FORMATION OF TRUST
A public charitable or religious institution can be formed either as a Trust or as a Society or as a Company registered u/s 25 of the Companies Act. It generally takes the form of a trust when it is formed primarily by one or more persons. To form a Society at least seven persons are required. Institutions engaged in promotion of art, culture, commerce etc. are often registered as non-profit companies. These forms are enumerated as under:
- Charitable Trust settled by a settlor by a Trust Deed or under a Will.
- Charitable or religious institution / association can be formed as a society.
- Charitable institution can be formed by registering as a company u/s. 25 of the Companies Act, 1956, as non profit company (without addition to their name, the word “Limited” or “Private Limited”).
CREATION /FORMATION OF TRUST
(A) Creation of a private trust: A Private Trust may be created inter vivos or by will. If a trust in created by will it shall be subject to the provisions of Indian Succession Act, 1925.
The following are the requisites for creation of a Trust:
(i) The existence of the author/settlor of the Trust or someone at whose instance the Trust comes into existence and the settlor to make an unequivocal declaration which is binding on him.
(ii) There must be a divesting of the ownership by the author of the trust in favour of the trustee for the beneficial enjoyment by the beneficiary.
(iii) A Trust property.
(iv) The objects of the trust must be precise and clearly specified.
(v) The beneficiary who may be particular person or persons.
Unless all the above requisites are fulfilled, a trust cannot be said to have come into existence.
(B) Creation of a Public Trust: Like the private trusts, public trusts may be created inter vivos or by will. In the case of Hanmantram Ramnath (Bom) it was held that “Although the Indian Trusts Act does not specifically apply to charitable trusts, there are three certainties required to create a charitable trust. They are:
(i) a declaration of trust which is binding on settlor,
(ii) setting apart definite property and the settlor depriving himself of the ownership thereof, and
(iii) a statement of the objects for which the property is thereafter to be held, i.e. the beneficiaries.
It is essential that the transferor of the property viz the settlor or the author of the trust must be competent to contract. Similarly, the trustees should also be persons who are competent to contract. It is also very essential that the trustees should signify their assent for acting as trustees to make the trust a valid one.
When once a valid trust is created and the property is transferred to the trust, it cannot be revoked, If the trust deed contains any provision for revocation of the trust, provisions of sections 60 to 63 of the Income-tax Act will come into play and the income of the trust will be taxed in the hands of the settlor as his personal income.
Public Trusts for Charitable or Religious Purposes
The income derived from a property held under charitable or religious trusts is exempt from tax u/s 11 subject to the fulfilment of certain conditions. However, any profit or gain of a business carried on by such trust shall not be exempt unless the business is incidental to the attainment of the objectives of the trust/institution and separate books of account are maintained by such trust/institutions in respect of such business.
Who can form a Charitable or Religious Trust : As per section 7 of the Indian Trusts Act, a trust can be formed –
a. by every person competent to contract, and
b. by or on behalf of a minor, with the permission of a principal civil court of original jurisdiction.
but subject in each case to the law for the time being in force as to the circumstances and extent in and to which the Author of the Trust may dispose of the Trust property.A person competent to contract is defined in section 11 of the Indian Contract Act as a person who is of the age of majority according to the law to which he is subject and who is of sound mind and is not disqualified from contracting by any law to which he is subject. Thus, generally speaking, any person competent to contract and competent to deal with property can form a trust. Besides individuals, a body of individuals or an artificial person such as an association of persons, an institution, a limited company, a Hindu undivided family through it’s karta, can also form a trust.
It may, however, be noted that the Indian Trusts Act does not apply to public trusts which can be formed by any person under general law. Under the Hindu Law, any Hindu can create a Hindu endowment and under the Muslim law, any Muslim can create a public wakf. Public Trusts are essentially of charitable or religious nature, and can be constituted by any person.
Capacity to create a Trust :-As a general rule, any person, who has power of disposition over a property, has capacity to create a trust of such property. According to section 7 of the Transfer of Property Act, 1882, a person who is competent to contract and entitled to transfer the property or authorized to dispose of transferable property not his own, either wholly or in part and either absolutely or conditionally, has ‘power of disposition of property’.
Thus, two basic things are required for being capable of forming a trust – power of disposition over property and competence to contract.
Who can be a Trustee :-Every person capable of holding property can become a trustee. However, where the trust involves the exercise of discretion, he can accept or act as a trustee only if he is competent to contract. No one is bound to accept trusteeship. Any number of persons may be appointed as trustees. However, no trust is defeated for want of a trustee. Where there is no trustee in existence, an official trustee may be appointed by the court and the trust can be administered. An executor of a Will may become a trustee by his dealing with the assets under the provisions of the Will. When an executor is functus officio to any of the assets and yet retains them, he becomes a trustee in respect of those assets.
