The earning of profit per se would not disentitle the Trust, for exemption under sections 11 to 13 of the Act, unless the facts of the case warrant that the funds of the Trust have been misappropriated by the Trust.
As per section 11(a) of the Income Tax Act, exemption is allowed on income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied to such purposes in India; and, where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of 15% of the income from such property.
As per section 11(2) of the Income Tax Act, where 85% of the income is not applied, or is not deemed to have been applied, to charitable or religious purposes in India during the previous year but is accumulated or set apart, either in whole or in part, for application to such purposes in India, such income so accumulated or set apart shall not be included in the total income of the previous year of the person in receipt of the income, provided the following conditions are complied with, namely:
(a) Such person furnishes a statement in the Form-10 to the Assessing Officer, stating the purpose for which the income is being accumulated or set apart and the period for which the income is to be accumulated or set apart, which shall in no case exceed five years;
(b) The money so accumulated or set apart is invested or deposited in the forms or modes specified in sub-section (5); and
(c) The Form-10 is furnished at least 2 months prior to the due date specified under section 139(1) for furnishing the return of income for the previous year.
In-spite of following the above said provisions under income tax act, in many cases, it has been seen in recent past that, many of the trusts/institutions are served notices of denial of exemption by considering some of their activities as business purpose. Additionally, manytimes exemption is denied by department on the plea of failing to comply the 85% application of income or by disallowing capital expenditures even though those are spent for the main object of the trust or institution.
In this article we have tried to discuss how such show cause notices can be challenged by trusts and institutions and claim their genuine demand of exemption under section 11. Let us now delve into our analytical discussion on this topic.
Where profit-making is the predominant object of the activity, the purpose, though an object of general public utility would cease to be a charitable purpose. But where the predominant object of the activity is to carry out the charitable purpose and not to earn profit, it would not lose its character of a charitable purpose merely because some profit arises from the activity.
The exclusionary clause does not require that the activity must be carried on in such a manner that it does not result in any profit. It would indeed be difficult for persons in charge of a trust or institution to so carry on the activity that the expenditure balances the income and there is no resulting profit. The restrictive condition “that the purpose should not involve the carrying on of any activity for profit” would be satisfied if profit-making is not the real object.
The earning of profit per se would not disentitle the Trust, for exemption under sections 11 to 13 of the Act, unless the facts of the case warrant that the funds of the Trust have been misappropriated by the Trust.
Even, making of profits on regular basis, which has been utilized for the specified purpose, cannot be construed as expenditure not incurred for charitable purpose and this must be considered while deciding the exemption under section11..
The Hon’ble Jurisdictional High Court of P&H has also held in the case of Pinegrove International Charitable Trust Vs. Union of India and others, that the capital expenditure incurred by the Trust or Institution such as construction of school building or providing infrastructure etc is also in the nature of charitable purpose, if the purpose of such expenditure is to support the main object.
In the case of CIT Vs. Surat Art Silk Cloth Manufacturer Association 121 ITR 1 (SC), the Hon’ble Supreme Court held that, the dominant object had to be examined to see whether it was charitable and the existence of certain objects which may not be charitable in themselves but which were merely ancillary and incidental to the primary purpose would not prevent the trust or institution for a valid charity.
In the case of Andhra State Road Transport Corporation Vs. CIT 100 ITR 392 (AP), it was noted that not only the dominant but sole purpose of the assessee corporation was providing transport facilities to public, trade and industry and, therefore, it was for a charitable purpose and eligible for exemption under section 11..
It was further held that if the undertaking acts on business principles an element of profit was involved. No doubt, profit may result in the running of the enterprises, but the balance of the income by way of profit was again to be spent for a purpose of public utility i.e. development of roads. Hence, it was held to be entitled to exemption u/s 4(3)(i) of the I.T. Act, 1922 for assessment year 1960-61 and 1961-62.
In respect of assessment year 1962-63 also, when the 1961 Act had come into force, it was held that the purpose or object of the institution or concern should be public utility and not profit making and the assessee was held to be entitled to exemption u/s 11 of the I.T. Act. This decision of the Hon’ble High Court was approved by the Hon’ble Supreme Court in the case of Surat Art Silk Cloth Manufacturers Association and affirmed in the case of CIT Vs. Andhara Pradesh State Road Transport Road Corpn. 159 ITR 1 (SC).
