Insights

Scheme of Taxation of a Charitable Trust

Charity and Non-Profit Sector

The non-religious charities and the non-profit sector in India had been inherently functioning in regulatory disarray resulting from a serpitine regulatory regime, lax enforceability, and a general oversight. However, owing to the rising incomes, new fundraising methods, and the 2013 CSR mandate, the vibrant role of non-profit entities in augmenting developmental programs, policymaking, monitoring, and evaluation is currently the epicenter of the legislative scrutiny.

From 2013 to 2019, charitable and religious donations witnessed a marked growth rate of 3.5 among registered organizations; additionally, as per the findings of India Philanthropy Report, 2020 private philanthropic giving in the country for the year 2020 amounted to approximately Rs 64,000 crore as compared to Rs 12,000 crore in 2010.

To encourage charitable activities, the Indian Tax laws have consistently extended tax exemptions to these philanthropic organizations. However, the Central Board of Direct Taxes (CBDT) issued Notification no. 19/2021 dated March 26, 2021, efficiently re-engineering the registration and approval process of Non-Profit Organizations (NPOs) in the country in a bid to standardize and monitor their activities, prior to the extension of tax benefits.

This article seeks to carefully dissect the scheme of Taxation of a Charitable Trust under Income-tax Act, 1961 (Act) and also analyze the implications of the recently introduced pre-requisites that Charitable Trusts now must comply with to enjoy tax-exemptions. 

What is a Charitable Trust?  

Chapter III of the Act governs the taxation of a Trust, particularly sections 11, 12, 12A, 12AA and 13 of the Act. In addition, the Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020 (Act No.38) introduced section 12AB w.e.f 01/04/2021 to revive the registration mechanism making section 12AA of the Act inoperative from 1st day of April 2021.

An institute with no profit motive, catering to the socio-economic needs of the public at large, is a Charitable organization. It generally functions as a Public Charitable Trust, a Society, Non-Government Organization (NGO) or a Company formed with charitable objective under section 8 of the Companies Act, 2013.

Section 11 of the Act provides an exemption for income from property held in a Trust established wholly for charitable or religious purposes to the extent that a Trust applies (utilizes) its income for charitable or religious purposes or accumulates it for spending in subsequent years. Therefore, the term ‘charitable purpose’ holds significance as it sets a qualification for a Trust to meet to avail the benefit of exemption provided under section 11. In addition, clause 23C of section 10 of the Act exempts from tax the income of certain educational institutions, hospitals, institutions, funds etc.

Charitable Purpose

Clause 15 of section 2 of the Act defines the term “charitable purpose”. It includes activities like education, the relief of the poor, yoga, medical relief, and the advancement of any other object of general public utility. However, when an institution with the aim of “advancement of any other object of general public utility” carries out any commercial activity including trade, commerce, or business for consideration, even if ancillary to the attainment of the main object, the receipts from such operation must not exceed 20% of the total receipts for availing exemptions under the Act.

Taxation of Voluntary Contributions/Corpus donations and Anonymous donations

To operate, most of the Trusts receive voluntary contributions. Income tax law considers such contributions as income of the Trust except when received with a direction to apply it to form part of the Corpus of the Trust.  However, when a Trust uses the voluntary contributions for meeting a ‘charitable purpose’ according to section 11, it is exempted from tax. But when a trust/institution receiving donations and does not maintain any record, i.e., name, address & required particulars of the donor’s identity, Section 115BBC of the Act stands to tax it.

Registration of a Trust – Conditions of Section 12A

Exemption under section 11 and section 12 is only available when a Trust is registered u/s 12AB of the Act. To register, Trust must follow section 12A and apply in Form 10A or Form 10AB as the case may be to the Principal Commissioner of Income Tax or Commissioner Income Tax for Registration. Section 12AB provides a detailed procedure of Registration. Before the 1st day of April 2021, insertion of section 12AB, Registration of a Trust, was valid in perpetuity unless cancelled. However, by insertion of section 12AB in the Act, now a new registration mechanism is provided. Provisional Registration is for new Registrations. The existing 12A/12AA registered trusts get Registration u/s 12AB for 5 years and shall now renew their Registration u/s 12AB every five years.

The applicant is required to file for Registration at least six months before the expiry of provisional Registration or within six months from undertaking activities, whichever is earlier.

As with the insertion of section 12AB, registrations existing under section 12AA of the Act will become inoperative from the 1st day of April 2021, a Trust to continue to avail the exemption under section 11 and 12 of the Act, have to now apply for afresh Registration under the new scheme provided by way of section 12 AB of the Act at least six months before the expiry of the existing Registration.

FORM 10A

Form 10A shall be used for the following objectives.

  • Revalidation of registration/approval for existing organizations registered/approved under section 12A/12AA/80G.
  • For an application of provisional registrations/approval under section 12AB/80G

FORM 10AB

Form 10 AB shall be applicable for the following purposes.

