By Fahad Mohammad Khan*
In recent years, important changes and greater restrictions in tax laws covering charitable organisations have been introduced almost every year now through multiple amendments in Income Tax Act. The latest Finance Act, 2017 continues this trend by bringing in the following major amendments:
Restriction on Inter-Charity Corpus Donations [Ss. 10(23C), 11]
Under the existing law corpus donation by a charitable institution to another charitable organisation out of its income is treated as direct utilization of funds by the former. At the same time, if due to reasons of being corpus donation the amount is not treated as income in the books of the donee organisations, the latter is not bound by utilization norms on income. This was a loophole in the Act which had the unintended effect of an organisation continuing to enjoy tax exemption without having to spend the required 85% of income.
The Finance Act, 2017 has plugged this loophole by amending section 10(23C) and 11 with effect from 1st April 2018. The proviso inserted in section 10(23C) clarifies that any amount credited or paid out of income of an institution referred to in sub-clause (iv), (v), (vi) or (via), to any charitable trust or institution registered under section 12AA, being voluntary contribution with specific direction that they shall form part of the corpus of the institution, shall not be treated as application of income to its objects. A corresponding change in section 11 has been effected by insertion of Explanation 2 at the end of sub-section (1) which similarly provides that corpus donations through income referred to in clause (a) or (b) of sub-section (1) shall not be treated as application of income for charitable or religious purpose.
Additional Conditions for Applicability of Section 11 and 12 [Ss. 12A, 12AA]
Registration under section 12AA is an essential condition for an organisation to avail tax exemption on its income under sections 11 and 12. The Finance Act, 2017 has amended sections 12A and 12AA to impose following additional conditions on organisations registered under section 12AA with effect from 1st April, 2018:
- To make application to the Commissioner of Income Tax (CIT) within 30 days if there is any change in the objects clause which do not conform to the conditions of registration and have it registered.
- Mandatory filing of income tax returns within the time allowed under section 139(4A).
It is obvious that a change in the object of the trust or institution which does not conform to the original conditions of the registration would render the registration untenable. What the amendment achieves is bring clarity in such a scenario, both on the power of CIT and the procedure that should be followed in this regard. The amendment will put an end to instances where CIT would insist on prior approval of any modification in the objects of the trust which was clearly beyond their statutory power.
The change with regard to mandatory filing of income tax return makes enjoyment of tax exemption under section 11 and 12 conditional upon timely filing of return. It is a step towards increasing compliance under section 139(4A).
Restriction on Money Donations [S. 80G(5D)]
The Finance Act has amended sub-section (5D) of section 80G to mandate that in order to avail deduction under the section, donation for an amount greater than two thousand rupees be made in modes other than cash. The amendment has further lowered the limit on cash donations under section 80G that had been reduced to ten thousand by the Finance Act, 2012. The move is in consonance with government’s overall efforts to push towards a cashless economy and increase transparency in the system. It shall come into effect from 1st April, 2018.
Expansion of Power of Survey to Charitable Activities [S. 133A]
A less noticed aspect of the present Finance Act has been the amendment of section 133A to include the place of ‘activity for charitable purpose’ within the scope of Section 133A. This amendment expressly empowers the income tax authority to enter any places of activity of charitable purpose for inspecting books of accounts, verifying cash, stock or valuable articles or furnishing any relevant information.
Changes by Finance Act, 2016
Amongst the major changes brought by Finance Act, 2016 withdrawal of exemption under Section 35AC and introduction of a new chapter on taxation of accreted with respect to cha
Sunset Clause in S. 35AC
An important change in the Finance Act, 2016 was the phasing out of deductions available for donations under section 35AC. This is part of larger government scheme to reduce corporate tax from 30% to 25% and gradually phase out deductions and exemptions available to them.
The deductions under the section included expenditure incurred by way of payment of any sum to public sector corporation or a local authority or to an approved institution, etc. on eligible social development project or a scheme. The amendment inserts a new sub-section (7) with effect from 1st April, 2017. It provides that : “(7) No deduction under this section shall be allowed in respect of any assessment year commencing on or after the 1st day of April, 2018.”.
Section 35AC was a preferred mode for organisations having income from business or profession to avail 100% deduction on their donations. It thus contributed a big chunk of domestic source of income for voluntary sector in India. In the short term phasing out of Section 35AC deductions shall have a substantial effect on the sustainability of organisations running on section 35AC donations.
Introduction of Tax on Accreted Income (Chapter XII-EB)
The Finance Act 2016 has introduced a very harsh amendment in the Income Tax Act in the form of a new Chapter XII-EB – “Special Provisions Relating to Tax on Accreted Income of Certain Trusts & Institutions.” The new sections 115TD, 115TE and 115TF provide for taxation of accreted income at the maximum marginal rates and shall come into play in the following instances:
- Conversion of organisation into any form which is not eligible under section 12AA
- Conversion of an exempt legal entity into a non-exempt one
- If in case of dissolution the organisation fails to transfer its assets to exempt entities
Under the following circumstances an organisation shall be deemed to have been converted into a nonexempt entity:
- Cancellation of registration under section 12AA
- If a fresh application for registration is not made within 30 days, where there is modification in the objects of the organisation in violation of the conditions of the registration
- If the aforementioned application for registration is made and is rejected by the CIT.
In above circumstances yearly income and accreted income of the organisation shall be subject to the lone charge of tax at maximum marginal rate, i.e. the rate of income-tax (including surcharge on income-tax, if any) applicable in relation to the highest slab of income in the case of an association of persons (presently fixed at 30%). Accreted income refers to the fair market value of the assets minus liabilities on the specified dates.
