By TIOL News Service:

AHEMDABAD, SEPT 23, 2016: THE ISSUE IS - Whether mere payment of lease rent or interest on borrowed funds, by an educational trust, without there being any element of such payments being excessive or unreasonable compared to the normal rates prevailing, would fall within the mischief of section 13(1)(c) of Income Tax Act. NO IS THE ANSWER.

Facts of the case:

The assessee is an educational trust and is engaged in running a school in the name of Delhi Public School at Rajkot. It had filed the return for the A.Y 2003-04, declaring total loss of Rs.8,47,901/-. The same was taken up for scrutiny and notices were issued to the assessee requiring it to show cause the details in respect to assessee's claim of exemption u/s 11. He pointed out that substantial payments were made by the trust to the settler of the trust as well as the trustees and their near relatives, which according to him, were in violation of section 13(1)(c). These payments were made in the nature of interest on deposits from the trustees and lease rent paid for the land taken on lease from them. He therefore, came to the conclusion that the trust was not engaged in any charitable activity and hence denied exemption u/s 11. In response, the assessee pointed out that the trustees and their relatives have substantial landed properties which were taken on lease. In support of such contention, the assessee produced a lease deed executed between the trustees/relatives of the trustees and one M/s. Max New York Life Insurance Co. Ltd. With respect to payment of interest to the trustees on borrowed funds, the trust pointed out that it needed to raise loan of Rs.2 crores, for which, the Joint Commissioner had also given permission. The AO discarded such defence, and came to the conclusion that the assessee was running the educational institution on commercial basis with profit motive. On appeal, the CIT(A) held that the trust was imparting education with sole motive of profit making. He discarded the comparison of lease rent which the trustees had charged from the Max New York Life Insurance Co. Ltd on the ground that the assessee trust was occupying a larger area, whereas Max New York Life Insurance Co. Ltd. was occupying a very small piece of land and, therefore, comparison of rent was not possible. With respect to borrowing from the trustees, he discarded the assessee's contention that borrowing from the Bank would entail higher interest and lengthy procedure by suggesting that the investment of idle funds by the trustees in the Bank would fetch lower interest than what was offered by the trust. He concluded that such monetary transactions were nothing but planning of tax evasion in camouflage.

The High Court held:

1. The Revenue had two principal contentions for denying the exemption to the assessee. First was that the trust was running the educational institution for profit making. The second was that the trust had diverted its income in favour of the trustees and their near relatives, thereby breaching section 13(1)(c). So far as the first issue is concerned, the revenue authorities seem to be relying on the fact that the assessee was charging, what they considered, was high rate of fees compared to the other schools in the region. That, by itself, would not establish that the school was running for profit making. Through series of decisions, it is by now well settled that the trust, in the course of running an educational institution, is entitled to make a reasonable surplus and setting apart a surplus after expenditure from the receipts, by itself, would not mean that the purpose is profit making. In the present case, in fact, as reproduced by the Tribunal in its impugned order, if we consider the last seven years accounts of the assessee trust, there was not even a surplus after the assessee adjusted its expenditure for the respective years. The first ground of objection of the revenue, therefore, must fail. This brings to the element of diverting the income of the trust to the trustees and near relatives. Section 11 grants exemption to income from property held for charitable or religious purpose subject to fulfillment of condition contained therein. Section 13 on the other hand, pertains to cases where section 11 would not apply. As per section 13(1)(c), nothing contained u/s 11 shall operate so as to exclude from the total income of assessee being a trust for charitable or religious purpose or a charitable or religious institution, if any part of such income or any property of the trust or the institution is, during the previous year, used or applied directly or indirectly for the benefit of any person referred to in sub-section (3). Thus, if any part of the income of the trust was, during the previous year, used or applied directly or indirectly for the benefits of any such person, in relation to such income, section 11 exemption would not apply.

2. In the present case, we may recall that the Revenue relies on two factors to press in service breach of section 13(1)(c). One is that the trust had taken a large part of land belonging to the trustees or relatives on lease, for which, the trust would pay lease rent at the rate of Rs.1/- per sq.ft. per annum. This lease rent, according to the revenue, amounted to applying the trust income in favour of the trustees. The second factor pressed in service by the revenue was the interest on borrowed funds paid by the trust to these persons, Here again, the revenue contended that the income of the trust was being applied for the benefit of such persons. Insofar as the lease rent is concerned, the revenue had not brought on record any evidence to suggest that such lease rent was either excessive or even higher than the normal market rate prevailing in the region at the relevant time. In fact, the assessee produced material to show that a part of the land belonging to the trustees was leased to one Max New York Life Insurance Co. Ltd. at the rate of Rs.5/- per sq. ft. as against the rate of Rs.1/- per sq. ft. being paid by the assessee. The CIT(A) discarded such comparison on the ground that the area occupied by the Max New York Life Insurance Co. Ltd. was much smaller, as compared to the area leased to the assessee. The size of the land under occupation may have some bearing on the lease rent which the land may fetch, nevertheless, in the present case, the difference of rate between two cases was nearly five times. Without there being any further material on record, the CIT(A) could not have come to the conclusion that the rent paid by the assessee to the trustees for the leased land, was excessive. Similarly, the assessee pointed out to the authorities that it needed to raise a fund of Rs.2 crores by taking loan from the financial institutions for which permission was also granted by the Charity Commissioner. The Bank had offered loan at the interest rate of Rs.12.50% per annum which would also require giving securities and executing documents. As against this the trustees offered unsecured loan at the interest rate of Rs.9% per annum. Here again, the CIT(A) discarded such comparison by contending that the trustees themselves would have fetched lower fixed deposit rate from the Bank.

3. For multiple reasons, this was not a correct approach. First, we are trying to ascertain whether the trust was paying the interest at the rate higher than the market rate. What the trustees could have got from the Bank was not correct comparison. Secondly, the trustees were offering unsecured loan, which with inherent risks, invites higher interest than the bank loans. Last but not the least, if the trustees had parked their money in the Bank fixed deposits, the liquidities and security of such investment would be much higher than lending substantial amount to the trust without a collateral security. Section 13(1)(c) does not prohibit normal transactions between the trust and the persons referred to u/s 13(3) of the Act. What is relevant is the use or application of any part of the income of the trust directly or indirectly for the benefits of any such person referred to u/s 13(3). Mere payment of lease rent or interest on borrowed funds, without there being any element of such payments being excessive or unreasonable compared to the normal rates prevailing, would not fall within the mischief of section 13(1)(c). For the reasons recorded above, we do not find that the Tribunal correctly analyzed the situation.

(See 2016-TIOL-2232-HC-AHM-IT)