In the latter decision the Hon’ble Supreme Court held that the assessee could not be expected or required to be run at a loss. The provision under the RTC Act that the assessee shall act on business principles could not, therefore, deprive the assessee from exemption u/s 11. Since the object of the corporation under the RTC Act was admittedly of general public utility within the meaning of section 2(15) and if the dominant object was to carry out charitable purpose and not to earn profit, the purpose would not loose charitable character merely because some profit arose from the activity. The assessee was held to be entitled to exemption u/s 11 of the Act.
In the case of ACIT Vs. Thanthi Trust etc. 247 ITR 785 (SC), it was held that after 1.4.1992, in view of the amended provisions of section 11(4A), a business whose income was utilized by the trust or the institution for the purposes of achieving the objects of the trust or the institution was a business which was incidental to the achievement of the objects of the trust and entitled to exemption u/s 11.
From the discussion above, it can be inferred that having profits per se does not disentitled an eligible trust or an institution from the exemption u/s 11 of the Act , if the sole or the dominant purpose of the trust or institution is charitable in nature.
The question whether a trust is charitable or not has to be examined with reference of its object and activities as to whether they fall within the purview of section 2(15) of the Act. A determination in this regard has to be made by the Commissioner u/s 12A and, after 1.4.1997, u/s 12AA. Once the Commissioner had made the determination that the trust was a charitable one, the AO is not entitled to re-examine the question as to whether the trust is charitable or not, as held by the Hon’ble Supreme Court in the case of Surat City Gymkhana 300 ITR 214 (SC).
During assessment the AO can only determine whether the income has been applied for charitable purpose. In light of the decision of the Hon’ble Supreme Court in the case of Surat City Gymkhana (supra), the AO was not empowered to take the view that the trust was not wholly for charitable purposes, since the CIT had granted registration u/s 12AA of the I.T. Act to the assessee. Section 12AA(3) grants power to the Commissioner to cancel the registration of the trust or institution if he is satisfied that the activities of the trust or institution are not genuine or are not being carried out in accordance with the objects of the trust or institution.
Hence, once the Commissioner has granted registration or u/s 12AA, it has to be taken that the objects of the institution and the genuineness of the activities of the trust are such that the institution is eligible for deduction of its income u/s 11. If the activities of the institution are not genuine or not in accordance with the objects, the Commissioner may cancel the registration granted earlier. The power of such cancellation is vested only with the Commissioner and not with the AO. The AO cannot determine that the objects of the instruction are not charitable.
If the AO believes so, he may bring this belief, along-with reason thereof to the knowledge of the Commissioner for determination as to whether the registration granted to the trust or institution should be withdrawn. However, till such time that the registration u/s 12A or 12AA is not cancelled, it has to be presumed that the trust or institution is charitable. Once that is so, the AO during assessment, cannot hold that the trust or institution is not ‘eligible’ for exemption u/s 11.
The AO can, of course, examine if the income from property held under trust has been applied for the stated charitable or religious purposes, and if there is an excess over 15% of the income not so applied, then whether the other conditions for allowing deduction of the unspent amount have been fulfilled.
For this proposition, I draw support from the decision in the case of Madhya Pradesh Madhyan Vs. CIT 256 ITR 277 (MP), in which it has been held that once registration has been granted u/s 12A, I.T. Authorities were bound by the same. The Hon’ble Supreme Court have also held in the case of ACIT Vs. Surat City Gymkhana that registration u/s 12A was a fait accompli to hold the AO back from further probe into the objects of the Trust.
Considering the facts of the case and the decisions discussion above, I hold that the AO is precluded from examining the eligibility of the trust or institution for exemption u/s 11, though he may examine if the income has been applied for charitable purposes.
Interpretation of charitable purposes u/s 2(15) has been done by several courts including by the Hon’ble Supreme Court in the lite of exemption under section 11.
