By TIOL News Service

NEW DELHI, MAY 21, 2008 : THE issue before the Apex Court was related to the grant of exemption u/s 10(23C)(vi) to the branch of a non-resident educational institution. And the prescribed authority (PA) in this case was the Central Board of Direct Taxes itself which had rejected the application on the ground that the applicant had remitted certain amount to its Head Office (HO) in America and it did not exist solely for the purposes of education. What also prompted the Board to do so was its understanding that the suplus generated by any educational body should be spent 'in India' for educational purpose. However, the Apex Court has now held that the monitoring conditions attached to the relevant Section cannot be enforced right at the stage of grant of exemption. If an institution exists solely for education and meets the primary condition of Sec 10(23), the PA is at liberty to lay down any conditions, including application of certain percentage of accounting money in India, but cannot insist on compliance with the conditions which would arise only in future after the stage of grant of exemption.

Brief facts of the case:

The appellant is a non-profit organization set up in USA and has been granted tax exemption as an educational institute in that country. Appellant has a branch office in India, mainly to comply with its obligations under various agreements with Government of India (Ministry of Tourism). Its branch provides a central focal point in India for Indian missions to avail of its educational courses. Its branch collects data from educational institutions/persons wishing to take the courses offered in the field of Hospitality and fees for the required course material which is thereafter remitted to USA. After collection of data and fees, the Head Office sends course materials, examination papers etc. to the branch in India for onward transmission to the actual user. It is the case of the appellant that, it's Indian branch is the small office in which administrative work is done. Few employees attend to this work. The costs of running the branch office is met by deducting the same from the amounts remitted to the H.O.

Thus, the appellant is an Institution whose objects are known as "Statement of Purposes" in US. Under the Internal Revenue Code, 1954 in the U.S. it enjoys tax exemption status as an educational institution. It is governed by an elected Board of Trustees and it offers high quality educational and training resources to enhance the professionalism of the hospitality industry worldwide.

In 1993, the National Council of Hostel Management and Catering Technology, the apex Indian body overseeing hostel management and catering education under the Ministry of Tourism, signed MoU with the Educational Institute under which approval was granted to use courses, resources and expertise of the appellant in India with a view to improve the quality of hospitality education and training in India. Consequently, the appellant opened a liaison office in Mumbai in July 1994 with the approval of Reserve Bank of India. Subsequently, in February 1995 the liaison office was upgraded to a branch office with the approval of the Ministry of Finance, GoI, and the RBI.

At this stage, it may be noted that the appellant got exemption under Section 10(22) up to the year ending 31.3.1998. The branch office accounts during the said period showed the gross amounts collected on the income side and the costs for running the branch were shown on the expenditure side. The difference between these figures represented what was receivable by the HO from the branch for the provision of course materials and other services provided by the HO. These accounts were accepted by the Department till 31.3.1998.

One more fact needs to be mentioned. Appellant had also moved the Authority for Advance Ruling which had ruled in its favour and the Department had accepted the same.

A troubled phase started for the appellant when Sec 10(22) stood omitted by Finance Act, 1998 w.e.f. 1.4.1999.

On 7.4.1999, i.e., within seven days, appellant herein made an application to CBDT (the Prescribed Authority) for initial approval in terms of the first proviso to Section 10(23C)(vi) of the 1961 Act. The appellant applied for initial approval in the prescribed standarised form under rule 2CA of the Income-tax Rules, 1962 i.e. Form No 56D.

Over the next 5 years CBDT did not pass any order on the appellant's application. During this period certain queries were put to the appellant which were replied to by the appellant by various letters. The important point to be noted is that by the said letters appellant clarified its position regarding the type of accounts required and maintained by its branch in India under which excess of receipts over payments was not treated as income/profit/surplus as appropriate costs incurred by the HO had not been taken into account therein because the purpose for which the accounts of the branch office were required to be made was only to establish how much money was owned to the HO and not to ascertain its income or surplus. In the said correspondence it was clarified that even the AO in assessment proceedings had accepted that the excess income over and above the expenditure shown in its account, could not be taken as appellant's income. In fact, the AO had called for information regarding the HO expenses for the year ending 31.3.1999 which had not been considered in the branch office accounts.

During the hearing before CBDT, appellant also furnished a certificate attested by the certified public accountant that Head Office expenses for the year ending 31.3.1999 amounted to USD 2,63,647. The appellant also pointed out to CBDT that even the assessing officer and CIT (appeals) have not deducted the aforestated sum of alleged surplus while computing the appellant's income allegedly chargeable to tax.

