TAXATION OF CHARITABLE TRUSTS by CA Rajesh Kadakia

TAXATION OF CHARITABLE TRUSTS by CA Rajesh Kadakia Workshop on Charitable Trusts Jointly organized by Bombay Chartered Accountants' Society (BCAS) & The Chamber of Tax Consultants (CTC) Mumbai 7 th November, 2015

Synopsis • • • • Introduction Conditions for a charitable trust to be entitled to special dispensation under s. 11 Charitable purpose [s. 2(15)] Broad scheme of computation of income under s. 11 Corpus donations [s. 11(1)(d)] Income Application of income [s. 11(1)(a)] Basic accumulation up to 15% of income [s. 11(1)(a)] Secondary accumulation for 5 years up to 85% Capital gains exemption [s. 11(1 A)] Circumstances in which a charitable trust is not entitled to the special dispensation under s. 11 [s. 13] S. 10(23 C) S. 80 G 07 -11 -2015 Taxation of Charitable Trusts 2

Introduction • Special scheme of taxation for eligible charitable or religious trusts or institutions (“charitable trusts”) under - s. 11 to 13. - s. 10(23 C). • Deduction for the donor if charitable trust is approved under - s. 35 AC - s. 80 G 07 -11 -2015 Taxation of Charitable Trusts 3

Conditions for a charitable trust to be entitled to special dispensation under s. 11 • The object of the trust is “charitable purpose” as defined under s. 2(15) or a religious purpose. • The trust is wholly for charitable or religious purposes [s. 11(1)(a)] • The trust income is not includible in the hands of settlor / donor under s. 60 to 63 [s. 11(1)(a)] • The trust is registered under s. 12 A(1)(a)/(aa) / 12 AA(1) • Audit of accounts of the trust is carried out when total income without giving effect to s. 11/12 exceeds the exemption limit and audit report is filed along with return of income [s. 12 A(1)(b)] • The registration is not cancelled under s. 12 AA(3) or s. 12 AA(4). • The trust is not covered by s. 13. 07 -11 -2015 Taxation of Charitable Trusts 4

Charitable purpose [s. 2(15)] “Charitable purpose”, includes • relief of the poor • education • yoga • medical relief • preservation of environment • preservation of monuments or places or objects of artistic or historic interest • advancement of any other object of general public utility 07 -11 -2015 Taxation of Charitable Trusts 5

Definition of charitable purpose – proviso to section 2(15) Law prior to amendment [up to assessment year 2015 -16] Advancement of any object of general public utility was not a charitable purpose, if it involved carrying on of (a) any activity in the nature of trade, commerce, business; or (b) any activity of rendering any service in relation to any trade, commerce or business [first proviso to section 2(15)] Exception Aggregate value of receipts from the activities < Rs. 25 lakhs in a previous year [second proviso to section 2(15)] 07 -11 -2015 Taxation of Charitable Trusts 6

Definition of charitable purpose – proviso to section 2(15) (cont. ) Amendment [with effect from assessment year 2016 -17] Advancement of any object of general public utility is not a charitable purpose, if it involves carrying on of 1 st Limb* (a) any activity in the nature of trade, commerce, business; or (b) any activity of rendering any service in relation to any trade, commerce or business Unless (a) The activity is undertaken in the course of actual carrying out of such advancement of any other object of general public utility; and (b) aggregate receipts from such activity < 20% of the total receipts of that previous year, of the institution. [proviso to section 2(15)] 2 nd Limb * Identical to pre-amendment first proviso 07 -11 -2015 Taxation of Charitable Trusts 7

Definition of charitable purpose – proviso to section 2(15) (cont. ) Analysis/Issues 1. Applies only to “advancement of any other object of general public utility”. 2. First limb of the amendment Business: Profit motive – whether essential? Whether mere surplus constitutes ‘profit motive’? 07 -11 -2015 Taxation of Charitable Trusts 8

