Bird’s Eye view onTaxation of Charitable Institutions

Team Professional Times

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Taxation of Charitable Institutions

Contents

Meaning

Types

Charitable Purpose

Scheme of Taxation

Direct Tax Code

Highlights

Case studies

Types of Donations

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Meaning of Charitable Institutions

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Charitable Institution

Three Facets

Private CausePrivate Initiative

Business Organisation

Charitable Organisation

Government

Private/Non governmental

InitiativePublic Cause

Public Initiative Public Cause

A charitable organisation is a legally constituted organisation created by natural or legal persons that operates independently from any government and are not conventional for profit businesses.

The Income-tax Act, 1961 (“ITA”) grants exemptions to charitable organizations subject to fulfillment of certain conditions. The object is to encourage the role of philanthropy in relieving distress and in helping to meet the basic economic, social, cultural and religious needs of the society.

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Types of Public Charitable Institutions

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Types of Public Charitable Institutions

Trust SocietySection

25 Company

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Trust

• Trust, is not defined under the Income- tax Act.• A trust is a relationship in which :

‒ Settlor vests its property with the trustees‒ A person/s or entity (the trustee) holds legal title. ‒ to certain property (the trust property or trust corpus), but is bound by a

fiduciary duty to exercise that legal control.‒ for the benefit of one or more individuals or society (the beneficiary), who

hold ‘beneficial’ or ‘equitable’ title. • Offers a simplicity and ease in registration procedures, A trust deed registered

under the Indian Registration Act is sufficient for obtaining registration under the ITA.

• Minimum two trustees are required to form a trust• It is floated with some property (immovable or movable) that legally vest in

trustees.• These institutions are built on the private lands given away for public good. • Trust is easy to set up and operate, requires less compliance and offers

greater control and autonomy.

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Society

• A group of 7 or more persons may get together and form a society.• Society is governed by the Societies Registration Act, 1860 and the Specific

Societies Registration Rules of each state• The liability of the members are limited to the assets of the society.• Management of a society vests in the governing body• On dissolution of society, surplus only to be transferred to another society

having similar objects.• Members of the general body enjoy voting rights and rights to view the accounts

and annual reports of the society. • Generally educational institution, hospitals are founded as societies.

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Section 25 company

• Company may be licensed as a Section 25 company on satisfaction of the Central Government that:

‒ Company shall be formed for the purpose of promoting commerce, art, science, religion, charity (including education) or other useful object, and

‒ Company shall apply its profits only for promoting its objects – hence prohibition on payment of dividends to members.

• License may be revoked in case of contravention of any conditions

• Certain exemptions relating to filing requirements applicable to regular companies.

• Company may be set up with a share capital or may be limited by guarantee

• No alteration of the Object clause without prior approval of Central Government.

• Management vest with Board of Directors.

• Company not required to suffix the term limited or private limited to its name

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Charitable purpose

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Section 2(15) : Charitable Purpose

• According to Section 2(15), ‘charitable purpose’, includes relief of the poor, education, medical relief, preservation of environment (including watersheds, forest and wildlife) preservation of monuments, places or objects of artistic or historic interest and the advancement of any other object of general public utility.

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Charitable Purpose

• The definition of charitable purpose is inclusive and not exhaustive or exclusive. The expression “object of general public utility” was not restricted to objects beneficial to whole of mankind. An object beneficial to a section of the public was an object of general public utility. [CIT v Andhra Chamber of Commerce 55 ITR 722 (SC)]

• Charitable purpose should not necessarily benefit poor only. What is required is benefit to a section of public as distinguished from specified individuals.

• Mere fact that the activities of trust yield profit, will not alter the charitable character of the trust.

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Relief of the poor

• It is not necessary that the relief of the poor, in order to be charitable, should provide something for nothing or less than its cost in the form of free doles, alms, etc to the poor. The relief may be given to the poor generally or to an identifiable section of poor public like poor tea planters in the form of provision of wages for work done, providing shelters to workers.

