Business Income vs Charitable Institutions
“I cannot forget the services rendered by the commercial class, but I want you to make Congress your own and we would willingly surrender the reins to you. The work can be better done by you. But if you decide to assume the reins, you can do so only on one condition. You should regard yourselves as trustees and servants of the poor. Your commerce must be regulated for the benefit of the toiling millions” Mahatma Gandhi
The above message was conveyed by the father of nation while addressing annual session of a leading chamber of commerce. The clarity of the vision and ideology with which the above message to the nation was conveyed itself spells out the inability of the state to match the growing demand in the development of commerce the basic factor for the growth of economy of any country as is in the case of other important areas of charity i.e. providing education to all, providing medical relief/treatment to masses and render helping hand to vast population of our country living under the shadow of poverty. This must have been the reason behind extending exemption form paying income tax on surplus earned, if any, by such service providers to the vast population without much help from the state for a better and prosperous nation building. The charitable purposes defined under section 2(15) of the Income-tax Act, 1961 is:-
Section 2(15) of the Income Tax Act, 1961 (Act) defines charitable purpose to include (i) Relief of the poor,(ii) Education,(iii) Medical relief, and(iv) the advancement of any other object of general public utility.
In view of the circular No. 11/2008, dated 19th December, 2008 effective from 1st April, 2009 speaks about the changes made by the Government withdrawing tax exemption to such institutions till now claming exemption under section 11.
An entity with a charitable object of the above nature was eligible for exemption from tax under section 11 or alternatively under section 10(23C) of the Act. However, it was seen that a number of entities who were engaged in commercial activities were also claiming exemption on the ground that such activities were for the advancement of objects of general public utility in terms of the fourth limb of the definition of charitable purpose. Therefore, section 2(15) was amended vide Finance Act, 2008 by adding a proviso which states that the advancement of any other object of general public utility shall not be a charitable purpose if it involves the carrying on of
(a) any activity in the nature of trade, commerce or business; or
(b) any activity of rendering any service in relation to any trade, commerce or business;
for a cess or fee or any other consideration, irrespective of the nature of use or application, or retention of the income from such activity.
The above circular highlights the following changes:-
1. The changes are effective from 1st April, 2009 and are applicable to fourth limb only. In other words any activity which is in the nature of business but is incidental to normal working of a trust will be treated as tax free only in the case of first three limbs.
2. It is not the deployment of funds for charitable purposes which will determine the status of an income but the source of income will also be examined and will be segregated into two parts a) which qualifies as charitable income and b) which qualifies as business income. Tax will be levied on the income which is of business in nature.
3. Services provided to non members against fee or cess or whatever the name of the fee may be given will be treated as business income and tax will have to be paid on such income. However, service provided to members against payment will not be taxed based on the concept of mutuality.
4. All activities with an aim to earn surplus will be treated as business income and taxed accordingly except in the cases where assessing authorities are satisfied that such surplus earned are not in the nature of a commercial activities.
Before making above changes it was not the income which was treated as test to determine whether the objects of a trust or society belonging to fourth limb are charitable in nature and exempted from paying tax on the surplus, if any. The main thrust was being given on whether the trust or society is properly registered as required by law, do not pay dividend or distribute surplus, deploys funds on the activities which qualify for attainment of objects for which the trust/society was created and in case of surplus the same has been carried forward and spent on the eligible activities. No doubt in certain cases income tax authorities has treated certain incomes as business income by charging tax on such incomes. In almost all such cases courts have held that such incomes were incidental for attainment of main objects thus not taxable. This uncertainty has been removed by the above circular. But the question here arises why the change has been made applicable only in the case of fourth limb. Secondly, by putting brakes on the resource generation from the activities being incidental to the attainment of the main objects how can we expect an institution to carry out charitable activities? It is not charitable activity which generates income and to do charitable activities income needs to be generated from different sources. Lastly, how tax authorities can be satisfied about particular income which may be taxable in the hands of an institution but might not taxable in the hands other institution in the same group.The books of account will have to be maintained in such a manner as it becomes easy to identify the various sources of income and surplus thereof after deducting the relevant expenditures.
In the words of Honorable Justice Venkataramiah J. “today when the State is a welfare State, would it be right either morally or constitutionally to allow amounts which should legitimately form part of the revenue of the state to be dealt with by non-governmental agencies administering trusts, is a question which requires examination in an appropriate case. This, however, is a large question which, if logically pursued, may justify total deletion of the exemption accorded in the case of charitable and religious trusts.”
May be we are moving towards a no exemption regime and may witness withdrawal of exemption to other limbs in a long drawn phased manner. But has state done enough to believe that public at large does not require the services of these charitable trusts. India being a vast country with a huge population is still not able to provide the basic amenities e.g. water, power, health services, education etc. Under such circumstances curtailing the activities of these charitable institutions will do more harm than good to the nation. There is no dispute to the fact that institutions misusing the provisions of this section of income tax act need to be dealt sternly and this job was been carried by the authorities regularly which is evident from the disputes being contested in the courts.
Dilip K Raina
Chartered Accountant & Microsoft Certified Professional
CAclubindia
