In this article, Kavya Lalchandani discusses Charitable Institutions and Tax Planning.
Charity is mainly an altruistic activity which predominantly is done for the benefit of other that is to say public as a whole. When an individual through an institution or an institution itself is involved in such a noble activity is the duty and responsibility of the state to not tax the income of such an institution at least in part, at the same time the state is also endowed with the responsibility of keeping a check on the misuse of exemptions so provided.
In India, the forms of charitable institutions that are most commonly found are of three basic types: Trust, Not for Profit Companies (Section 8 Companies in the Companies Act, 2013) and a Society run for Charitable Objects. Trust is defined under the Indian Trusts Act, 1882 as “obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the owner or declared and accepted by him, for the benefit of another, or of another and the owner.” It is not necessary that the Trust may be formed under a Trust deed but it is always desirable.
Section 8 (Previously Section 25) companies are governed by the Companies Act, 2013 and the allied rules in entirety. Any company which is incorporated for “promotion of commerce, art, science, sports, education, research, social welfare, religion, charity, protection of environment or any such other object” is eligible to be called as a Section 8 Company and is entitled for the exemptions as the case may be.
Section 20 of the Societies Registration Act, 1860 lays down the criteria (Science, Literature and charitable purpose) which would enable a society to be able to claim exemptions under the Income Tax Act. Some of the grounds for the same are
To answer the question as to what practices should be adopted by the Charitable Institution while doing tax planning we need to answer two questions in terms of law firstly, What do you mean by charitable Institutions and secondly, what is meant by tax planning.
To see what practices can be adopted by charitable institutions in order to do tax planning we have to look into the legal requirements under the Income Tax Act, 1961 to be complied with for the same. There are specific sections under the Act that deal with the exemptions for charitable institutions.
While the definition of Charitable Institution is given under the Income Tax itself under Section 2(15), tax planning is not defined under the Act.
Tax Planning has to be differentiated from illegal practices like tax avoidance or tax evasion. Tax planning is legal and means how an individual or an institution (tax payer) can plan his taxes in order to avail deductions under the provisions of Income Tax Act. Tax Planning can be short term or long term but in order to avail its benefit, individuals and institutions have to plan beforehand so as to get the benefit of deductions and rebates under the Act.
Charitable purpose is the key factor in claiming any exemption and therefore it defines the kind of business to be done for claiming such benefit. There can be subjective approach as to what constitutes as charitable and what not but the law is clear on that point and is still evolving. Although there can be lot of acts which are charitable but when it comes to exemptions, only those acts which are mentioned under Section 2(15) of the Act are entitled to exemption.
According to Section 2(15) of the Act, Charitable Purpose includes any act that can be related to advancement of a public as a whole, i.e., “relief of poor, medical relief and education, or any activity that helps in advancement of any other object of general public utility.” It concentrated more on philanthropy rather than earning monetary gains.
There can be several objects of the trust but the Courts will look into the dominant purpose of the trust and will decide on the basis of the fact that if that very purpose is of charitable or non-charitable in nature.
The Assessment Year 2009-2010 was an important year for charitable institutions and trusts as prior to this year all the charitable institutions and trusts were easily exempted to pay taxes provided activities were done to attain its objectives mentioned and separate books of accounts were maintained for the same. But after this assessment year, the “advancement of any other object of general public utility” now does not include any object when the same is carried out for a consideration that is to say when the object is carried out as a trade or business.
It is also to be noted that the definition has been increased in its scope to include preservation of environment and monuments. However, providing employment does not come in the ambit of this definition as it includes object that indirectly or directly benefits by providing relief. It is not necessary that the activity should benefit the mass (public) as a whole but individuals who can be identified based on a certain common criteria in contrast to benefitting only a particular individual.
The objects that are carried out by an institution should be specific and if they are too wide, they might not be able to fit into the criteria under the Act and would not fall within the provisions in order to claim exemptions in the form of rebates or deductions.
While first three criteria i.e. Relief of the poor, education and medical relief have a fairly limited scope, the term “general public utility” is wide in its ambit and perhaps will have to be defined with the help of application of judicial minds of the courts. For instance, the object of the trust, the way in which the funds are being utilised are some of the factors that can be considered by the Court. Very specifically the Honb’le Supreme Court has gone into the objects of the trust and institutions, for example Chamber of Commerce since was established without any profit motive under the Section 25 of the Companies Act, 1956 (now Section 8 of the Companies Act, 2013) had to be declared as a charitable institution because of the dominant objects of the institution. The term general public utility has to be understood with respect to the surrounding circumstance, no statute has defined this term and the term cannot possible is defined because of wide nature of it. While on one hand wildlife protection is one activity that is included on the other hand state bar councils set up in order to promote the quality and competency of lawyers would also be included in the same. Similarly maintenance of a public park or public ground would also be covered in its ambit.