• It is not essential that the services should be provided free or less than the cost. An benevolent element is not essential nor it is necessary that the benefit be confined to the poor at the entire exclusion of rich. [Goodman vs. Mayor of Salfash (1889) 7 AC 633.]

• If the relatives of the settlor are the sole beneficiaries, then the trust cannot be considered as charitable even if the relatives are poor and indigent. [Mullich Somnath Charitable Trust vs CIT, 160 ITR 3]

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Education

• Education connotes the process of training and developing the knowledge, skill, mind and character of students by normal schooling and the use of said words in section 2(15) is not in wide and extensive sense to consider every acquisition of further knowledge as “education.”

[Loka Shikshana Trust vs CIT (1975) 101 ITR 234]

• Education should be considered in its broadest sense and includes diffusion of useful knowledge, publication of journals and promotion of search for truth and should not be restricted to normal schooling. [Ecumenical Christian Center vs. CIT (1983) 139 ITR 226];

• Little Angels Shiksha Samiti v. Union of India, [2011] 11 taxmann.com 37 (MP) If an educational society introduces object to manage and maintain a library, reading room and conduct classes of stitching embroidery, weaving and schooling, adult education and education in the field of entertainment arts, it cannot be said that the object of the society was not for educational purpose

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Education

• Coaching classes run on a pure commercial principles would not qualify for exemption as educational institutions as they are not for a charitable purpose. [Saurashtra Education Foundation vs. CIT 273 ITR 139 (Guj.)]

 • Where activities of assessee-society were inter-woven for furthering

projects and activities pertaining to education, it was entitled to registration under section 12AA [Baba Deep Singh Educational Society - [2012] 21 taxmann.com 38 (Punjab and Haryana)]

• A careful reading of the definition of 'charitable purpose' in section 2(15) does not state that activities enumerated therein viz. relief of the poor, education, medical relief etc. are charitable purposes per se. It only states that charitable purpose includes those activities as well. [Professional Education and Research Foundation - [2012]]

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Medical relief

• A hospital or other medical institution is considered charitable if, in order to provide itself with revenue for its maintenance , it runs special wards for the patients who pay full price, over and above the voluntary donations and subscriptions it receives. [IRC vs Peebleshire 11TC 335,350];

• Business connotes some real, substantial and systematic or organized source of activity or conduct with a set purpose. The receipts or income of a hospital cannot be treated as business income merely on account of the fact that the hospital recover some charges from patients. [Narain Swadeshi Weaving Mills vs. Commissioner of Excess Profit, 26 ITR 765]

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Preservation of Environment and Monuments

• Trust for Preservation of Taj Mahal, Wildlife, Waterfalls and like.

• They charged entrance fee from tourists and sold memento's to earn income, however there primary object was PRESERVATION.

• Before Finance Act, 2009-Hit by first proviso

• Post the amendment, specifically included under the defination of charitable purpose.

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Proviso(s) to section 2(15)

• Proviso 1: Provided that the advancement of any other object of general public utility shall not be a charitable purpose , if it involves the carrying on of any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or any business, for a cess or fee or any other consideration, irrespective of the nature of use or application, or retention, of the income from such activity. [Finance Act 2008]

• Proviso 2: Provided further that the first proviso shall not apply if the aggregate value of the receipts from the activities referred to therein is twenty five lakhs rupees or less in the previous year. [Finance Act 2012]

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General Public Utility

• Meaning of wider import.

• “Any object of general public utility” would exclude the object of private gain such as industrial undertaking for commercial profit, even though the said undertaking may sub-serve general public utility. [All Indian Spinner’s Association vs CIT 12 ITR 482 (PC)]

• Where the primary and dominant purpose of the Association was to promote and protect the textile industry, the activities were for general public and not for personal benefit of its members and any incidental benefit to its members would not mitigate against its charitable character. [ACIT vs Surat Art Silk Cloth Manufacturer’s Association (121 ITR 1)(SC)]

• What if the trust is formed for medical facilities and also for general public utility?