Who can be a Beneficiary:- In a private trust the beneficiaries are one or more ascertainable individuals. In a public trust the beneficiaries are a body of uncertain or fluctuating individuals and may consist of a class of the public or the whole public. Generally, a private trust is not a permanent one. But a public trust is of a permanent nature. If properties are dedicated to temples and mosques or gifts are made to religious or charitable institutions they create a trust.
Requisites of a Trust
-The existence of the author/settler of the trust or someone at whose instance the trust comes into existence.
-Clear intention of the author/settler to create a trust.
-Purpose of the Trust.
-The Trust property
-Beneficiaries of the Trust.
-There must be divesting of the ownership by the author / settlor of the trust in favour of the beneficiary or the trustee.
Unless all these requisites are fulfilled a trust cannot be said to have come into existence.
TAXATION OF TRUST
Trusts have not been defined under the Income-tax Act, 1961. The dictionary meaning of “trust”, in so far as it relates to the realm of law, is “an arrangement” by which property is handed over to or vested in a person, to use and dispose it off for the benefit of another person.”
Trusts can be broadly classified into two categories, viz.,—
However, there may be trusts which are a blend of both and are known as Public-cum-Private Trusts.
1A Public trust: A public trust is one which benefits the public at large or some considerable portion of it. A public trust can be of two types, viz., (a) Public charitable trust, (b) public religious trust.
1B Private trust: In case of private trust, the beneficiaries are individuals or families. Private trusts are further broadly classified into:—
(i) Private specific trust, also referred to as Private Discretionary Trust with beneficiaries and shares determinate in respect of both.
(ii) Private Discretionary Trust where the beneficiaries or their share or either is indeterminate.
Private Trusts are created and governed by Indian Trusts Act, 1882 whereas charitable trusts are beyond this Act and have not been defined by law. According to section 3 of this Act, a trust is an obligation annexed to the ownership of the property and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another or of another and the owner. The person who reposes or declares the confidence is called the author of the trust, the person who accepts the confidence is called the trustee, the person for whom the benefit is created is called the beneficiary.
The subject-matter of the trust is called trust property or trust money, the beneficial interest or interest of the beneficiary is his right against the trustee as owner of the trust-property; and the instrument, if any, by which the trust is declared is called the instruments of trust.
From the analysis of the above definitions, it may be observed that three types of persons are involved in the creation of a trust—
(i) Author of the trust i.e. the person who reposes or declares the confidence;
(ii) Trustees i.e., the persons who accept the confidence;
(iii) Beneficiary i.e., the person(s) for whose benefit the confidence is accepted.
In case of private trusts, the beneficiary may be another person or the author.
1C Public-cum-Private Trusts: There may be certain trusts whose part of the income may be applied for public purposes and a part may go to a private person or persons. Such trusts are known as Public cum Private Trusts. Such trusts, in respect of the portion of the income going to private person or persons are assessable as private trusts and in respect of that portion of the income which is applied for public purposes, they shall be eligible for exemption under section 11 provided these trust are created before the commencement of Income-tax Act, 1961 i.e. before 1-4-1962. Public-cum-private created on or after 1-4-1963 shall not be eligible for exemption u/s 11,.
TAX Exemption under sections 11 to 13
Subject to the provisions of sections 60 to 63, certain incomes of a charitable/ religious trust or institution are not included in its total income to the extent and subject to the conditions specified in the Act. The word Trust as used in the context of sections 11 to 13 of the Income-tax Act, includes in addition to the trust “any other legal obligation“.
Subject to the provisions of sections 60 to 63: Section 11 starts with the opening phrase “subject to the provisions of sections 60 to 63. It means that if there is:
(a) a transfer of income without transfer of an asset; or
(b) revocable transfer of assets,
the income from that asset, in that case, shall be taxable in the hands of transferor and not the transferee.
Sections applicable for charitable or religious trust:
The following sections of the Income-tax Act deal with the subject of exemption of income from property held for charitable or religious purposes:
Section 11 :- Exemption of Income from property held in trust or other legal obligation, for religious or charitable purposes.
Section 12 :- Exemption of Income derived by such a trust from voluntary contributions not being contributions made with a specific direction that they shall form part of the corpus of the trust or institution.
Section 12A :- Prescribes the conditions for registration of a trust etc.
Section 12AA :- Prescribes the procedure for registration.
Section 13 :- Enumerates the circumstances under which exemption available under sections 11 and 12 will be denied.
