Charitable trusts are granted exemption for their income under section 11 of the Income-tax Act, 1961. This tax benefit is subject to fulfilment of stringent conditions laid down in sections 11 and 13.
Subject to certain exceptions, an important condition under section 11 is that 85% of the income of a financial year has to be applied towards the charitable objects of the trust. Another important condition of section 11 pertains to investments of trust funds. Failure to comply with these conditions would deny the charitable trust its right to claim exemption.
Section 13 of the Act lays down onerous conditions for claiming the exemption. One such condition is that no benefit should be received by an interested person out of the income of the property of the charitable trust. Such benefit is deemed to be granted where any part of the income or property of the trust or institution is, or continues to be, lent to any person referred to in section 13(3) for any period during the previous year without either adequate security or market-related interest, or both.
Benefit would also be deemed to arise where any land, building or other property of the trust or institution is, or continues to be, made available for the use of any person referred to in section 13(3), for any period during the previous year without charging adequate rent or other compensation. Further, benefit would be deemed to be granted where any amount is paid by way of salary, allowance or otherwise during the previous year to any person referred to in section 13(3) out of the resources of the trust or institution for services rendered by that person to such trust or institution and the amount so paid is in excess of what may be reasonably paid for such services.
Benefit is deemed to be granted where the services of the trust or institution are made available to any person referred to in section 13(3) during the previous year without adequate remuneration or other compensation. Benefit would also be deemed to be provided where any share, security or other property is purchased by or on behalf of the trust or institution from any such person during the previous year for consideration, which is more than adequate.
Benefit would also arise if any share, security or other property is sold by or on behalf of the trust or institution to any person referred to in section 13(3) during the previous year for consideration, which is less than adequate. Benefit will be deemed to be availed where any income or property of the trust or institution is diverted during the previous year in favour of any such person, provided that this will not apply where the income, or the value of the property or, as the case may be, the aggregate of the income and the value of the property, so diverted does not exceed Rs 1,000.
The basic requirement for the exemption under sections 11 and 12 is that if any money is lent to an interested party as defined in section 13(3) of the Act for “any period” during the previous year, the trust should charge “adequate interest” and there should be “adequate security”. Section 13(1)(c) of the Act refers to “any income”, which has been used to benefit “directly or indirectly” any person referred to in section 13(3). A plain reading of this section would show that it is intended to eliminate any possibility of the trust’s fund being used for the benefit of any interested person.
Once the exemption under sections 11 and 12 is denied, the voluntary contribution would be treated as income, as defined in section 2(24) of the Act, according to which income includes voluntary contributions, meaning thereby that all receipts of the trust either by voluntary contribution or income derived from its property would be income of the trust in the normal course and chargeable to tax.
This point was considered by the Delhi High Court in Kanhaya Lal Punj Charitable Trust v Director of Income-tax (Exemption) (297 ITR 66). The facts in this case were that the assessee, a society registered under section 12-A of the Act, had income mainly from interest on fixed deposits. During the course of assessments proceedings, the assessing officer noticed that the assessee had advanced huge amounts to a company P, which was substantially interested in the trust. From the bank statements, the assessing officer found that as on March 31, 1997, a sum of Rs 75 lakh was outstanding with P.
In response to a query, the assessee stated that it had paid this amount to P as earnest money for purchase of land for a school project to be set up near Dehradun and that interest charged by the bank from the trust was fully reimbursed by P to the trust. The assessing officer observed that the trust had not taken adequate security but the assessee explained that security was provided in the form of equitable mortgage of commercial space owned by P.
The assessing officer denied the exemption under sections 11 and 12 of the Act. The assessee preferred an appeal before the commissioner of income tax (appeals), who confirmed the denial of the exemption. The tribunal dismissed the appeal filed by the assessee.
The Delhi High Court held that the contention of the assessee that the payments were in the nature of earnest money for purchase of land, and the whole exercise was of a commercial nature, did not explain the reason for interest free advances being given. The act requires very strictly that the trust should use its funds only for the charitable objects for which it has been set up and cannot be permitted to loan or deposit available funds without interest.
Further, not only had interest not been charged, even adequate security was not taken. It could not be denied that a benefit had “directly or indirectly” reached the interested person, namely, P, and thus, there was a clear violation of section 13(1)(c) and (2)(a) of the act. Thus, the charitable trust was not entitled to exemption of its income.
The aforesaid decision emphasises the strictness of the provisions of section 13, which disables a charitable trust from claiming exemption of its income, though it may be set up entirely for charitable purposes and exemption may have been granted right from its inception. If the disabilities laid down in section 13 are attracted for a particular financial year, it would prove fatal for claiming tax exemption for such specific year.
?The author is advocate, Supreme Court