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 recent times, numerous trusts and institutions have faced notices denying their income tax exemptions, often leading to significant challenges. Despite adhering to the provisions of the Income Tax Act, certain activities of these entities are being interpreted as business purposes, resulting in the denial of exemptions. Additionally, exemptions are frequently rejected on grounds such as failure to meet the 85% income application requirement or disallowance of capital expenditures, even when such expenditures align with the primary objectives of the trust or institution.
This article aims to provide insights into how trusts and institutions can address these show-cause notices, defend their eligibility for exemptions, and ensure their rightful claims under Section 11 of the Income Tax Act. Let’s delve deeper into this critical issue and explore practical approaches to challenge these denials effectively.
Common Grounds for Denial of Tax Exemptions
- Misinterpretation of Activities as Business Purpose
- In many cases, authorities classify certain activities of trusts as commercial or business-related, leading to the conclusion that the trust is not operating exclusively for charitable purposes.
- Non-Compliance with 85% Income Application Rule
- Section 11 mandates that trusts apply at least 85% of their income toward charitable purposes to qualify for exemptions. Failure to meet this criterion, whether due to timing mismatches or other factors, often results in exemption denial.
- Disallowance of Capital Expenditures
- Even when trusts utilize funds for capital expenditures aligned with their core objectives, these expenditures are sometimes disallowed by authorities, further complicating exemption claims.
How to Challenge Denial of Exemptions
Trusts and institutions can adopt the following strategies to respond to show-cause notices and assert their claims effectively:
1. Demonstrating Charitable Intent
- Clearly establish that all activities, even those interpreted as business-like, are integral to the trust’s charitable purpose.
- Maintain robust documentation, such as board resolutions, financial records, and project reports, to substantiate the charitable nature of activities.
2. Compliance with 85% Rule
- Provide detailed accounts to demonstrate compliance with the 85% application rule.
- If compliance was delayed or partially met due to legitimate reasons, submit explanations and seek the benefit of Section 11(2), which allows accumulation of income for specific purposes.
3. Justifying Capital Expenditures
- Emphasize the alignment of capital expenditures with the trust’s objectives by providing evidence such as project plans, beneficiary records, and utilization reports.
-
Highlight judicial precedents where similar expenditures were accepted as valid for exemption purposes.
Key Takeaways from various Court Verdicts
Understanding the nuances of what qualifies as “charitable purpose” under the Income Tax Act is critical for trusts and institutions seeking exemption under sections 11. The interpretations provided by various court rulings help clarify the application of these provisions. Below is an analysis of key legal precedents that shed light on the subject:
- Profit-Making and Charitable Purpose
If profit-making is the predominant objective of an activity, the purpose ceases to be charitable, even if it benefits the public. However, if the dominant intent is to achieve a charitable purpose and profit arises incidentally, the activity retains its charitable nature.
The exclusionary clause under the Act does not mandate that activities must result in zero profit. It suffices if profit-making is not the primary objective, making it feasible for trusts to operate without financial losses.
- Utilization of Profits
The mere generation of profits does not disqualify a trust from availing exemption under section 11, provided the profits are utilized for the charitable purposes outlined by the trust.
Consistent application of profits for specified purposes ensures eligibility for exemption, as noted in multiple legal precedents.
- Capital Expenditure as Charitable Purpose
Capital expenditures such as constructing school buildings or developing infrastructure are considered charitable if aligned with the main objectives of the trust. This principle was upheld in case of Pinegrove International Charitable Trust vs. Union of India.
Judicial Precedents
- CIT vs. Surat Art Silk Cloth Manufacturers Association (121 ITR 1 SC):
Dominant charitable intent is key. Ancillary non-charitable objectives do not invalidate the trust’s charitable status.
- Andhra State Road Transport Corporation vs. CIT (100 ITR 392 AP):
Operating on business principles and earning profits does not negate charitable status if the profits serve a public utility purpose, such as infrastructure development.
- ACIT vs. Thanthi Trust (247 ITR 785 SC):
Post-amendment provisions under section 11(4A) allow businesses incidental to a trust’s objectives to claim exemption, provided the income is utilized for charitable purposes.
- Surat City Gymkhana (300 ITR 214 SC):
Registration under section 12A is binding and precludes the AO from re-evaluating the trust’s charitable status.
- Madhya Pradesh Madhyan vs. CIT (256 ITR 277 MP):
Registration under section 12A is definitive for recognizing a trust’s charitable objectives.
- Manav Mangal Society Case:
Expenditure on capital assets like school buildings qualifies as income application for charitable purposes.
Non-application of 85% income alone does not disqualify exemption unless compounded by non-compliance with other conditions.
Determination of Charitable Status
Under sections 12A and 12AA, the Commissioner assesses the trust’s charitable status. Once granted, the Assessing Officer (AO) cannot question the trust’s eligibility unless the Commissioner revokes the registration.
The AO’s role is limited to verifying whether the income has been applied for charitable purposes and ensuring compliance with conditions like the application of 85% of income.
Essence of above Legal Precedents
Legal precedents affirm that:
- Profit generation does not inherently disqualify trusts from exemptions under section 11.
- Charitable status is determined by the dominant purpose and genuine activities of the trust.
- Registration under section 12AA ensures eligibility unless revoked by the Commissioner.
In essence, adherence to charitable objectives, genuine utilization of income, and compliance with statutory conditions are critical for trusts and institutions to retain their tax-exempt status.
Key Considerations for a Strong Defense
- Engage Expert Legal Support: Collaborating with tax consultants or legal experts can help trusts build a compelling case and navigate technical nuances.
- Timely Response: Ensure prompt and well-documented replies to show-cause notices to avoid adverse rulings.
- Cite Relevant Precedents: Leverage judicial decisions and rulings that support the trust’s stance.
- Transparent Financial Practices: Adopt transparent and accountable financial practices to preempt doubts about the application of income.
Conclusion
Trusts and institutions play a pivotal role in driving social welfare and development. While tax exemptions are vital to their sustainability, the increasing trend of denial notices poses a serious challenge. By adhering to statutory requirements, maintaining robust documentation, and proactively addressing notices, trusts can defend their claims effectively and secure the benefits they rightfully deserve under Section 11 of the Income Tax Act.
This comprehensive approach not only safeguards the interests of trusts but also ensures the continuity of their valuable contributions to society.
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