The exemption outlined in section 11 are subject to the fulfillment, not only of the various conditions set out in this section but also those set out in sections 12, 12A, 12AA, 13 and 60 to 63
Conditions to be satisfied for claiming exemption under section 11:
For claiming exemption under section 11, the following conditions must be satisfied:
(a) Trust must have been created for any lawful purpose;
(b) Such trust/institution must be for charitable or religious purposes. According to section 2(15), charitable purpose includes relief of the poor, education, medical relief and the advancement of any other object of general public utility;
Amendment made by the Finance Act, 2008
With a view to limiting the scope of the phrase “advancement of any other object of general public utility”, the Act has amended section 2(15) so as to provide that “the advancement of any other object of general public utility” shall not be a charitable purpose if it involves the carrying on of—
(a) any activity in the nature of trade, commerce or business or,
(b) any activity of rendering of 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 of the income from such activity, or the retention of such income, by the concerned entity.The purpose of bringing this amendment was that number of entities operating on commercial lines are claiming exemption on their income either under section 10(23C) or section 11 of the Act on the ground that they are charitable institutions. This is based on the argument that they are engaged in the “advancement of an object of general public utility” as is included in the fourth limb of the current definition of “charitable purpose”. Such a claim, when made in respect of an activity carried out on commercial lines, is contrary to the intention of the provision.
The entities effected due to the above amendment are housing boards, chamber of commerce, port trust, etc. as the Supreme Court in case CIT v Gujarat Maritime Board (2007) 295 ITR 561 (SC) held that the assessee who is engaged in developing and maintaining minor ports in State of Gujarat is carrying on a object of general public utility.
Amendment made by the Finance Act, 2009
Charitable trusts with the objective of the preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest were as such covered u/s. 2(15) of the Act. However, such objectives would fall under the category of advancement of general public utility. When a charitable trust carries on with the objective of advancement of general public utility, it would not be able to carry on 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 cess or fee or any other consideration. Since these objectives need to be encouraged, it is a welcome amendment being proposed to provide that such objectives would form separate objectives in themselves u/s. 2(15) and therefore would not fall under the category of advancement of general public utility and as a result would be excluded from the applicability of the condition that such trust cannot carry on 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 cess or fee or any other consideration : The amendment is effective from A. Y. 2009-2010 and therefore trusts with these objectives would not entail such restriction even in the F. Y. 2008-09 when for the first time such restriction was introduced.
Donations to Certain Funds, Charitable Institutions, etc., Perpetual Certificates u/s. 80G :
Because of amendments by the Finance Act, 2008 in section 2(15), a number of organizations have ceased to be charitable for the purposes of the Income-tax Act. However, such institutions and trusts continued to collect donations during the financial year 2008-2009 for funding relief work for floods in Bihar and other public purposes. The donors made these donations under a bonafide belief that they would be entitled to benefit under section 80-G. With a view to mitigate hardship to the donors, one time relaxation proposed for donations made during financial year 2008-09 in respect of an institution or fund approved under clause (vi) of sub-section 5 of section 80G for the previous year beginning on the 1st day of April 2007 and ending on the 31st day of March, 2008. Amendment shall accordingly, apply in relation to assessment year 2009-10 only.
Certificates granted u/s. 80G expiring on or after 1st October, 2009 would remain valid in perpetuity unless specifically withdrawn.
(a) The property from which income is derived should be held under trust by such charitable or religious trust/institution.
(b) The accounts of the trust/institution should be audited for such accounting year in which the total income, before giving effect to provisions of section 11 or 12, exceeds the maximum amount which is not chargeable to tax and the person in receipt of the income should obtain an audit report in Form No. 10B [Rule 17B] and furnish the same alongwith the return of income.
(c) The trust must get itself registered with the Commissioner of Income-tax within the prescribed time.
(d) Where the “property held under a trust” includes a business undertaking, the provisions of sections 11(4) shall be applicable. On the other hand, if the trust wishes to carry on business, the profits or gains earned from such business shall not be exempt under section 11, unless the business is incidental to the attainment of the objectives of the trust/institution and separate books of account are maintained by such trust and institution in respect of such business.
(e) The charitable trust created on or after 1-4-1962 should satisfy the following further conditions:
(i) it should not be created for the benefit of any particular religious community or caste;
(ii) no part of the income of such charitable trust or institutions should enure directly or indirectly for the benefit of the settlor or other specified persons; and
(iii) the property should be held wholly for charitable purposes.
However, the religious trust created before or after 1.4.1962 may not satisfy the condition (i) mentioned above, but if it is created after 1-4-1962, it should satisfy the conditions (ii) and (iii) mentioned above.
Thus, the charitable trust or religious trust created before 1-4-1962 can be partly public charitable or religious trust and partly private charitable/religiou s trust but charitable or religious trust created after 31-3-1962 should be wholly for charitable or religious purposes.
(f) The funds of the trust should be invested or deposited in the permissible forms and modes prescribed in section 11(5).