  • Conversion of provisional Registration into regular Registration.
  • Renewal of Registration or approval after five years
  • Activation of inoperative Registration under section 10(23C)/10(46)
  • Re-registration for the impetus of modification of objects for entities registered under section 12

Application of Trust Income

Section 11 prescribes qualifying conditions for a Trust to comply with for availing exemption provided therein; it answers to what extent a Trust income is to be applied (utilized) to meet the prescribed conditions. In this regard, the law provides a concession. Thus, a trust can avail exemption even if the Trust used only 85% of its income for meeting charitable purposes. The shortfall amount is taxable at standard slab rates.

In cases where the shortfall in a previous year is due to a reason beyond the control of the Trust, Section 11 provides relaxation under the deemed application concept. In such cases, the Trust is allowed to apply the shortfall in the immediate, subsequent year subject to it intimating in the prescribed form to the Income Tax Department before the due date for filing the ”original” return of income about the Trust postponing the said application of income.

The Act allows Trust to set apart; accumulate the income for five years. However, when a Trust fails to utilize it for charitable purposes consequent to an injunction order of a court of law, the period of such order is excluded while calculating the five years.

The law provides a condition of application of 85% of income if such income so accumulated or set apart is invested or deposited in approved modes including investment in savings certificates under the Small Savings Schemes of Government; deposits with the Post Office Savings Bank, scheduled bank/co-operative society, construction, or purchase of residential property; urban infrastructure and investment in units of the Unit Trust of India and public sector company. 

When a Trust utilizes consideration arising from the transfer of a capital asset to acquire another capital asset, the Act recognizes the capital gain arising from the transfer as a deemed application of income for charitable or religious purposes.

Computation of Income of the Trust

A Charitable Trust can undertake commercial operations only when operations are connected directly to the attainment of the objects of the Trust, and separate books of account are maintained. 

When the Assessing Officer finds from the books of accounts of the Trust that a Trust is undertaking a business activity and earns business income, though such activity is incidental to the main object of the Trust, the same is taxable following sub-section 4 of section 11 of the Act. However, in the case of a Trust with the aim of “advancement of any other object of general public utility”, the law restricts the commercial receipts to 20% of total receipts for eligibility to get an exemption.   

The Income of a Charitable Trust is computed in a commercial sense and not as per the standard mechanism of computation of income prescribed under the Act [(Circular no. 5-P(LXX-6), dated June 19, 1968]. Therefore, an expense incurred to generate/ or earn an income is allowed as a deduction while computing the Trust’s income. However, the law does not allow depreciation if the Trust has already claimed an asset’s purchase as an application of income under section 11 of the Ac.

Following Finance Act 2021, for the computation of income applied or accumulated during the previous year, no setting-off or carrying forward of excess application of earlier years is allowed. Also, if a Trust uses funds received as loans and borrowings for charitable purposes, it does not qualify as an application of income. Still, when a Trust repays a loan or borrowing from the previous year’s income, the law recognizes it as an application of income. Furthermore, a registered Trust shall get its accounts audited as per the provisions of section 12A of the Act.

What triggers withdrawal of tax benefits and its impact?

When the amount accumulated and set aside is transferred to general funds and the accumulation condition is breached, this triggers withdrawal of exemption, making the amount so set apart as the previous year’s income. In addition, when Trust activities are not per the objects of the Trust or used for the benefit of a Specified Person, i.e., Founder or a Trustee or a Relative or the Trust fails to invest its income as per the specified modes, the Trust loses its exemption and is thus liable to tax and may even trigger the initiation of action for cancellation of Registration.

When the income of a Trust ceases to be accumulated, invested, or deposited, it is taxable. However, once the Assessing Officer is satisfied that the application of income was beyond the control of Trust, he can qualify it to have met the condition of application of 85% income prescribed under Section 11 of the Act.

Cancellation of a Trust Registration

When a Trust fails to establish its genuineness and compliance with sections 11 and 12 of the Act, the Principal Commissioner of Commissioner following sub-section 5 of section 12AB of the Act can by order in writing cancel the Trust registration after affording an opportunity. 

Impact of Cancellation of a Trust Registration

On cancellation of a Trust’s Registration or when a Trust converts into a form not eligible for Registration under section 12AB or a Trust merges with an entity not having similar objectives or fails to transfer upon dissolution its assets to an entity registered under Income Tax, Section 115TD provides to charge upon the Trust an additional income tax known as the tax on Accreted Income at the Maximum Marginal Rate (MMR) and also liable for penal consequences.

Conclusion

The new section 12AB has ended the perpetuity regime for a Charitable Trust introducing a new scheme of periodic check review on the Trust’s operations and its eligibility to enjoy the benefit of exemption to ensure that the conditions of approval or Registration or notification are adhered to and not abused. Therefore, under the new regime, it is advisable for a Trust to precisely interpret the new applicable law to continue enjoying benefits and progress its philanthropic objectives.

This article was originally published in Tax Review Online.