Introduction

The Income Tax Act, 1961 (‘IT Act’) provides for various benefits for trusts which are established for charitable or religious purposes and registered under the IT Act. Sections 11 and 12 of the IT Act are the substantive provisions for exemptions available to religious and charitable trusts. The exemption provided for under Sections 11 and 12 is, however, subject to certain restrictions provided under Section 13 of the said Act. The author in this Article would be discussing the implications of Section 13 which purports to deny the exemption available in certain scenarios.

Provisions under the IT Act w.r.t. exemption for trusts

Sections 11 and 12 of the IT Act provides for exemption with respect to certain incomes earned by charitable or religious trusts. The following incomes earned by such trusts are not taxable upon fulfillment of certain conditions:

1. any income derived from property held under trust wholly for charitable or religious purposes to the extent to which such income is applied to such purposes in India.
2. any income in the form of voluntary contributions made with a specific direction that they shall form part of the corpus of the trust or institution.

The expression ‘charitable purposes’ is defined in Section 2(15) of the IT Act to include relief of the poor, education, yoga, medical relief, preservation of environment and the advancement of any other object of general public utility. The exemptions granted under Sections 11 and 12 of the IT Act are subject to the conditions mentioned in Section 12A.

Considering that the trusts claim exemption under Section 11 of the IT Act, it is important to understand the implications of Section 13 which purports to deny the exemption available in certain scenarios. The bar in Section 13(1) is that the income or property of the trust should not be used directly or indirectly for the benefit specified persons^[1]. Section 13(2) enlists certain specified circumstances where it is deemed that the income or property of the trust is used or applied for the benefit of specified persons.

Section 13(3) defines specified persons which includes the author of the trust, the founder of the trust, any person who has made a substantial contribution to the trust or institution, etc. Therefore, if a trust carries out any transaction directly or indirectly for the benefit of the specified persons mentioned in Section 13(3), then the said trust will run the risk of losing out on the exemption provided under Sections 11 and 12 of the IT Act.

Denial of exemption – Entire or Partial?

A long-drawn issue w.r.t Section 13 is whether a contravention under Section 13(1) or 13(2) would lead to denial of partial or entire exemption under Sections 11 and 12. This issue arises since the language employed in Section 13 potentially paves way for two possible interpretations – one that the exemption in its entirety is to be denied and the other, that only the exemption for the respective income which is in violation of the provisions of Section 13 must be denied.

In order to remove the difficulty w.r.t the said issue, an amendment has been made in Section 13(1)(c)/(d). The said amendment provides that only that part of the income which has been applied in violation to the provisions of Section 13 shall be liable to be included in total income. It is essential to note that the said amendment will come into effect from 1 April 2023. Therefore, the said amendment will be applicable prospectively from AY 2023-24. Further, Section 115BBI has also been introduced by Finance Act, 2022 to tax the income in violation to Section 13 at special rates, which would also come into effect from 1 April 2023. 

In light of the said amendments, the moot question is what would be the position for the said issue for the AYs prior to 1 April 2023 (i.e., AY 2023-24) i.e., for periods prior to the amendment being made expressly effective.

Denial of entire exemption

The Delhi High Court in DIT (Exemption) v. Charanjiv Charitable Trust^[2]  dealt with an issue of whether the assessee violated Section 13(1)(c)(ii) read with Section 13(3) of the IT Act, in respect of the transactions of the assessee with one APIL. The Assessee was a Charitable Trust which was granted registration under Section 12A of the IT Act. The Assessee in furtherance of its objects to open school, entered into agreements with APIL in FY 2003-04 for purchase of land and an advance was also made. It was an admitted fact that APIL was a specified person under Section 13(3)(e) of the IT Act. The payment made was treated as application of income (towards charitable purposes) in the said financial year. The assessee due to various reasons changed its mind and the agreements were cancelled, and the advance amount paid by the assessee was refunded to it in the financial year relevant to the AY 2006-07. In deciding the assessment for FY 2003-04 relevant to AY 2004-05, it was noted by the AO that the advance amount continued to remain with APIL for the whole financial year without any progress in the transaction. There was no interest or compensation stipulated for the delay in conveyance of the land and no sale deed was signed for more than one year. The Revenue contended that if the Trust was quite serious about pursuing its objects of running schools/dispensaries, it should have insisted on conveyance of the lands within a reasonable period of time or at least stipulated for interest or adequate compensation or damages in case of failure to honour the alleged agreement. It was further contented by the Revenue that the monies were lying with APIL for a longer period without any interest or security. The Court agreed with the contentions of the Revenue that the real motive of the assessee was to advance its surplus monies to APIL without charging any interest and since APIL was a prohibited person within the meaning of Section 13(3), it was held that the assessee has committed a violation of the provisions of Section 13 of the IT Act and therefore, the Trust was not eligible for the entire exemption under Section 11 of the IT Act.^[3]