Sub-section (5) of section 115TD provides that the principal officer or the trustee shall be themselves liable for payment of tax within 14 days of:
- Receipt of cancellation order
- End of the previous year in which objects of the organisation were modified
- Receipt of rejection of fresh application of registration
- Date of merger
- End of twelve months from the month of dissolution of organisation
Further, in case of delay in payment, interest at the rate of 1% per month shall be chargeable.
Introduction of tax on accreted income is being seen in the light of ongoing litigation between I-T department and Escorts Heart Institute and Research Centre (EHIRC) which had transferred its assets worth Rs. 585 crore to Fortis Healthcare and thereby converted a charitable organisation into a commercial entity. The present amendment shall empower the I-T department to seek income tax at maximum marginal rate in such cases. However, the assumption that charitable institutions are convertible into commercial is open to doubt. It is not allowed in case of an irrevocable trust and in case of societies/companies the provisions ought to be so read that a possible conversion ensures that the existing assets are only applied to charitable activities.
There have been concerns that the deeming provision by which all cancellations under section 12AA(3) attract tax on accreted income is excessively harsh, particularly where the cancellation of registration under section 12AA takes place on some minor technical reason. CBDT too took note of this and has issued circular no. 21/2016 dated 27th May, 2016 advising the field authorities that, in view of provisions of Chapter XII-EB, the process for cancellation of registration under section 12AA be initiated strictly in accordance with section 12AA(3) and 12AA(4). This is expected to allay fears of misuse of these provisions.
Changes by Finance Act, 2015
The major changes brought by the Finance Act, 2015 with regard to non-profits include an important amendment in the definition of charitable purpose as well as inclusion of new funds under section 80G.
Changes in Definition of Charitable Purpose [S. 2(15)]
The Finance Act, 2015 has introduced major change in section 2(15) of the Income Tax Act with effect from 1st April, 2016. The amendment has the following effect on the definition of ‘charitable purpose’ under the Act:
- Inclusion of Yoga as a specific charitable purpose
- Changes in the permissible limits of receipts from business activity falling under general public utility clause from earlier 25 lakh rupees to now not greater than 10% of the total receipts of the organisation.
Yoga: The inclusion of yoga as a separate head under definition of charitable purpose seems to go with the general intent of the government to promote yoga at all levels. It is notable that even earlier courts had recognised yoga activities as a charitable purpose falling under general public utility. But with this amendment, Yoga now being a separate limb of charitable purpose opens the door for organisations engaged in Yoga who carry out incidental business activities to not be restricted by the proviso to section 2(15) which is applicable only to general public utility activities.
Business activity under General Public Utility: The major change in the definition of charitable purpose is the insertion of new proviso to the section substituting the earlier two provisos. The new proviso changes the limit of receipts from incidental business falling under general public utility from earlier Rs 25 lakh to 20 percent of the total receipts of the organisation.
The new proviso will be helpful for large organisations who felt their present business activities being restricted by a 25 lakh cap. But it will also be detrimental to the operations of small NGOs which were presently getting a blanket limit of Rs 25 lakh irrespective of their total receipts.
Changes in Accumulation related Provision [S. 11]
Under section 11 organisations can accumulate their income for an amount greater than 15% through two options:
- Exercise option under Clause (2) of the Explanation to Section 11(1) to utilize income in next 12 months or when it is actually received,
- Exercise option under Section 11(2) to utilize it in next 5 years.
The above options were to be exercised by informing the Assessment Officer (AO) by filing an intimation as well as Form 10. The amendment in section 11 provides that both these documents have to be filed within the time limit prescribed for filing of return under Section 139(4A). If the trust or institution fails to do this on time, the accumulated income shall become taxable. The move is towards ensuring greater compliance by the charitable organisations.
Inclusion of New Funds under section 80G
With effect from 1st April 2016, the list of funds and institutions eligible for exemptions under sub-section (2) of section 80G shall also include– Swachh Bharat Kosh (iiihk), Clean Ganga Fund (iiihl) and the National Fund for Control of Drug Abuse (iiihm).
Concerns and Way Ahead
Recent times have seen tax laws covering non-profits become increasingly complex in their scope and constraining in the regulations imposed on the sector. It is worth reminding to tax authorities that charitable trust are helping the welfare efforts of the government and trustees are rendering honourary services. Complicating tax laws for charitable trusts would hit badly small trusts who may lack qualified staffs to ensure higher level of compliances.
It is good that the government is following tax rationalization path but at the same time it should ensure that measures like phasing out of section 35AC exemptions to donor do not affect the voluntary sector badly.
The last few years have seen an increase in power of income tax authorities to initiate harsh measures (accreted income, increased grounds for cancellation of registration, etc.). While it accepted that there is a need for regulation of voluntary sector, it is questionable whether the same can be achieved by introducing harsher provisions and increasing the power of income tax authorities, given their prime interest lies in increasing collection of tax revenues.
Among other things the income tax authorities need to focus on bringing more clarity on issues such as treatment of project grants, expansion of general public utility clause in charitable purpose, providing relaxation to voluntary sector with regard to application of TDS norms and so on. The overall effort ought to be increasing transparency as well as creating an enabling environment for charitable entities.
 CIT v RMS Trust (2010)326 ITR 310 (Mad)
 CIT v. Rajneesh Foundation  280 ITR 553 (Bom.); CST v. Sai Publication Fund  258 ITR 70/122 Taxman 437
 5. PN Shah: “Overview on Taxation of Charitable Institutions”. The Chamber’s Journal (Vol. IV, No.9 June 2016)
*Centre for Social Justice, Ahmedabad