Introduction
The year 2022 has witnessed major changes in exemption regimes available to charitable institutions under the Income-tax Act, 1961 (‘IT Act’). Through these changes, while the Government has seemingly decayed one issue faced by charitable institutions, it has also given birth to a new one. The following paragraphs will discuss both these issues and analyze the Jekyll and Hyde nature of the amendments of 2022.
Meaning of ‘application of income’ – Opening a new can of worms
Section 11 and Section 12 of the IT Act provide for exemption for income derived from property held by charitable institutions in certain cases.
Section 11(1) of the IT Act exempts the income derived from property held under trust to the extent such income is ‘applied’ for charitable purpose in India, subject to certain conditions.
Through Finance Act, 2022, the Legislature has sought to define the term ‘application of income’. Any sum payable by a charitable trust or institution shall be considered as ‘application of income’ in the previous year in which such sum is actually paid by it. This would be irrespective of the previous year in which the liability to pay such sum has been incurred by the trust or institution. Similar meaning has been provided in Section 10(23C).
The Memorandum explaining the Finance Bill states that these amendments affirm the position taken by various Courts. However, an analysis of various decisions of High Courts (‘HC’) indicates that the settled position of law regarding the meaning of ‘application of income’ has been changed by this amendment.
In this regard, it is important to firstly refer to the decision of Allahabad HC[1]. In this case, HC took the view that the word ‘applied’ necessarily does not mean ‘spent’, and even if a particular amount has been earmarked and allocated for the purposes of the charitable institution, it would be considered to have been applied for its purposes.
Another important decision in this regard is that of the Andhra Pradesh HC[2]. Here also it was held that it would be incorrect to equate the words ‘applied’ with the word ‘spent’. Had the Legislature intended that an amount should actually have been ‘spent’, it would have used the said term. Thus, actual payment was irrelevant for purposes of finding out if there had been an application of funds.
Thus, as per judicial interpretation, even the setting aside or allocation of income for the charitable purposes will be considered as ‘application of income’. The position laid down in the aforesaid decisions has been accepted and followed by other High Courts as well as Tribunal in many decisions.
By these amendments, method of accounting for charitable institutions has become complicated where the institutions are following mercantile system of accounting. This is because while income is getting recognized as and when it accrues, application of such income will have to be recognized only when money is actually spent (for tax purposes).
These amendments have forced charitable institutions to:
- shift from mercantile system of accounting to cash system of accounting;
- alter their agreements with their donors; and
- rely more on the provisions that allow for accumulation of more than 15% of the income and hence, increase the compliance burden.
Impact of violating certain conditions – Contentious issue has got settled
Another major change brought by Finance Act 2022 is the introduction of a new Section 115BBI into the IT Act. To appreciate the newly inserted section, it is important to delve into the clauses (c) and (d) of Section 13(1) of the IT Act as well as the judicial decisions whereby these clauses have been interpreted.
Clause (d) of Section 13(1) of the IT Act lays down that if a charitable institution holds investments in any of the restricted modes or forms of investment which are not provided in Section 11(5) or are not the shares of public sector company, then Sections 11 or 12 will not operate to so as to exclude ‘any income thereof’ from the total income of such charitable institution.
On the other hand, clause (c) of Section 13(1) of the IT Act lays down that if during a particular year any part of the income of the charitable institution enures or if any part of its income or property is applied directly or indirectly for the benefit of one of the prohibited persons listed in Section 13(3), then Sections 11 or 12 will not operate to so as to exclude ‘any income thereof’ from the total income of such charitable institution.
In case of breach of certain conditions resulting in loss of exemption, the ‘extent’ to which the income of a charitable institution will become taxable has been a matter of differing judicial opinions under aforesaid clauses. This is highlighted below:
- In the context of clause (d) of Section 13(1), High Courts[3] have consistently held that only the income from a restricted investment should be taxed; and that complete exemption should not be denied under Section 11 on the total income of the charitable institution.
- In the context of clause (c) of Section 13(1), Delhi HC[4] held that the charitable institution would lose the complete exemption in respect of its entire income if there was violation of Section 13(1)(c) of the IT Act on account of even a single instance of application or use of the income or property of the trust directly or indirectly for the benefit of any prohibited person mentioned in Section 13(3).
In order to address this inconsistency in the two sub-clauses of Section 13(1), Finance Act 2022 introduced Section 115BBI. Section 115BBI lays down a flat tax rate of 30% for certain ‘specified’ non-exempt income under both the regimes. Among other things, this ‘specified’ income has been defined to mean income that is not exempt under Section 11 of the IT Act due to the operation of clauses (c) and (d) of Section 13(1).
Based on the above, it is possible to argue that the introduction of this new section would ensure that complete exemption would not be denied to charitable institution for a minor breach. Similar amendments have been made for some of the institutions registered under 10(23C). These amendments would remove difficulties for such institutions and provide them with certainty in future.
Conclusion
As may be seen from the above discussion, for charitable institutions, the Finance Act, 2022 has been a case of the Government giveth and the Government taketh away. While accounting has been made more complex for these institutions, certainty has been provided on the other hand.
[The author is a Senior Associate, Direct Tax Team, Lakshmikumaran and Sridharan Attorneys, New Delhi]
[1] CIT v. Radhaswami Satsang Sabha [1954] 25 ITR 472 (All HC).
[2] CIT v. Trustees of H.E.H. The Nizam's Charitable Trust [1981] 131 ITR 497 (AP HC).
[3] DIT (Exemption) v. Sheth Mafatlal Gagalbhai Foundation Trust [2001] 114 Taxman 19 (Bom HC), CIT v. Fr. Mullers Charitable Institutions [2014] 363 ITR 230 (Karnataka HC), CIT v. Orpat Charitable Trust, [2015] 230 Taxman 66 (Gujarat HC), CIT v. Working Women's Forum, [2014] 365 ITR 353 (Madras) with Department’s SLP against this decision being dismissed in [2015] 235 Taxman 516 (SC), CIT v. Santokba Durlabhji Trust Fund, [2018] 406 ITR 457 (Rajasthan) with Department’s SLP against this decision being admitted in [2018] 255 Taxman 368 (SC).
[4] DIT (Exemption) v. Charanjiv Charitable Trust [2014] 223 Taxman 71 (Delhi HC).