When it comes to religious purposes any contribution to public religious trusts are covered under the exemption but private religious trusts are not covered in its ambit. The exemptions under the Act do not cover religious trusts for specific purpose.
It is the object itself and not accomplishing it which has to be seen. The activity would be for profit motive if the predominant purposes of carrying on such activity would be to earn profit and in some other cases where the trust deed states clearly that the dominant object is to make profit out of the business.
The exemptions under the Income Tax Act, 1961 which are available to trusts and institutions which are created for charitable purposes are available to Section 8 Companies also since they are also formed without any motive of earning profit. An educational institution may also be entitled to an exemption under the Act.
Requirements under the Income Tax Act, 1961
Firstly, income under the Section 2(24) (ii-a) of the Act states that income includes any voluntary contributions received by any trust or any other institution mentioned under the Act which may be wholly or partly be established for religious or charitable purposes.
Further, Sections 10(23B), 10(23BBA), 10(23C), 11, 12, 12A and 13 deal with exemptions available to the religious trusts and charitable institutions. Exemptions under Section 10 and its various sub sections are exclusive and constitute as separate grounds for exemption than to exemptions available under the sections 11, 12 and 13.
Section 11, 12, 12 A and 13 deal with essential conditions required to be followed for claiming the exemptions for tax on income of the trusts or charitable institutions under the Act. If the income generated by the institution is allocated to the promotional activities of the trust then that portion of income becomes non-taxable. It is advisable for such institutions to retain the details of the donor while accepting donation; lack of proof may lead to non-eligibility of claiming exemption.
While there are no or less legal formalities for creating a charitable trust or institution, there are significant procedure attached to acquiring and allocating properties of the trust and charitable institutions. Therefore, a trust deed may or may not be created if there is a clear intention to show that intention was to create a charitable trust. There should be three clear cut things in order to establish an institution as a charitable institution: “declaration of trust binding on settler, setting apart of a definite property depriving settler of the ownership of the property and a statement of objects for which the property is held.”
- The Trust or the institution should have been firstly registered under Section 12A for claiming the benefit under sections 11 and 12 of the Act. The Commissioner has to register the trust with keeping in mind the provisions of the Act because it gives identity to the trust for claiming the exemptions under the Act. The objects of the trust are to be strictly complied with while granting registration and any change of objects after the registration has been granted, will lead to lapse of right of exemption and allied rights of the trust or institution which had been granted the registration for that very purpose.
- Further under 12A, the delay may be condoned by the Commissioner and it will operates since the day of creation of the trust once the registration is granted.
- Any income generated through property according to Section 11 should be generated through a property which is held under the trust’s name and is used for the objects of the trust which should be for the benefit of the public and not for fulfilling any requirements of trade or business of any individual. For instance, if the trust is created only for benefitting the poor relatives of the settler the trust would not be exempted even though it remotely does benefit the community. In case of any ambiguity with relation to the objects other extraneous factors should be considered.
- The burden of proof for proving whether or not property held by the trust is for charitable or religious purposes is on the trust (Assessee) and not the assessment officer.
- Such property should be held wholly and not partly by the trust or the institution. Such property shall not also be only to be used for a specific religious community or caste. Therefore, when the proceeds of renting a marriage hall were donated for charitable purposes, the income to the tune of the amount donated was exempted to be taxed. In the leading case of CIT v Krishna Warriar the Supreme Court had concluded with regards to the property partly held that any trust created before 1962 enjoys the exemption for property partly held where as trusts created after that do not enjoy the benefit and have to hold the property as a whole.
- The income generated by the property should be generated by carrying out the objects of the trust within India. The income can be yearly or accumulated for application of any of the charitable or religious purposes. Section 11 is very specific about the term property and would not for instance cover any donations for charitable purposes out of professional fees earned by an advocate or any other person.
- It also includes property held under legal obligations which means to include any property which may be in the possession because of order of the Court, Wakfs etc.
- If the trust holds any business undertaking then the income so long as it used for the charitable purposes is valid for exemption but when the income of such undertaking goes beyond the said purposes in the opinion of the Assessor then it will become taxable income.
- In any year where the income exceeds the amount of Rs. 50,000 the accounts have to be mandatorily be audited and report along with return of income will have to submitted.
Income available for ‘Application to Charity’ means total income minus the expenses and charges of the trust. Such income also includes and earmarked allocation in favour of the beneficiary. And accumulation of money in a reserve account for meeting the future contingencies also would be considered as exempted income under the assumption that the fund is going to be used for charitable or religious purposes.