The High Court of Kerala in Agappa Child Centre v. CIT^[4] dealt with a similar issue. The Assessee a public charitable trust, purchased a refrigerator and kept it at the residence of its managing trustee. As the trustee was enjoying the use of the property of the trust, the ITO held that the provisions of Section 13 were attracted. The Court observed that from a bare reading of the provisions, it can be inferred that the legislative emphasis is on availability for the use of any person referred to Section 13(3) and that too for any period during the previous year without charging adequate rent or compensation. The Court held that the Managing Trustee was one of the prohibited persons as per Section 13(3). Therefore, the Court held that the entire exemption of the trust is to be denied.

Denial of partial exemption

The High Court of Karnataka in CIT v. Fr. Mullers Charitable Institutions^[5] dealt with a similar issue. The Assessee was a Charitable Trust running a large number of Institutions. During the course of an enquiry, the Assessing Officer noticed that the assessee-trust had advanced a sum of INR 80,00,000 to ‘J’ Ltd which was running a Kannada daily for the purpose of advertisements, printing, etc. The AO opined that advancing of such a huge amount was in violation of Section 11. Hence, the assessee was not entitled for exemption for the said amount. The Court observed that Section 13(1)(d) makes it clear that it is only the income from such investment or deposit which has been made in violation of Section 11(5) that was liable to be taxed and that violation under Section 13(1)(d) does not tantamount to denial of entire exemption under Section 11 on the total income of the assessee trust.

The Bombay High Court in CIT v. Audyogik Shikshan Mandal^[6]  referring to the above mentioned decision of the Karnataka High Court held that where funds of the assessee-trust were utilized for purchase of car in the name of its trustee, there was a violation of Section 13, however the denial of exemption under Section 11 should be limited only to the amount which was diverted in violation and not the entire exemption under Section 11 of the IT Act.

Apart from the judicial precedents discussed above, it may also be of interest to refer to the language employed in Section 164 of the IT Act. If exemption under Section 11 is not available due to application of Section 13, then the income of the trust is taxable under Section 164 of the IT Act. Section 164 provides that where ‘the whole or any part of the relevant income’ is not exempt under Section 11 or 12, tax shall be charged on the relevant income at the maximum marginal rate. The use of the expression ‘whole or any part of the relevant income’ in Section 164, lends a meaning that denial of entire exemption is not contemplated in Section 13.

Conclusion

One may also take que from the Memorandum to Finance Act, 2022 which specifically provides that denying the entire exemption to the trust, for a small amount of income applied in violation creates difficulties to the trusts and institutions. Therefore, even though the beneficial amendment to Section 13(1)(c)/(d) is to come into effect only from 1 April 2023, the author is of the view that denial of the entire exemption for one violation may be too harsh on the trusts which are run for charitable/religious purposes for AYs prior to AY 2023-24.

[The author is a Senior Associate, Direct Tax Team, Lakshmikumaran and Sridharan Attorneys, Chennai]

1. [1] The term ‘person’ is defined in Section 2(31) of the IT Act to include an individual, a HUF, a firm, a company, an association of persons or body of individuals whether incorporated or not, local authority and every artificial juridical person, not falling within any of the preceding categories. 
2. [2] (2014) 43 taxmann.com 300 (Delhi)
3. [3] It may be noted that SLP filed before the Hon’ble Apex Court by the Assessee has been admitted in this case.
4. [4] (1997) 92 Taxman 327 (Kerala)
5. [5] (2014) 44 taxmann.com 275 (Karnataka)
6. [6] (2019) 101 taxmann.com 247 (Bombay)