Definition of charitable purpose – proviso to section 2(15) (cont. ) 3. Second limb of the amendment (a) activity to be undertaken in the course of actual carrying out of advancement of any other object of general public utility”. “actual” means real, genuine and not fictional, collusive or illusory [See CIT v. Poulose & Mathen (P. ) Ltd. , (1999) 236 ITR 416 (Ker); CIT v. Dalmia Dadi Cement Ltd. , (1980) 125 ITR 510 (Del)]. Hence, • the institution should really and genuinely carry out the advancement of object of general public utility; and • the activity should be undertaken in the course of such carrying out. 07 -11 -2015 Taxation of Charitable Trusts 9

Definition of charitable purpose – proviso to section 2(15) (cont. ) (b) interpretation of the expression following “unless” (second limb): View 1: exception to the proviso (first limb) will not apply unless both the conditions are cumulatively fulfilled that is, the activity of business, etc. undertaken in the course of actual carrying out of such advancement of any other object of general public utility; and the aggregate receipts from such activity or activities do not exceed 20% of the total receipts of the institution in the previous year. [see Hoshiarpur Improvement Trust v. ITO, TS-520 -ITAT-2015(Asr)] Illustration: (Rs. in lakhs) a. Net sales : 20 b. Other receipts : 79 c. Aggregate receipts (a+b) : 99 d. % of business receipts (net sales) to total receipts (a*100/c. ) : 20. 2% 07 -11 -2015 Taxation of Charitable Trusts 10

Definition of charitable purpose – proviso to section 2(15) (cont. ) Consequences: Intention not fulfilled See Memorandum explaining the provisions of the Finance Bill 2015 • • 07 -11 -2015 intent is to give relief to genuine charitable institution - undertaking activities as part of actual carrying out of the objects which are of charitable nature; and - protect them from hardship under first and second proviso to section 2(15) To ensure appropriate balance being drawn between - the object of preventing business activity in the garb of charity and - at the same time protecting the activities undertaken by a genuine organization as part of actual carrying out of the primary purpose of the institution Taxation of Charitable Trusts 11

Definition of charitable purpose – proviso to section 2(15) (cont. ) If “and” construed as imposing cumulative conditions, then, intent not fulfilled: • may not even cover charitable institutions whose gross receipts from business < Rs. 25 lakhs. - the activities mentioned in the Memorandum such as publishing books will continue to be put to hardship. • even if an institution is solely engaged in a business in the course of actual carrying out of the object, yet it will not be satisfying the definition of charitable purpose! • the higher the receipts of an institution in the actual course of carrying on the activity, four times higher is the requirement of other receipts! • Exemption to genuine charitable activity depends on quantum of unrelated donations and other receipts! 07 -11 -2015 Taxation of Charitable Trusts 12

Definition of charitable purpose – proviso to section 2(15) (cont. ) View 2: exception to the proviso (first limb) will apply even if one of the conditions is fulfilled • • 07 -11 -2015 “and” could be construed as “or” - to carry out the intention of the legislature [Ishwar Singh Bindra v. State of U. P. , AIR 1968 SC 1450 cited in P. V. Devassy v. CIT, (1972) 84 ITR 502 (Ker)] - to avoid absurd consequences that would follow if the words are taken in their literal sense [CIT v. Puthuthotam Estates (1943) Ltd. , (1981) 127 ITR 481 (Mad)] literal interpretation to be avoided if it produces an absurd and unjust result [K. P. Varghese v. ITO, (1981) 131 ITR 597 (SC); CIT v. J. H. Gotla, (1985) 156 ITR 323 (SC)]. Applying the above rules of interpretation, in view of the harsh, unjust and absurd results under view 1 and to fulfil the intent, ‘and’ should be read as ‘or’. Conscious use of ‘unless’ v. second proviso Taxation of Charitable Trusts 13

