MARCH 15, 2012

Charitable Institutions and Income Tax

By R M Narayanan

A) Background:

1) Section 2(15) of the Income Tax Act 1961 defines “Charitable Purpose” to include relief of the poor, education, medical relief, preservation of Preservation of environment, monuments or places or objects of artistic interest or historic interest and the advancement of any other object of general public utility .

2) Registered charitable entities that fulfill certain prescribed conditions relating to investment of funds etc are entitled to exemption from income tax, provided they actually spend their income on charitable purposes or accumulate the same for spending within a five-year time frame.

3) Charitable entities were all along permitted to carry on business activities. The income from such business was also exempt from tax provided the business activities were incidental to the objects of charity with the profits being ploughed back towards the charitable objects.

4) The law on business run by charitable entities has evolved over the last three to four decades and had reached some finality with courts accepting the position that it is the end use of the profits from business that determines whether it is entitled to tax exemption. As long as the profit does not reach private hands, but is utilized for charitable purposes, it is exempt from taxation.

B) Amendment by the Finance Act 2008

5) The Finance Act 2008 amended the definition of “Charitable Purpose” under section 2(15) of the Income Tax Act 1961 by introducing a Proviso as below:

“Provided that the advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business or, any activity of rendering any service in relation to any trade, commerce or business, for a fee or cess or any other consideration, irrespective of the nature of use or application, or retention, of the income from such activity.”

6) The above amendment was made with a view to limiting the scope of the phrase “advancement of any other object of general public utility” and applied with effect from the Assessment Year 2009-10 ( ie financial year ending 31 st March 2009).

7) The impact of the said amendment was that NGO's carrying on charitable activities falling under the category of ‘advancement of any other object of general public utility' ceased to be charitable if they earn any business income.

8) The amendment does not impact institutions involved purely in the field of education, medicine and relief of the poor. It applies only to entities whose purpose is ‘advancement of any other object of general public utility'.

9) CBDT Circular No 11/2008 dated 19 th December 2008 issued in clarification mentions that the amendment was brought about since it was seen that a number of entities which 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 and, in such cases, the object of ‘general public utility' was only a mask or a device to hide the true purpose which is trade, commerce or business.

10) The Finance Act 2010 provided relief to small NGOs by specifying a limit of Rs. 10 lakh (increased to Rs.25 lakh by the Finance Act 2011) in respect of receipts from business activities.

C) Implications of the amendment:

9) Several charitable entities that are involved in spiritual, cultural or sports development fall in the category of entities advancing objects of general public utility.

10) It is not uncommon for such entities to derive income from sale of publications, guest houses, letting out of properties and certain other activities - all of which can be construed as commercial activities in the light of the 2008 amendment.

11) Activities of the nature mentioned above are not the purpose of those institutions, but are only incidental to the real objective viz, spiritual upliftment or development of culture or sports. No part of any income from such activities enures for any private purpose. On the contrary, the same is utilized only for the objects of the said institutions. The objectives of such institutions are not a mask to carry on any commercial activity .

12) However, the Income Tax department inappropriately applies the amendment to genuine institutions. Consequently, several such charitable institutions carrying on significant work over the last several decades have lost or run the risk of losing their charitable and tax-exempt status. This is contrary to the assurance given by the Hon'ble Finance Minister in Parliament while proposing the amendment that genuine charitable organisations will not, in any way, be affected.

13) The amendment could also be interpreted by the tax department to tax all receipts of charitable institutions, including those by way of donations and voluntary contributions, and not just income from activities termed commercial.

D) The Request:

14) The amendment has served to unsettle genuine charitable institutions involved for long in spiritual, cultural and sports development and will severely impact their laudable initiatives.

15) Any misuse of the tax exemption provisions must be prevented only by administrative action rather than through a sweeping amendment such as the 2008 amendment.

16) The 2008 amendment may be repealed and the accepted situation prevailing prior to that amendment may be restored.