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Issues

• An organisation with general public utility whose gross receipts exceeds 25 lacs in a financial year, shall not be treated as charitable organisation.‒ Whether the entity be liable to pay advance tax?Since this would be realized only after the end of year or after the gross receipts for the year from such activities exceed the limit.

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Types of Donations

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Types of Donations

Corpus

Anonymous

Voluntary

Voluntary Donations

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• Not defined

• Referred in sec 2(24)• Voluntary contributions by

specified institutions

Note:

Contributions received by a temple from its pilgrims are not treated as income. [Guru Estate vs CIT (1963) 48 ITR 53 (SC)]

Treated as income

• Irrespective of the fact ‒ Trust is exempt

• u/s 10 or 11

Tax treatment

• Donee – can claim exemption u/s 11.

• Donor – can claim deduction u/s 80G

• Sub bullet

Corpus Donations

Treated as income

100% Exempt u/s 11(1)(d)

What is corpus donation

Conditions

• Section 2(24)‒ Brings all donations within its purview

‒ Presumably will also cover Corpus Donations

• Section 11(1)(d):‒ Voluntary contribution

‒ Specific direction to form part of the corpus of the trust

Not defined

• Black’s law dictionary- principal or capital sum, as opposed to interest or income.

• It should be Voluntary in nature

• Direction to form part of the corpus of the trust.

• Obtain specific letter from the donor mentioning clearly that donation is given towards corpus of the trust

• Separate numbered receipts must be issued for corpus donations

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Anonymous Donations

‒ Voluntary contributions

‒ No record of the identity

• Name & Address of the donor

• Such other particulars as prescribed

L̵ { Anonymous Donations- ( Higher of the 5% of the total donations received by the assessee or One lakh rupees)}

• Wholly religious trust

• Partly Religious & charitable trust

• Educational/ Medical Institutions u/s 10(23C)(iiiab)& (iiiac)

• Political Parties exempt u/s 13A

Anonymous Donations

Defined u/s 115BBC

Taxed @ 30%

Whom it is not applicable

Can Anonymous Donations be Corpus?

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Issue- Anonymous Donations

• Whether anonymous donations should be covered for the purposes of accumulation under section 11(1)(a)?

• Example: say a charitable trust has an income of Rs 3 lakhs, including anonymous donation of Rs 1 lakhs.‒ View 1: Pay tax on Rs 1 lakh and apply 85% of the remaining Rs 2 lakhs ie

Rs 1.70 lakhs (85% of Rs 2 lakhs)‒ View 2: Since tax is payable on Rs 1 lakhs, apply Rs 1.55 lacs (85% of Rs 3

lakhs- Rs 1 lakhs). ‒ View 3: Treat tax paid on anonymous donation as application of Income.

Therefore net application is Rs 1.25 lakhs [Rs 1.55-0.30-tax paid on anonymous donation]

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Scheme of Taxation of Charitable Trusts

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Scheme of Taxation

• The exemption is governed by the provisions of section 11 to 13 of the Income-tax Act, 1961 contained in Chapter-III “Incomes which do not form part of the total income”.

• Section 11 provides the manner in which income is exempt from income-tax.

• Section 12 provides the income of trust or institutions from contributions.

• Section 12A provides the conditions as to registration of trusts, etc.

• Section 12AA provides the procedure for registration.

• Section 13 provides section 11 not to apply in certain cases.

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Section 11: Income from Property held for charitable or religious purposes

Section Nature of Income Extent to which exemption allowed

11(1)(a) Income derived from property held under trust wholly for charitable or religious purposes.

To the extent income applied to such charitable or religious purposes in India.

Whereas accumulated or set apart for such application, to the extent of 15% of the income from such property.

11(1)(c) Income derived from property held under trust for a charitable purpose, which tends to promote international welfare in which India is interested.