Broad scheme of computation of income under s. 11 a. b. c. d. Gross receipts (excluding corpus donations) Less: deductions Income derived from property held under trust [s. 11 (1)(a)]. [a – b] Less: i) application of income in India [s. 11(1)(a)] ii) “deemed” application of income [s. 11(1)(a) r. w. Expl. (2) to s. 11(1)] iii) “basic” accumulation up to 15% of income [s. 11(1)(a)] iv) “secondary” accumulation for 5 years up to 85% [s. 11(2)] v) application of capital gains [s. 11(1 A)] vi) anonymous donations (taxed separately under s. 115 BBC @ 30%) [s. 13(7)] e. Add: i) income chargeable under section 11(1 B) II) “deemed income” [s. 11(3)]. iii) business income not incidental to attainment of objects [s. 11(4 A)] iv) value of medical or educational services to interested parties [s. 12(2)] v) income which is not derived from property held under trust. 07 -11 -2015 Taxation of Charitable Trusts 14

Corpus donations [s. 11(1)(d)] • • • Voluntary contributions made with a specific direction that they shall form part of the corpus of the trust are exempt Whether donations for specified purposes (say, acquiring a capital asset) with no reference to the term ‘corpus’ can be treated as corpus donation? [CIT v. Sthanakvasi Vardhaman Vanik Jain, (2003) 260 ITR 366 (Guj); St. Ann’s Home for the Aged v. ITO, (1980) 10 TTJ 144 (Bang)] Whether corpus donations can be utilized towards objects of the trust? - For capital purposes - For revenue purposes Implications of utilisation of corpus donations towards revenue purposes - Breach of trust? - Cancellation of registration? - Corpus donation to be treated as income? - Utilisation to be treated as application of income? Basic accumulation of 15% not available on corpus donations. 07 -11 -2015 Taxation of Charitable Trusts 15

Income Meaning of ‘income’ • Commercial or book income or ‘real’ income, subject to statutory modifications [Circular No. 5 -P(LXX-6) dt. 19 th June 1968, para 4] or Computation as per the provisions of the Act, including s. 14? • Whether following items deductible in computing income? - Depreciation debited to the accounts of a trust > full cost of asset allowed as application of income > other assets [CIT v. Society of the Sisters of St. Anne, (1984) 146 ITR 28 (Kar)] - Expenses for earning or looking after income - Management charges for looking after and managing affairs [CIT v. Lucknow Diocesan Trust Association, (1980) 123 ITR 38 (All)] - Rebate under s. 24(a) for income from house property [ACIT v. Nandlal Tolani Charitable Trust, (2014) 42 taxmann. com 154 (Mum Trib) (Not allowable)] • ICDS – whether applicable? 07 -11 -2015 Taxation of Charitable Trusts 16

Application of income [s. 11(1)(a)] Meaning of ‘application of income’ The word “applied” • means “to put to use” or “to turn to use” or “to make use” or “to put to practical use” [CIT v. Maharana of Mewar Charitable Foundation (1987) 164 ITR 439 (Raj); CIT v. Shri Plot Swetambar Murti Pujak Jain Mandal (1995) 211 ITR 293 (Guj); para 5. 5(i) in “Assessment of Charitable Trusts and Institutions” published by the Income-tax Department] • is wider than “expended” and the money need not go out irretrievably, when it is “applied” to a purpose [CIT v. St. George Forana Church (1988) 170 ITR 62 (Ker)]. 07 -11 -2015 Taxation of Charitable Trusts 17

Application of income [s. 11(1)(a)] (cont. ) Illustrations of ‘application of income’ • • • Acquisition of a capital asset for fulfilling a charitable purpose or promoting the objects of the trust. - Para 5. 5(i) in “Assessment of Charitable Trusts and Institutions published by the Income-tax Department - Sathya Vijay Patel Hindu Dharamshala Trust v. CIT, (1972) 86 ITR 683 (Guj) Deficit of earlier years. - CIT v. Shri Plot Swetambar Murti Pujak Jain Mandal, (1995) 211 ITR 293 (Guj) - CIT v. Institute of Banking Personnel Selection, (2003) 264 ITR 110 (Bom) Repayment of a loan taken for the purposes of the trust. - CBDT Circular No. 100 dated 24 th January 1973, (1973) 88 ITR 66 (St) - Para 5. 5(i) in “Assessment of Charitable Trusts and Institutions” published by the Income-tax Department - DIT v. G. K. R. Charities, (2012) 21 taxmann. com 45 (Chennai) (cost of assets for which loan taken already allowed as application of income) 07 -11 -2015 Taxation of Charitable Trusts 18

