Budget 2019: Charitable Trusts And Institutions’ Tax Exemptions Face Existential Crisis
Have amendments in the Finance Bill 2019 put onerous conditions on charitable trusts and tax authorities to ensure compliance?
The Story So Far…
The government has always endeavoured to create an enabling regulatory and fiscal framework to promote acts of philanthropy and charity in the country.
Hence, it has provided tax exemptions to charitable institutions/trust if such trust has been granted registration under section 12AA of the Income Tax Act and if the following conditions are met:
- 15 percent of any income from trust properties would be exempt if such amount is set-aside and invested in specified instruments and would be utilised in the future for the objects of the trust.
- Balance 85 percent of the income received during the year would also be exempt if the same is utilised for the objects of the trust.
- Donations received by the trust with the specific direction to utilise the same would be exempt.
- Donation received without any specific direction would be considered as part of the income and exemption mentioned in point one and two would be applicable.
Further, donations to such specified charitable institutions are eligible for tax benefit under Section 80G of the Income Tax Act subject to certain conditions.
However, there have been instances wherein charitable trusts were being used as vehicles of tax avoidance whereby wealth was created in such charitable trusts and after the accumulation of assets, such trusts were closed or assets were transferred to other entities without payment of any tax, as there was no clarification on taxability in such instances. Therefore, in Finance Act, 2016, the government had introduced specific provisions to deal with such instances and provided for exit tax in situations where trust is converted into or merged with or has transferred its asset to a non-charitable entity.
However, neither the existing tax provisions nor the aforesaid amendments dealt with non-compliance with other applicable provisions by such charitable institutions.
Measures Introduced In Budget 2019
Budget 2019 proposes to close this gap by introducing provisions for enhanced scrutiny of such charitable institutions.
Until the present amendment, the only aspects considered by the tax officer while granting registration under Section 12AA were to satisfy himself on the charitable nature of the trust objects and genuineness of the activities of the trust. Further, any deviation or non-compliance of the Trust activities from its stated objects led to a potential cancellation of the registration of such trust. Hence, loss of tax exemption.
However, the present Budget has introduced additional conditions (highlighted below) to grant registration/cancellation under section 12AA of the Income Tax Act, which are as follows:
The commissioner to satisfy himself that:
For granting registration
- Trust is charitable in nature;
- Activities of the trust are genuine; and
- The trust complies with requirements provided under any other law which is applicable to trust and compliance of such object is material to achieve the objects of the trust.
For cancellation of registration
- The trust is found to be non-genuine or not in accordance with its objects;
- The trust is not eligible to claim an exemption on account of violation of provisions of section 13(1);
- The trust has not complied with the requirement provided under any other law as provided for registration and order/direction/decree has been passed for such non-compliance under such law and such order/direction/decree has not been challenged or reached its finality.
The proposed amendments, among others, cast an obligation on the tax officer granting the registration to satisfy himself on due compliance under ‘any’ law applicable to the trust, prior to granting such registration. Considering the plethora of laws that could potentially be attracted to a trust/charitable institution depending on the location where such trust/institution is situated, it would be an onerous task on the part of the income tax officer to duly consider the compliance of all the laws and also the materiality of each of them for achieving the objects of the trust. This could potentially lead to delay in granting of registrations and subsequently tax exemption.
Considering conditions provided for cancellation, the law provides for cumulative satisfaction of two conditions:
a) that the trust or institution has not complied with the requirement of any other law; AND
b) the order, direction or decree, by whatever name called affirming the non-compliance, which order has either attained finality or such order, direction or decree is not disputed by the trust or institution.
Therefore, unless both the conditions are satisfied, the cancellation of Section 12AA registration on account of non-compliance cannot be sustained.
Thus, for example, if an association registered under the Foreign Contributions Regulation Act, 2010, is derecognised on grounds of non-compliance the association could also potentially lose its registration under Section 12AA of the Income Tax Act. However the Income Tax Act has built in safeguards to avoid any arbitrary cancellation by providing a reasonable opportunity of being heard to such defaulting institution and if it can be proved to the satisfaction of the tax officer that the default is not material for furthering the stated objects of the trust, the same may not be liable to cancellation.
Further, upon cancellation of registration of the charitable trust, the following implications would arise in the hands of the trust:
- The income earned during the financial year would be taxable;
- Accreted income (i.e. net asset created by the trust from the date of granting registration under Section 12AA to the effective date of cancellation of registration) would be taxable at the maximum marginal rate.
Further, the latest income tax return for the trust, i.e. ITR 7, also requires trusts/institutions to furnish details of all the other registrations and approvals like registration with the charity commissioner, Registrar of Societies / companies, FCRA, etc., which can be a starting point for the commissioner to analyse the compliance of other laws.
Some Open Issues…
The proposed changes would need the government to clarify on:
- If after the cancellation of registration based on non-compliance of law, the trust has taken steps to comply with such law, then whether the registration would automatically be restored, or whether trust can re-apply for registration?
- Will the cancellation of registration hold good in case of compoundable offences which are subject to rectification under the relevant that law?
The intent of the government, obviously, seems to be to implement an effective governance mechanism in public charitable institutions and to exercise greater scrutiny to avoid any misuse of the beneficial provisions under various laws to such institutions which is indeed noble.
However, the amendments expect the tax authorities to have expert knowledge in all the applicable laws in force and gives them unfettered powers to raise huge tax demands in case of cancellation of license.
This may be unreasonable, firstly on the tax authorities who may – under the fear of missing out of any applicable law/statute – delay the grant of license; and also on the part of charitable trust who may be staring at an existential crisis upon default without an opportunity to potentially course-correct.
Most of the educational and healthcare institutions in the country like universities, hospitals, etc. operate in a charitable trust structure. The managements governing these institutions would now need to take cognisance of this significant development and ensure timely compliance to ensure continuity of tax benefits.
One also hopes that the proposed amendments enhance the regulatory awareness both on the part of the Income Tax Department and the relevant people managing and promoting charitable activities such that they collaborate and implement the best practices to govern and deliver charity in our country without causing unnecessary harassment and misuse of the extant laws.
Girish Vanvari is Founder, and Krishnan TA is Director, at Transaction Square LLP.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.