- In the case of accumulation of profits from the above mentioned property cannot be more than fifteen percent of the total income derived from the property. The total income here means total receipt (proceeds) from the property and not the income assessed. It is best to utilise eighty five percent of the income in that very accounting year in order to claim the full exemption under the Act.
- In case the trust needs exemption for more than fifteen percent in a particular year, it has to fill the form 10 under Rule 17 and give a notice to the assessing officer before the assessment is completed.
- The accumulation of such income cannot be done for more than 5 years which excludes the period where such income is not being utilised or has been on injunction by the order of the Court. Such accumulation should be for a specific purpose. Donation by one charitable institution to another charitable institution for a specific purpose is valid application of the income and well within the ambit of exemption.
- While, Section 11 of the Act deals only with income derived from property, the voluntary contributions are covered under Section 12.
- Section 12 is an extension of the previous section where in it states that when the trust or any other institution is wholly created for charitable or religious purposes, any voluntary contributions which are not to be utilised in a specific direction of the corpus will be presumed under Section 11 to be wholly for charitable purposes.
In this scenario, it is proper to note where voluntary contributions are taxable and where they are not. In case the trust or the institution is registered under the Section 12AA of the Act the contributions are not taxable and if not then voluntary contributions towards a specific direction are taxable. Here, Voluntary contribution is not decided by the willingness of the person to contribute but means gratuitous contribution without any consideration.
- Section 12 further states that any medical or educational services give to persons referred to in clauses a, b, c, cc and d of the Section 13(3) which will be discussed later would also be covered under income from property as stated under Section 11(1).
As per Section 13 of the Act following incomes would not be exempt under the Act which is to say under Section 11 and Section 12 of the Act:
- If the property held by the institution or the trust is not for the benefit of public as a whole or is held for a particular religious community.
- If any part of income ensure (trust established after the Act commenced in its operation) or is applied (whenever created) to the benefit of author or founder of the trust, any person who has substantially contributed towards the trust (person contributing more than Rupees 50,000 in any previous year), where the above mentioned persons belong to an HUF (Hindu Undivided Family) and are members of that family, trustee or manager of the trust or institution or any relative of the above mentioned persons or any concern that might have been set up which has a substantial interest in the same. Section 13(2) clearly states about the scope of applied income in the favour of such persons.
- If any shares are held by the trust or institution in a public sector company or invested in the prescribed mode. Dividend income which is derived from the shares which were donated to the trust are exempted however when it itself purchases such shares Section 13(2) (h) has to be kept in mind.
Apart from these sections Section 80G has various provisions which talk about deduction with regards to donations to charitable institutions.
Therefore, when it comes to charitable institutions’ tax planning following incomes are to be kept in mind:
- Nature of the trust or institution.
- Nature of income from property or otherwise
- Donations received if any and their utilisation
Any income received that is not related to the purpose of such institution or trust is not eligible for claiming an exemption under the Act. In fact the income tax would be charged at a maximum rate of 30%.
Thus, all the above three factors with the relevant sections in the Income Tax Act, 1961 as stated above are required to be kept in mind while tax planning and to claim maximum exemption under the provisions of the Act.
 Income Tax Act 1961, s. 2(15).
 East India Industries v. C.I.T., 65 I.T.R. 611.
 Yograj Charity Trust, 103 I.T.R. 777(SC).
 C.I.T. v. Andhra Chamber of Commerce, 130 I.T.R. 184.
 C.I.T. v. Bar Council of Maharashtra, 130 I.T.R. 28.
 Hanmantram Ramnath v. C.I.T., 14 I.T.R. 716.
 New Life Association v C.I.T., 246 I.T.R. 532.
 Allahabad Agricultural Institute v. Union Of India, 291 I.T.R. 116.
 Anand Marg v. C.I.T., 218 I.T.R. 254.
 Gordhandas Govindram Family Charity Trust v. C.I.T., 21 I.T.R. 231.
 C.I.T. v. Sri Narayana Guruviah Chetty Estate and Charities, 326 I.T.R. 662.
 C.I.T. v. Krishna Warriar, 53 I.T.R. 176.
 C.I.T. v. Thakardas, 40 ITR 301.
 Charitable Gadodia Swadeshi Store v. C.I.T., 12 I.T.R. 385.
 C.I.T. v. Programme for Community Organisation, 248 I.T.R. 1.
 Income Tax Act 1961, s. 11(2) Proviso.
 D.I.T. v. Singhania Trust, 199 I.T.R. 819.
 C.I.T. v. Nagi Reddy, 241 I.T.R. 431.
 Society of Writers v. I.R., 2 T.C. 257.
 Income Tax Act 1961, s. 13(3).
 C.I.T. v. Ambalal Sarabhai Charity Trust, 212 I.T.R. 610.