Application of income [s. 11(1)(a)] (cont. ) Illustration: Income Capex on objects Other expenditure on objects of the trust (Deficit) Loan taken / (repayment of loan) Year 1 100 60 80 (40) 40 (Rs. In lakhs) Year 2 200 140 (40) Whether the following are application of income in year 2: - Deficit of year 1? - Repayment of loan? Illustrations of situations/payments not resulting in ‘application of income’ • Application of income outside India. Whether s. 40/40 A/43 B applicable to an institution not having business income? 07 -11 -2015 Taxation of Charitable Trusts 19

Deemed application of income [s. 11(1)(a) r. w. Expl. (2) to s. 11(1)] Income applied in a subsequent year shall be deemed to be income applied in the first year, subject to option for such deeming to be exercised • before expiry of time for filing ROI under s. 139(1); • in prescribed form and manner Illustration: Income Application of income in Year 2 Basic accumulation (15% of income) Taxable income in Year 1 (Rs. In lakhs) 100 70 15 15 Nil Whether option can be exercised for an amount exceeding 15%? See CIT v. G. R. Govindarajulu & Sons, (2015) 61 taxmann. com 400 (SC), TS-552 -SC 2015 07 -11 -2015 Taxation of Charitable Trusts 20

Basic accumulation up to 15% of income [s. 11(1)(a)] If entire income is not applied or deemed to be applied, but some income is accumulated, the accumulated income to the extent of 15% of income would be exempt from tax. • Basic accumulation is not a standard deduction but only to the extent of income accumulated or not spent. Illustration: (Rs. In lakhs) Income Application Basic accumulation (15% of income or income not applied, whichever is lower) 07 -11 -2015 Taxation of Charitable Trusts 100 90 10 21

Basic accumulation up to 15% of income [s. 11(1)(a)] (cont. ) • Should there be a conscious act and a clear indication on the part of the trustee to accumulate / set apart the income? Yes: - H. E. H. Nizam’s Religious Endowment Trust v. CIT, (1966) 59 ITR 582 (SC); - CIT v. State Bank of India (1988) 169 ITR 298 (Bom); - ACIT v. Bhopal Campion School Society, (2011) 14 taxmann. com 59 (Ind). No: - Mohanlal Hargovind Das Public Charitable Trust v. CIT, (1980) 122 ITR 130 (MP); - CIT v. Estate of B. P. Kayan Trust, (1985) 155 ITR 60 (Cal); - V. Ramakrishna Charitable Trust v. DDIT, (2015) 62 taxmann. com 297 (Chennai Trib) 07 -11 -2015 Taxation of Charitable Trusts 22

Secondary accumulation for 5 years up to 85% • • If 85% of income is not applied, it could be accumulated or set apart such income would be exempt from tax in first year, if - Prescribed statement filed with AO on or before due date for filing ROI - ROI filed on or before due date for filing ROI - it is applied in subsequent 5 years - Invested in accordance with s. 11(5) Illustrations a. Income b. Application c. Basic accumulation up to 15% of income d. Secondary accumulation [s. 11(2)] e. Total income (a-b-c-d) Situation 1 100 80 15 5 Nil (Rs. in lakhs) Situation 2 100 Nil 15 85 Nil Purpose of accumulation Whether a charitable trust can list all its objects as purposes for accumulation of income or whether purpose to be concrete and specific? 07 -11 -2015 Taxation of Charitable Trusts 23

Capital gains exemption [s. 11(1 A)] • • Capital gains is deemed to be applied if whole or part of net consideration is utilised for acquiring another capital asset. Exemption applies to all gains, whether short term or long term Utilization has to be made before year end even if capital gains is earned just before the year end. However, - option under Expl. (2) to s. 11(1) (“deemed application”) can be exercised; or - secondary accumulation under s. 11(2) can be opted. Fixed deposit with a bank – whether capital asset? Period for which new asset to be held • View 1: Six months [Instruction No. 883 dated 24 th September 1975]. • View 2: up to year end [Dalmia Charitable Trust v. ITO (1986) 15 ITD 480 (Del)]. • View 3: less than six months [CIT v. Hindustan Welfare Trust (1994) 206 ITR 138 (Cal) (60 days)]. 07 -11 -2015 Taxation of Charitable Trusts 24

