accumulated Income under Section 11(2)With effect from assessment year 2023-24, if a trust is not able to apply 85% of its income in a particular year, it can accumulate the shortfall to be used for religious or charitable purposes within the next five years.

The accumulation is allowed if the Assessing Officer is informed about the purpose of  accumulation and the period for the income is to be furnished in Form 10 on or before the due date for furnishing the return of income under Section 139(1).

The income set apart or accumulated has to be utilized in terms of the provisions of Section 11(2). However, the accumulated income is not applied and remains to be invested even after five years, in such a case, the amount or part of the accumulated income which has not been so utilized shall be treated as income of the trust of that previous year under Section 11(3). However, if the accumulated income is not utilized in the year immediately following the expiry of the 5 years period, the trust has one more year for utilization of accumulated funds. Though Section 11(2) provides a 5 years period for accumulation but by virtue of Section 11(3), the penal provisions are attracted only after the expiry of sixth year. The Act provide a one year grace period to utilize the income accumulated under Section 11(2). Therefore, if the accumulated income is not applied within 5 years, it shall be taxed in the sixth year.

The Finance Bill 2022, purposes to amend the provisions of section 11(3) of the Act to provide that any income referred to in Section 11(2) which is not utilized for the purpose for which it is so accumulated or set apart shall be deemed to be the income of such person of the previous year being the last previous year of the period, for which the income is accumulated or set apart but or not utilized for the purpose for which it is so accumulated or set apart.

Thus, after the proposed amendment, if the accumulated income is not applied within 5 years, the same shall be taxed in the 5th year itself.

Restriction on extending the benefit of specified personUnder Section 13, trusts or institutions registered under Section 12AA/12AB are required not to pass any unreasonable benefit to the trustee or any other specified person.

The Finance Bill, 2022 proposes to insert twenty- first proviso in Section 10(23C) of the Act to provide that where income or part of income or property of any trust or institution has been applied directly or indirectly for the benefit of any person referred to in Section 13(3), such income or part of income or property shall be deemed to be the income of such person of the previous year in which it is so applied. The provisions of Section 13(2)(4) and (6) of the Act shall also apply to trust or institution referred to in Section 10(23C).

Interested PersonThe following are interested person –

  • The author of the trust or the founder of

    the institution;

  • Any person who has made a total contribution upto the end of the relevant previous year of an amount exceeding Rs. 50,000;
  • Where author, founder or substantial contributor is an HUF, a member of the HUF;
  • Any trustee of the trust or manager of the institution;
  • Any relative of such author, founder, substantial contributor, member, trustee, manager as aforesaid; and
  • Any concern in which any of the persons referred to above has a substantial interest

Meaning of Relative
Relative in relation to an individual means

  • His spouse;
  • His brother or sister; 
  • Spouses of the brother or sister;
  • Brother or sister of his spouse;
  • Spouses of brother or sister of his spouse;
  • His lineal ascendant or descendant and of his spouse;
  • Spouses of any of his lineal ascendant or descendant;
  • Spouses of his spouse’s lineal ascendant or descendant;
  • Any lineal descendant of his or his spouse’s brother or sister.

Meaning of substantial interestA person is deemed to have substantial interest in a concern if he (or along with interested persons as mentioned above) at any time during the previous year.

  • Holds atleast 20% of equity share capital in the company; or
  • Entitled atleast 20% of profits, in case of any other concern.

Benefit of medical or educational servicesWhere a charitable or religious trust is running a hospital or a medical institution, or an educational institution and it provides medical or educational services to interested persons, the value of medical / educational services to interested persons, the value of medical / educational services is deemed to be income of the trust or institution derived from property held under trust. The value of such services is chargeable to tax during the previous year in which such services are rendered. The exemption of Section 11 or Section 10(23C) shall not apply to the value of such services.

The income or the property applied for benefit of interested person:

The income or the property of the trust shall be deemed to have been applied for the benefit of interested person in the following cases.

  • Loan without adequate interest or security

    An interested person is deemed to be benefitted if any part of the income or property of the trust or institution is (or continues to be) lent to any interested person for any period during the previous year without either adequate security or adequate interest or both.

  • Use of property without any rent

    An interested person is deemed to be benefitted if any land, building or other property of the trust or institution is (or continues to be) made available for use by any interested person, for any period during the previous year without charging adequate rent or other compensation.

  • Excess payment of salary

    Any interested person is deemed to be benefitted if any amount is paid by way of salary, allowance or otherwise during the previous year to any interested person, out of the resources of the trust or institution and the amount so paid is in excess of what may be reasonably paid for such services.

  • Inadequate remuneration for services rendered

    An interested person is deemed to be benefitted if the services of the trust or institution are made available to an interested person during the previous year without adequate remuneration or other compensation.

  • Excess payment for purchases

    An interested person is deemed to be benefitted if any share, security or other property is purchased by or on behalf of the trust or institution from an interested person during the previous year for consideration which is more than adequate consideration.

  • Consideration of sales

    An interested person is deemed to be benefitted if any share, security or other property is sold by or on behalf of the person during the previous year for consideration which is less than adequate consideration.

  • Diversion of income

    An interested persons is deemed to be benefitted if any income or property of the trust or institution is diverted during the previous year in favour of the interested person and the aggregate value of such income and property exceeds Rs. 1,000.

  • Investment in a concern

    An interested person is deemed to be benefitted if any funds of the trust or institution are or continue to remain, invested for any period during the previous year, in any concern in which the interested person has a substantial interest. However, if the aggregate of funds invested in a concern, in which any interested person has a substantial interest, does not exceed 5% of capital of that concern, exemption under Section 11 will be denied only from the income arising to the trust form such investment. 

    In other words, in such a case, the exemption under Section 11 will not be denied for any income other than the income arises out the said investment. In Birla Charity Trust [1987] 34 Taxman 504 (Cal), the Hon’ble High Court held that if the funds of the trust are construed to include assets (other than money in hand or bank account), the same are not capable of being invested as such other assets of the trust, apart from money in hand or cash will have to be converted into money or cash before the same can be invested. Therefore, only cash and bank balances are included in the expression of “funds” for the purpose of section 13(2)(h).

ConclusionThe law of charitable trust/institution has been complicated frequent changes in law which makes compliance difficult. Lots of judgments of various Courts have been nullified by making amendments in various sections of charitable trust / institutions such as Section 10(23C) (iiiad), Section 10(23C)(iiiae), Section 11(1A), Section 11(2), capital gain etc. Litigations will increase considerably. Thus trust funds would be affected due to heavy tax demand. The law of charitable trust / institution could have been made simple and easy for various compliances.

“Take up one idea, make that one idea your life. Think of it, dream of it, Live on that idea let the brain, muscles, nerves, every part of your body be full of that idea, and just leave every other idea alone. This is the way to success.”

  — Swami Vivekananda

 

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