To the extent income is applied to such charitable or religious purposes outside India.

Exemption is available only if the Board has directed such exemption

11(1)(d) Income in the form of voluntary contributions made with a specific direction that they shall form part of the corpus of the trust or institution.

100% exemption

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Property held under Trust

• Sec 11(4)The property includes Business.

• Sec11(4A) – Conditions to claim exemption.

• In CIT vs Hamdard Dawakhana (Wakf) , it was held that the income tax refund was not income from property held under trust.

• Test for Claiming exemption under section 11.

‒ There must be obligation to apply income for charity and not merely a Practice, as it is always permissible for the assessee to deviate from the practice.

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Application of Income

• It is not correct to equate the word “applied” as used in section 11 with the word “spent”. For instance, if the charitable trust debits its accounts as soon as it passes resolutions sanctioning donations to various donees and such amounts, as are outstanding, are shown as liabilities in the balance sheet (this will happen when in certain cases the amounts, though sanctioned and debited as expenditure in one accounting year, are actually disbursed in the next year) the amounts which are sanctioned but not actually spent in the relevant accounting year will constitute application of funds for charitable purpose with the meaning of section 11(1)(a). [CIT vs. Trustees of H. E. H. the Nizam’s Charitable Trust [1981] 131 ITR 497 (AP)]

• It is not the situs of the property that is relevant for granting exemption, but the purpose of charitable activity is India. CIT vs. Trustees of H. E. H. the Nizam’s Charitable Trust [1981] 131 ITR 497 (AP)]

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Application of Income

• Administrative expenditure- Not only direct but also indirect expenditure.• Capital Expenditure- for furtherance of objects of the Trust.• Depreciation- Depreciation on assets of trust is deductible from income. • Where the income applied falls short of 85%, because –

I. the whole or any part of the income has not been received during the previous year; or

II. for any other reason the assessee has an option to :

(a) apply such income for such purposes during the previous year in which it is received or during the previous year next following the said previous year; and

(b) apply such income for such purposes during the previous year next following the previous year in which the income was derived.

The option is to be exercised in writing within the time allowed for filing return of income u/s. 139(1).

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Accumulation of Income

• Accumulation up to 15% is without any conditions. The trust is under no obligation to spend the sum so accumulated or to invest the funds in any specified manner.

• If a trust/institution cannot utilize its income wholly or partially, or wants to accumulate its, it can obtain exemption under section 11(2) by accumulating the income subject to the conditions :‒ Application in Form No. 10 as per Rule 17 to the Income-tax Officer for

permission to accumulate the income, stating the purpose and period of accumulation, which shall, in no case, exceed 10 years.

‒ Section 11(2)(b) provides that the money so accumulated should be invested or deposited in any mode or form prescribed under section 11(5), as in the case of investments of other funds.

‒ The time limit for filing Form No. 10 is the same time limit as for filing return under section 139(1). This time limit is prescribed in Rule 17. The time limit for making investments is not laid down either in the Act or the rules, but Form No. 10 contains a declaration that the amount accumulated has been or will be invested within six months of the end of the previous year.

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Accumulation of Income

• Though Rule 17 states that Form No. 10 should be filed before the expiry of the time limit u/s. 139(1), the Bombay High Court in the case of CIT vs. Nagpur Hotel Owners Association (1994) 209 ITR 441 had held that this rule is beyond the scope of the section and that the application for accumulation can be made even after completion of assessment, at the stage when the matter is pending before the Tribunal. The matter went up to the Supreme Court and it was held at 247 ITR 201 and 165 CTR 1 that Form No. 10 must be filed with the assessing officer before completion of the assessment proceedings.

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Conditions for claiming exemption under section 11

Conditions

Created for lawful purpose and ensures Benefit to Public at large

Exemption confirmed to such portion of Income which is applied for charitable

purposes.