Circumstances in which a charitable trust is not entitled to the special dispensation under s. 11 [s. 13] • Any part of the income of a private religious trust does not enure for the benefit of the public [s. 13(1)(a)]. • Any income of a trust established after the commencement of the Act is for the benefit of any particular religious community or caste [s. 13(1)(b)] • Income or property of trust is used or applied for benefit of “interested parties” [s. 13(1)(c) read with s. 13(2)]. • Funds of the trust are invested or deposited contrary to the mode prescribed in s. 11(5) [s. 13(1)(d)] and the case is not covered by s. 13(4). 07 -11 -2015 Taxation of Charitable Trusts 25

Trust for the benefit of any particular religious community or caste [s. 13(1)(b)] Meaning of “for the benefit of” any particular religious community or caste. 07 -11 -2015 Taxation of Charitable Trusts 26

Use of income or property of a trust for benefit of interested parties [s. 13(1)(c)] Conditions for applicability • Any part of income enures under the trust deed for benefit of interested parties or • Any part of income or property of the trust is used or applied directly or indirectly for the benefit of interested party Consequences • Income of the trust is denied exemption. • Recognition for exemption under s. 80 G could be withdrawn. • Registration could be cancelled [s. 12 AA(4)]. • Exemption under s. 10 would be available. Analysis • Prohibition applies to use of any “income or property”, that is, even exempt income, corpus donations, etc. • Applies even if a single default irrespective of the smallness of amount or period of use of benefit? 07 -11 -2015 Taxation of Charitable Trusts 27

Investments contrary to prescribed modes [s. 13(1)(d)] Conditions for applicability • Such funds of trust are “invested” or “deposited” otherwise than in a mode under s. 11(5); or • Shares in a company (other than a public sector company) are held by the trust Exemptions • any asset of the type referred to in (a) or (b) above is not held after the expiry of one year from the end of the previous year in which it is acquired; • funds representing profits and gains of business. Consequences • Whether full income (including voluntary contributions and corpus donations) or only income from such investments loses exemption? • Recognition for exemption under s. 80 G could be withdrawn. • Registration could be cancelled [s. 12 AA(4)] • Exemption under s. 10 would be available. 07 -11 -2015 Taxation of Charitable Trusts 28

Investments contrary to prescribed modes [s. 13(1)(d)] (cont. ) Analysis • Prohibition applies to investment of ‘funds’, that is, even exempt income, corpus donations, etc. • Gifts of shares / other assets – does it affect s. 13(1)(d)? • Acquisition of assets towards objects of the trust but not in accordance with s. 11(5) e. g. loans given – where s. 13(1)(d) applicable? 07 -11 -2015 Taxation of Charitable Trusts 29

Deemed use or application for benefit of interested parties [s. 13(2)] Income or property of trust shall be deemed to be used or applied for benefit of interested parties in the following situations: (a) (b) (c) (d) (e) (f) (g) (h) Loan to interested parties [s. 13(2)(a)] Use of movable or immovable trust property [s. 13(2)(b)] Payment of excessive salary or remuneration [s. 13(2)(c)] Inadequate consideration for service provided [s. 13(2)(d)] Purchase of investments at excessive price [s. 13(2)(e)] Sale of investments for inadequate consideration [s. 13(2)(f)] Diversion of trust income or property in excess of Rs. 1, 000 [s. 13(2)(g)] Investment in concern in which interested party has substantial interest [s. 13(2)(h)] 07 -11 -2015 Taxation of Charitable Trusts 30