As has been discussed earlier, merely making of profits or of surplus will not disentitled an eligible trust from exemption u/s 11 of the Act as long as the objects of the trust are charitable, its activities are genuine and the income is applied towards the charitable purposes authorized to be undertaken by the trust or the institution; conversely, if the income is diverted to persons mentioned in section 13 of the Act or is spent for purposes which are not charitable, exemption may be denied to the assessee trust or institution.
In a recent decision in the case of CIT Vs. Manav Mangal Society, the Hon’ble Jurisdictional High Court in IT Appeal No.450 of 2008 dated 19.08.2009 (reported in 28 DTR (P&H) 129) have upheld the grant of exemption u/s 11 of the Act to the society. Two questions of law were raised before the Hon’ble High Court.
The first question was whether in the facts and circumstances of the case the ld. Tribunal erred in law in allowing the exemption to the assessee u/s 11(1)(a) instead of exemption of 11(4A) because as per aims and objects and therefore, the establishment of school was incidental to promoting the aims and objects of the charitable societies/institutions.
The second question was whether the ld. Tribunal erred in allowing the application of money on construction of building when no verification was done by AO nor was it put to the AO during the assessment proceedings.
Besides, the construction of the building had been taken directly into the balance sheet and not into the income and expenditure account by the assessee and it was held by the Hon’ble Uttarakhand High Court in CIT Vs. Queens’ Educational Society 223 CTR (Uttarakhand) 395.
It was held that investment in fixed assets like furniture and building were the properties of the society and may be connected with imparting of education but the same had been constructed and purchased out of income from imparting the education with a view to expand the institution and to earn more income and also referring to the decision of Hon’ble Supreme Court reported in (1992) 3 SCC 390 agreeing with the findings of the High Court.
The Hon’ble Jurisdictional High Court noted that the AO had rejected the claim on the ground that the assessee had not applied 85% of the profits for the purposes of the society. The CIT(A) reversed this view taking into account the fact that the assessee had spent an amount equal to more than 85% after considering the application of income for charitable purposes.
It was held by the CIT(A) that the amounts spent on construction of school building at Panchkula was capital expenditure but for the purpose of section 11 it was an outgoing which was application of the income of the assessee for charitable purposes and this shpould be considered for the purpose of claiming exemption under section 11. .
He also held that the assessee would be entitled to claim depreciation on the school building. The assessee was carrying on no activity other than running a school and imparting education to the students: as such the assessee had applied his income when it constructed school building which amounted to applying income for charitable purposes only and allowing exemption should be considered.
The Hon’ble Tribunal confirmed the view of CIT(A) and held that the amount incurred for construction of the building did not violate the aims and objects of the assessee-society and the Revenue had not claimed that the expenditure was incurred for the personal benefit of the persons who were managing the society.
The Hon’ble Tribunal held that the income of the society would be covered u.s.11(4A) but sub-section (1), (2), (3) or (3A) would not apply to any income of trust or institution, being profits and gains of business, unless the business was incidental to the attainment of the objectives of the trust and separate accounts were maintained in respect of such business.
The Hon’ble High Court held that once exclusion contemplated u/s 11(4A) was not applicable, the exemption had to be allowed as sub-sections 11(1), 11(2) and 11(3) became applicable even in respect of profits and gains.
As regards the contention of Revenue that factually conditions laid down in section 11(2) did not exist as 85% of the income had not been applied in the manner contemplated, the Hon’ble High Court held that the same had not force. It was held that if 85% of income had not been applied in the manner laid down, it was not enough to disallow exemption unless there was a further condition of accumulation beyond contemplated period or not maintaining the accounts or not intimating the AO as laid down.
The mere fact that the assessee is earning income and 85% of the income has not been applied for charitable purpose is not sufficient to disallow exemption u/s 11 to the assessee unless the other conditions required are also not met.
Ref: EXEMPTION UNDER SECTION 11 OF INCOME TAX ACT, 1961
Also Read: CBDT Notification 6/2024: Mandatory E-Filing of Specified Forms under Rule 131
READ MORE
Direct Tax Vivad Se Vishwas (DTVSV) Scheme, 2024: A Comprehensive Guide
ITAT Jaipur Upholds Exemption of Capital Gains from Sale of Agricultural Land