Which income will be exempt under section 11
Subject to the provisions of sections 60 to 63, the following incomes of a religious or charitable trust or institution are not included in its total income, provided the conditions mentioned under para 3a above are satisfied:
(a) Income from property held under trust wholly for charitable or religious purposes [Section 11(1)(a)]: Income derived from property held under trust, wholly for charitable and religious purposes, shall be exempt—
(i) to the extent such income is applied in India for such purposes; and
(ii) where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of 15% of the income from such property;.
(b) Income from property held under trust which is applied in part only for charitable or religious purposes [Section 11(1)(b)]:Income derived from property held under trust in part only for such purpose, shall be exempt:
(i) to the extent such income is applied in India for such purposes, provided, the trust in question is created before the commencement of Income-tax Act, 1961 i.e. before 1-4-1962; and
(ii) where any such income is finally set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of 15% of the income from such property.
(c) Income from property held under trust which is applied for charitable purposes outside India [Section 11(1)(c)]: (i) Income derived from property held under trust, created on or after 1-4-1952 for charitable purpose which tends to promote international welfare in which India is interested, shall be exempt to the extent to which such income is applied to such purpose outside India. Religious trusts are not covered here.
(ii) Income derived from property held under a trust for charitable or religious purposes, created before 1-4-1952, shall be exempt to the extent to which such income is applied to such purposes outside India.
In the above two cases, it is necessary that the Board, by general or special order, has directed in either case that it shall not be included in the total income of the person in receipt of such income.
(d) Voluntary contributions forming part of corpus [Section 11(1)(d)]: Income in the form of voluntary contributions made with a specific direction, that they shall form part of the corpus of the trust or institution, shall be fully exempt. The condition that at least 85% of the income should be applied during the previous year in which it is earned is not applicable in this case.
It is not sufficient that the property is indirectly responsible for the income; it is necessary that the income must directly and substantially arise from the property held under trust. The property must be the effective source from which the income arises. [J.K. Trust (Bom)].
4a Exemption is limited to the extent such income is applied for charitable or religious purposes: It has been mentioned above, that exemption for clauses (a), (b) and (c) is limited to the extent to which such income is applied in India [or outside India in case of clause (c) mentioned above].
Although, the exemption for clauses (a) and (b) is available to the extent income is applied during the previous year for charitable or religious purposes but it is not necessary that 100% of the income should be so applied for such purposes during the previous year itself to claim full exemption.
As per the Act, for claiming full exemption of such income, the assessee is required to apply atleast 85% of such income during the previous year for charitable or religious purposes. He can accumulate upto 15% of such income to be utilized for charitable or religious purposes in India at a later date. Such facility of accumulation is not available for trust mentioned in clause (c) above, whose income is to be applied outside India and as such these trusts will be allowed exemption only to the extent the amount has been applied for such purposes outside India.
1. After 28-2-1983, 15% of the income, which can the accumulated or set apart for any period, should also be invested or deposited in one or more of the forms or more specified in section 11(5).
2. Although the trust or institution is required to apply atleast 85% of income, and accumulate maximum 15% of income, but it can accumulate even more than 15% of such income in certain cases and subject to certain conditions mentioned in section 11(2) discussed later. [Refer para 5]
4b Income applied during the previous year includes the following: It is clear from the above discussion that for claiming full exemption atleast 85% of the income should be applied during the previous year, towards the purpose for which the trust has been created. Income applied during the previous year for this purpose includes the following:
(a) income actually applied during the previous year for charitable and religious purposes,
(b) income deemed to have been applied for charitable or religious purposes in India during the previous year.
Income deemed to have been applied during the previous year for charitable or religious purposes [Clause 2 of the Explanation to section 11(1)]: If the income applied to charitable or religious purposes during the previous year falls short of 85% of the income derived during the year either:
(a) for the reason that whole or part of the income has not been received during the previous year or
(b) for any other reason,
then the charitable trust has been given the option to spend such income for charitable or religious purposes in the following manner:
(i) In case of (a) either during the previous year in which the income is so received or in the immediately following previous year. Example, if the income of previous year 2006-07 is received on 15-4-2007, i.e., next year, such income should be applied for charitable or religious purposes either during previous year 2007-08 and/or 2008-09.
(ii) In case of (b) during the previous year immediately following the previous year in which the income was derived. If the income is received on 28-1-2007 and it could not be spent in the previous year 2006-07 for any reason, it could be applied in the next previous year i.e. 2007-08.
To avail the facility of the above extended period of application of income, the trust has to exercise an option in writing before the due date of filing return under section 139(1).
If such option is exercised by the trust, such income shall be deemed to have been applied for charitable and religious purposes during the previous year in which the income is earned, though it is actually spent at a later date. In this case, as such income is deemed to have been applied during the previous year in which it was derived, it shall not be treated as application of income for charitable purposes, of the previous year in which it is actually spent.
Consequences if the income is not actually applied within the prescribed period after exercising the above option [Section 11(1B)]