Expenditures on charitable purposes can include capital expenditures. The nature of the expense in the hands of the recipient entity does not affect its eligibility as an application of income.
Section 11(1) of the Income-tax Act provides significant tax benefits to charitable trusts and institutions. It states that subject to sections 60 to 63, certain types of income shall not be included in the total income of the previous year. However, it is essential to understand the term “income” as referred to in section 11(1)(a), which differs from the term “total income” defined under section 2(45) of the Act.
Distinction between “Income” and “Total Income”
The term “total income” under section 2(45) refers to the amount computed as per the Act’s provisions. However, in section 11(1)(a), the term “income” is not restricted by such a definition. This differentiation was clarified by the Central Board of Direct Taxes (CBDT) in Circular No. 5 LXX-6 of 1968, dated June 19, 1968. According to the circular, the term “income” in the context of section 11(1)(a) should be interpreted in its commercial sense.
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Income in the Context of Charitable Trusts
The computation of income for charitable trusts should reflect the actual surplus available after deducting necessary expenses for earning or managing the income. This principle was upheld in several judicial pronouncements, including:
- C.I.T. v. Rao Bahadur Calavala Cunnan Chetty Charities: The Madras High Court ruled that income should be considered based on what is available to the trust after deducting necessary expenses, excluding artificial provisions used for tax assessments.
- C.I.T. v. Sheth Manilal Ranchoddas Vishram Bhawan Trust: The Court emphasized that depreciation should be deducted to compute the net income available for application towards charitable purposes.
Commercial Principles in Income Computation
Several High Courts, including those of Madras, Karnataka, Gujarat, and Calcutta, have consistently held that charitable trusts must compute their income on commercial principles. Depreciation and necessary expenses should be deducted to determine the net income.
Key rulings include:
- CIT v. Framjee Cawasjee Institute (Bombay High Court): Depreciation is a valid deduction for determining funds available for charitable purposes.
- CIT v. Institute of Banking Personnel Selection (Bombay High Court): Reaffirmed that depreciation must be accounted for in the income computation of charitable trusts.
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Treatment of Income from Various Sources
- Voluntary Contributions: In CIT v. Ashoka Charity Trust, the Calcutta High Court held that expenditure should first be considered as met from income derived from property held under trust, with no pro-rata allocation of expenditure.
- Mutuality and Subscriptions: The Bombay High Court in CIT v. Silk and Art Silk Mills’ Association Ltd. ruled that expenditures must be presumed to have been met out of taxable income first for section 11 purposes.
- Agricultural Income: Differing views exist regarding the inclusion of agricultural income in section 11(1)(a). While the Allahabad High Court (in CIT v. Panchayati Akhara Nirmal) allowed allocation of expenditures between agricultural and non-agricultural income, the Madhya Pradesh High Court (in CIT v. Nabhinandan Digambar Jain) excluded agricultural income, as it is exempt under section 10.
- Capital Gains: Losses on investments, such as in Hindusthan Welfare Trust v. Director of Income-tax (Exemption) (Calcutta High Court), cannot be deducted in the computation of real income of a trust.
Application of Income for Charitable Purposes
Expenditures on charitable purposes can include capital expenditures. The nature of the expense in the hands of the recipient entity does not affect its eligibility as an application of income. Judicial precedents, including C.I.T. v. Programme for Community Organisation (approved by the Supreme Court), emphasize that income must be applied based on its commercial computation.
Also Read: Direct Tax Vivad Se Vishwas (DTVSV) Scheme, 2024: A Comprehensive Guide
Accumulation and Permitted Limits
Section 11(1)(a) allows trusts to accumulate up to 15% (formerly 25%) of their income. This calculation is based on the commercial income reflected in the trust’s accounts and not the “total income” as defined under section 2(45). Courts, including the Kerala High Court in C.I.T. v. Programme for Community Organisation, have highlighted the importance of this distinction.
Summary
- Income for charitable trusts under section 11(1)(a) is computed based on commercial principles.
- Depreciation and necessary expenses are deductible in computing net income.
- Income from various sources, including property and voluntary contributions, is treated with specific considerations.
- Application of income includes expenses for charitable purposes, whether revenue or capital in nature.
- Permitted accumulation is based on commercial income, not total income as per section 2(45).
By adhering to these principles and judicial interpretations, charitable trusts can ensure compliance while maximizing their income available for charitable purposes.
Ref: Taxation of Charitable Trust and Computation of Income
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