Registered with CIT under section 12A

85% of Income is required to be applied for approved purposes

Property should be held for charitable purposes

Unapplied income to be invested in specified forms and modes

property from which income is derived should be held under a trust

No part of Income should ensure benefit to trustee or specified persons u/s 13(3)

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Income not exempt under section 11

Section Nature of Income

13(1)(a) Income from property held under private religious trust which does not ensure benefit to the public.

13(1)(b) Income from charitable trust established for the benefit of any particular religious community or caste.

13(1)(c) Income/ property of charitable or religious trust applied for direct or indirect benefit of person referred in 13(3).

13(1)(d) Any income, is taxable if ;If any funds are invested other than in 11(5)

11(4A) Income from business which is not incidental to the attainment of the objectives of the trust, or in respect of which separate books of accounts have not been maintained.

12(2) Value of medial/ education services provided to specified persons by trust running hospital and educational institution shall be income of trust and will be chargeable in the year in which services are provided and chargeable to tax, despite section 11(1).

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An ExampleParticulars Amount in Rs.

Income from Property held under the trust xxxxx

Voluntary donations other than Anonymous Donations xxxxx

Corpus Donations Exempt

Total Income xxxxxx

Less:

15% exempt u/s 11(1) xxxxxx

Expenses incurred (Application of Income) xxxxx

Option exercised u/s11 (Explanation 2) xxxxx

Amount for purposes u/s 11(2) xxxxx

Income XXXX

Add:

Anonymous donations XXXXXX

Net Income XXXXX

Anonymous donation @ 30% [XXXXX-{Higher of (5% of XXXX) or 100000}]= XXXXX+ Tax on other Donations as per slab rate

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Section 80G: Deduction on donations to certain trusts, charitable institutions• Only donation of a sum of money are eligible for deduction.• Conditions

‒ Trust deed and rules do not contain provision for application on purpose other than charitable.

‒ Maintenance of regular books of accounts.‒ Constituted as a trust, society, university established by law, institution

financed by government or a local authority.

• Form 10G for taking approval from Commissioner- One time approval

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Miscellaneous

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Registration of charitable trust

• Registration before the Commissioner is precondition for exemption.

• Registration u/s. 12AA does not mean that the trust is automatically entitled to the exemption u/s. 11 each year, as the issue of whether there is any application of income for charitable or religious purposes or accumulation of income during the previous year or whether any of the provisions of section 13 are attracted for the year, can be examined by the Assessing Officer each year, before granting the exemption.

• Registration of trust under section 12A, once done is a fait accompli and the AO cannot thereafter make further probe into the objects if the Trust. [ACIT vs Surat City Gymkhana 300 ITR 214]

• Application for registration to be made to the Commissioner of Income Tax in Form 10A

• Compulsory audit where total income exceeds maximum income not chargeable to tax. Submission of Audit Report in Form 10B.

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Direct Tax Code

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Direct Tax Code (“DTC”)- Non Profit Organisations

Non Profit Organisations carrying out charitable activity

Tax rate: If Total Income

</= INR 100,000- Nil

> INR 100,000- 15%

Organisations of Public importance specified in Seventh Schedule

Exempt from tax

Public religious trust or institution

Exempt from tax on fulfillment of specified conditions

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Direct Tax Code (“DTC”)

• Chapter IV of DTC deals with the provisions relating to the computation of total income of Non profit organizations.

• Income to be computed in accordance with cash basis of accounting. However, for section 25 companies, income to be computed as per Mercantile system of accounting.

• Gross receipts to be aggregate of specified incomes, except loans taken during the financial year and donations forming part of the corpus.

• Compulsory audit, if gross receipts exceed INR 500,000 in any financial year. • Public religious trusts fulfilling certain conditions and notified entities of public

importance not liable to income tax.

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Professional Opportunities

• Assistance in preparing registration documents;

• Assistance in obtaining Income-tax registration;

• NGO’s are prone to extensive litigation – litigation expert

• Advisory on whether the activity proposed to be carried upon, classifies as a charitable organisation.

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