By its Order dated 12.10.2004, CBDT rejected appellant's application holding that "there is a surplus repatriated outside India and, therefore, appellant has not applied its income for the purpose of education in India".

The said Order dated 12.10.2004 was challenged by the appellant in the Delhi High Court vide Writ Petition No. 17978/04. By the impugned judgment dated 24.11.2006, the Delhi High Court held that the gross receipts collected by the appellant's branch office in India is "income" chargeable to tax. It further held that since the gross receipts constituted "income" chargeable to tax such "income" was required to be applied to educational purposes in India and since the appellant had failed to do so CBDT was right in rejecting the application dated 7.4.99. In this connection, the Delhi High Court placed reliance on the third proviso to Section 10(23C)(vi).

Thus the matter reached before the Apex Court which observed that,

++ Actual existence of the educational institution was the pre-condition of the application for initial approval under Section 10(22). On grant of approval under Section 10(22), Sections 11 and 13 did not apply. Therefore, earlier prior to 1.4.1999 when exemption was given to the appellant, there was no assessment nor demand. Section 10(22) had an automatic effect;

++ The mere existence of profit/surplus did not disqualify the institution if the sole purpose of its existence was not profit-making but educational activities as Section 10(22) by its very nature contemplated income of such institution to be exempted. Under Section 10(22) the test was restricted to the character of the recipient of income, viz, whether it had the character of educational institution in India, its character outside India was irrelevant for deciding whether its income would be exempt under Section 10(22);

++ The moot question in Section 10(22) was - whether the activities of the applicant came within the definition of "income of educational institution". Under Section 10(22) one had to closely analyse the activities of the Institute, the objects of the Institute and its source of income and its utilization. Even if one of the objects enabled the Institute to undertake commercial activity, the institute would not be entitled to approval under Section 10(22). The said section inter alia excludes the income of the educational institute from the Total Income;

++ In deciding the character of the recipient, it is not necessary to look at the profits of each year, but to consider the nature of the activities undertaken in India. If the Indian activity has no co-relation to education, exemption has to be denied;

++ Section 10(23C)(vi) is analogous to Section 10(22). The problem arises with the insertion of the provisos to Section 10(23C)(vi). With the insertion of the provisos to Section 10(23C)(vi) the applicant who seeks approval has not only to show that it is an institution existing solely for educational purposes but it has now to obtain initial approval from the PA, in terms of Section 10(23C)(vi) by making an application in the standardized form as mentioned in the first proviso to that section. That condition of obtaining approval from the PA came to be inserted because Section 10(22) was abused by some educational institutions/universities. This proviso was inserted along with other provisos because there was no monitoring mechanism to check abuse of exemption provision;

++ With the insertion of the first proviso, the PA is required to vet the application. This vetting process is stipulated by the second proviso. It is important to note that the second proviso also indicates the powers and duties of the PA. While considering the approval application in the second proviso, the PA is empowered before giving approval to call for such documents including annual accounts or information from the applicant to check the genuineness of the activities of the applicant institution. Earlier that power was not there with the PA;

++ Under the third proviso, the PA has to ascertain while judging the genuineness of the activities of the applicant institution as to whether the applicant applies its income wholly and exclusively to the objects for which it is constituted/established;

++ Under the twelfth proviso, the PA is required to examine cases where an applicant does not apply its income during the year of receipt and accumulates it but makes payment therefrom to any trust or institution registered under section 12AA or to any fund or trust or institution or university or other educational institution and to that extent the proviso states that such payment shall not be treated as application of income to the objects for which such trust or fund or educational institution is established. The idea underlying the twelfth proviso is to provide guidance to the PA as to the meaning of the words "application of income to the objects for which the institution is established". Therefore, the twelfth proviso is the matter of detail;

++ The most relevant proviso for deciding this appeal is the thirteenth proviso. Under that proviso, the circumstances are given under which the PA is empowered to withdraw the approval earlier granted. Under that proviso, if the PA is satisfied that the trust, fund, university or other educational institution etc. has not applied its income in accordance with the third proviso or if it finds that such institution, trust or fund etc. has not invested/deposited its funds in accordance with the third proviso or that the activities of such fund or institution or trust etc. are not genuine or that its activities are not being carried out in accordance with the conditions subject to which approval is granted then the PA is empowered to withdraw the approval earlier granted after complying with the procedure mentioned therein.