Property for use of interested party [s. 13(2)(b)] Applies if any land, building or property of a trust is made available for the use of an interested party without adequate rent or other compensation. Illustrations: • • • includes movable and immovable property. refrigerator kept at residence of managing trustee without adequate rent or compensation [Agappa Child Centre v. CIT, (1997) 226 ITR 211 (Kar)]. FDRs of the trust used for raising loans for an interested party without any compensation or security [Society for Integrated Development in Urban and rural Area, (2004) 90 ITD 493 (Hyd)]. 07 -11 -2015 Taxation of Charitable Trusts 31

Excessive remuneration to interested party [s. 13(2)(c)] • • Reasonable salary is not barred [DIT v. Parivar Seva Sansthan (2002) 254 ITR 268 (Del)]. Applies to all services including property on rent [see New Noble Educational Society v. CCIT (2011) 334 ITR 303 (AP)]. 07 -11 -2015 Taxation of Charitable Trusts 32

Interested parties [s. 13(3)] • Interested parties include - Author or trustee of a trust - Founder or manager of an institution - Person whose contribution > Rs. 50, 000 - Relatives of aforesaid persons - Concerns in which aforesaid persons have a substantial interest • Manager of a trust vis-à-vis manager of an “institute” [CIT v. Rai Bahadur Biseswarlal Motilal Kalwasiya Trust, (2001) 252 ITR 84 (Cal)]. • Substantial contribution has to be calculated on the basis of total contribution during the life of the trust [CIT v. Charat Ram Foundation, (2001) 250 ITR 64 (Del)]. 07 -11 -2015 Taxation of Charitable Trusts 33

S. 10(23 C) Fourteen categories, including • • Educational institution existing solely for educational purposes and not for profit - with receipts ≤ Rs. 1 crore [s. 10(23 C)(iiiad)] or - approved by prescribed authority [s. 10(23 C)(vi)] Hospital, etc. existing solely for philanthropic purposes and not for profit - with receipts ≤ Rs. 1 crore [s. 10(23 C)(iiiae)] or - approved by prescribed authority [s. 10(23 C)(via)] Institution established for charitable purpose and approved by prescribed authority having regard to its objects and its importance throughout India or any State any institution wholly for public religious purposes or public religious and charitable purposes approved by prescribed authority having regard to the manner in which the affairs of the institution are administered and supervised for ensuring that its income is properly applied to the objects; 07 -11 -2015 Taxation of Charitable Trusts 34

S. 10(23 C) (cont. ) Which income is exempt? Exemption under s. 10 not available (except agricultural income) [Expl. to s. 10(23 C)] Third proviso to s. 10(23 C) : • Applies to institutions covered by sub-clause (iv), (vi), (via) • Income to be applied wholly and exclusively to its objects - Application could be towards capital expenditure or revenue expenditure - Accumulation > 15% to be applied in next 5 years, that is, 85% of income to be applied in 6 years - Expl. (2) to s. 11(1), 11(1 A), 11(2) and 11(3) are not applicable - No forms to be filled for accumulation and application in year 2 to year 6. • Investments in accordance with s. 11(5) Thirteenth proviso to s. 10(23 C) • Approval liable to withdrawn if, interalia, violation of third proviso. 07 -11 -2015 Taxation of Charitable Trusts 35

S. 80 G Deduction available to donor if the donee charitable institution is approved Some conditions for approval: (a) Income of institution not liable to inclusion in total income (b) Institution not for the benefit of any particular religious community or caste (c) The institution is for charitable purpose (which does not include any purpose the whole or substantially the whole of which is of a religious nature). However, if expenditure of religious nature < 5% of its total income purpose deemed to be charitable purpose [s. 80 G(5 B)]. • Whether even one purpose should not be of religious nature? [Upper Ganges Sugar Mills Ltd. v. CIT, (1997) 227 ITR 578 (SC)]. • Prayer hall and places of worship constitute religious purpose [Upper Ganges Sugar Mills Ltd. v. CIT, (1997) 227 ITR 578 (SC)] (d) The institution has maintained regular accounts of receipts / expenditure. 07 -11 -2015 Taxation of Charitable Trusts 36

Thank You 07 -11 -2015 Taxation of Charitable Trusts 37