++ Having analysed the provisos to Section 10(23C)(vi) one finds that there is a difference between stipulation of conditions and compliance thereof. The threshold conditions are actual existence of an educational institution and approval of the prescribed authority for which every applicant has to move an application in the standardized form in terms of the first proviso. It is only if the pre-requisite condition of actual existence of the educational institution is fulfilled that the question of compliance of requirements in the provisos would arise.

++ We find merit in the contention advanced on behalf of the appellant that the third proviso contains monitoring conditions/requirements like application, accumulation, deployment of income in specified assets whose compliance depends on events that have not taken place on the date of the application for initial approval;

++ To make the section with the proviso workable we are of the view that the Monitoring Conditions in the third proviso like application/utilization of income, pattern of investments to be made etc. could be stipulated as conditions by the PA subject to which approval could be granted. For example, in marginal cases like the present case, where appellant-Institute was given exemption up to financial year ending 31.3.1998 (assessment year 1998-99) and where an application is made on 7.4.1999, within seven days of the new dispensation coming into force, the PA can grant approval subject to such terms and conditions as it deems fit provided they are not in conflict with the provisions of the 1961 Act. While imposing stipulations subject to which approval is granted, the PA may insist on certain percentage of accounting Income to be utilized/applied for imparting education in India. While making such stipulations, the PA has to examine the activities in India which the applicant has undertaken in its Constitution, MoUs. and Agreement with Government of India/National Council. The PA is at liberty to stipulate conditions subject to which approval may be granted finds support from sub-clause (ii)(B) in the thirteenth proviso.

The next question which came up for consideration was : whether the words "in India" should be read into Section 10(23C)(vi) and/or in the third proviso thereto?

And the Bench noted that,

++ Section 10(23C)(vi) seeks to exempt income of institutions with laudable objects and activities such as universities, hospitals etc.. As stated above, stipulation of monitoring conditions is different from compliance of those conditions. Compliance or non-compliance can only be gauged at the assessment stage.

++ even after the Finance Act, 1998 w.e.f. 1.4.1999, the third proviso to Section 10(23C)(vi), which refers to monitoring conditions, confines the words "application of income" to the objects for which the Institution is established. The third proviso does not use the words "in India" in the matter of application or accumulation of income though in several other sections like Sections 10(20A), 10(22B) and 11(1)(a) etc., Parliament has used the words "in India". Therefore, for this one more reason, we cannot read in the words "in India" into the third proviso.

++ As stated, Parliament in its wisdom has stated in the third proviso that the educational institution has to apply its income wholly and exclusively to the objects for which it is established. Therefore, the plain words of the third proviso do not require application of income to be in India. Our judgment should not be understood to mean that the applicant has not to impart educational activities in India. If the applicant wants exemption under Section 10(23C)(vi) it has to impart education in India and only then it would be entitled to claim initial approval under that section. That is the reason for our saying that the "non-profit" qualification has to be tested against Indian activities. Our conclusion is that impartation of education must be in India if applicant desires exemption under Section 10 (23C)(vi) and that excess/deficit of income over expenditure will not decide whether the applicant exists for profit or not.

++ items such as application of income or accumulation of income or investment in specified assets indicated in clauses (a) and (b) in the third proviso are a part of compliance/monitoring conditions. As stated, however, there is a difference between application/utilization of income and outward remittance of income out of India. As discussed above, with the insertion of the provisos in Section 10(23C)(vi) of the 1961 Act, it is open to the PA to stipulate, while granting approval, that the approval is being given subject to utilization/application of certain percentage of income, in the accounting sense, towards impartation of education in India. Such exercise would be based on estimation. There is a difference between `accounting income' and `taxable income'. At the stage of Section 10, we are concerned with the accounting income. Therefore, it is open to the PA, if it deems fit, to stipulate that certain percentage of accounting income would be utilized for impartation of education in India. Therefore, in our view, it is always open to the PA to impose such terms and conditions as it deems fit. The interpretation we have given is based on harmonious construction of the provisos inserted in Section 10(23C)(vi) by the Finance Act, 1998.

++ Lastly, we may reiterate that there is a difference between stipulation by the PA of such terms and conditions, as it deems fit under the provisos, and the compliance of those conditions by the appellant. The compliance of the terms and conditions stipulated by the PA would be a matter of decision at the time of assessment as availability of exemption has to be evaluated every year in order to find out whether the institution existed during the relevant year solely for educational purposes and not for profit.

(See 2008-TIOL-115-SC-IT in 'Income Tax' + 2008-TIOL-115-SC-IT in 'Legal Corner')