INTRODUCTION:
The Finance Bill 2016 proposed by the Parliament has introduced a new Chapter XII EB to impose tax on the accreted income of charitable institutions that would convert into or merge with non-charitable entities. The Bill also provides under Clause 60 of its Memorandum to the Provisions an explanation to the sections introduced via the above Chapter. The existing provision of Section 11 of the Income Tax Act, 1961 (hereinafter called ‘the Act’) exempts income derived from the property held under trust wholly for charitable or religious purposes if it registered under Section 12AA of the Act. In a nut shell, what the above Chapter intends is to alter the prior provision of law with regards conversion of charitable institutions and trusts into non-charitable entities with additional levy on the accreted income. This legislative intent is sought to be analysed in the forthcoming paragraphs.
BASIS:
The title of the new Chapter XII EB is ‘Special Provisions Relating to Tax on Accreted Income of Certain Trusts and Institutions’ and hence it is important to note that the object of such trusts and institutions are governed by Section 2(15) of the Income Tax Act, 1956 This Section is inclusive in nature and is stated as follows:
Section 2 (15) – “charitable purpose” includes relief of the poor, education, yoga, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest, and the advancement of any other object of general public utility.
The proviso to this Section provides that 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, irrespective of the nature of the use or application or retention of income from such activity shall not be charitable. This proviso is relevant in the light of Section 12AA with regard to procedure for registration of such trusts and institutions. Under Section 12AA, the Principle Commissioner has the power and discretion to grant or deny registration after satisfying himself about the objects of the trust or institution and the genuineness of its activities. He shall then pass an order in writing registering the trust or institution; and shall, if he is not so satisfied, pass an order in writing refusing to register the trust or institution, and a copy of such order shall be sent to the applicant after giving a reasonable opportunity of being heard.
He has to pass such orders within six months from the date of application. Further, if he is subsequently satisfied that the activities of such trust or institution are not genuine or are not being carried out in accordance with the objects of the trust or institution, as the case may be, he shall pass an order in writing cancelling the registration of such trust or institution.
This being the position of law with regard to registration and cancellation of a trust or institution under the Act, the effect of such denial or cancellation of registration and the taxability of such income thereof prior to the Finance Bill, 2016 need to be examined..
EFFECT OF REGISTRATION AND DENIAL OR CANCELLATION:
The existing provisions of Section 2(24) of the Act define “Income” in an inclusive manner. Any voluntary contribution received by a charitable trust or institution or a fund is included in the definition of income. A trust or institution registered under Section 12AA is exempted from tax on income from property held for charitable or religious purposes under Section 11 and such income is excluded from total income under Section 10 (23C) of the Act. Further, Section 12 provides for income of trusts or institutions from voluntary contributions shall be deemed to be income derived from property held under trust wholly for charitable or religious purposes.
However, such exemption under Sections 11 and 12 is subject to Section 13 which categorically states that, nothing in the above mentioned Sections shall operate so as to exclude from the total income of the previous year of the person in receipt thereof from privately held trusts which do not ensure for the benefit of the public or trusts held for charitable and religious purposes created through trusts or institutions for the benefit of specific caste or community and so forth.
Thus the effect of registration under Section 12AA is qualified by Section 13 to be eligible for exemptions and such trusts or institutions which fail under Section 12AA are not eligible for exemption in the first place resulting in the taxability of such income received by the trusts or institutions.
The primary condition for grant of exemption is that the income derived from property held under trust should be applied for the charitable purposes, and where such income cannot be applied during the previous year, it has to be accumulated and invested in the modes prescribed and applied for such purposes in accordance with various conditions provided in the section. If the accumulated income is not applied in accordance with the conditions provided in the said section within a specified time, then such income is deemed to be taxable income of the trust or the institution[1].
POSITION OF LAW POST FINANCE BILL 2016:
According to the law in force at present, a trust or an institution carrying on charitable activity may voluntarily wind up its activities and dissolve or may also merge with any other charitable or non-charitable institution, or it may convert into a non-charitable organization. In such a situation, the existing law does not provide any clarity as to how the assets of such a charitable institution shall be dealt with. Although Section 11 provides for exemption, it also enumerates circumstances in which the exemption is not applicable and the income will be charged to tax. Further, the law is vague on the use of corpus and asset base of the trust accreted over a period of time, with promise of it being used for charitable purpose, continues to be utilised for charitable purposes and is not used for any other purpose.
The introduction of Chapter XII EB for tax on accreted income of trusts and institutions seems to be a major game changer with respect to levy of additional income-tax in case of conversion into, or merger with, any non-charitable form or on transfer of assets of a charitable organisation on its dissolution to a non-charitable institution. On the one hand, the proposal is much appreciated for laying down definitive standards of law with respect to transfer of assets by charitable institutions to non-charitable institutions which are not available under the existing regime. This is indispensible to curb the mischief caused to the law by converting into non-charitable institutions and such corpus and asset base accumulated over years be utilised for non-charitable purposes with no tax consequences. However on the other hand, the proposed amendment seems to bring about an impending danger in case of cancellation of registrations under Section 12AA and appears to be a possible abuse of process.
- Section 115TD provides that notwithstanding anything contained in any other provision of the Act, a trust or institution registered under section 12AA in any previous year shall be liable to tax on accreted income in the event of certain eventualities mentioned in the proposed new section, as on the specified date, at the maximum marginal rate, in addition to the income-tax chargeable in respect of the total income.
- The proposed section provides for specific situations under which a trust or institution can be said to have converted into any form which is not eligible for grant of registration. The additional income-tax to be charged shall be in addition to the income-tax chargeable in respect of the total income of such trust or institution whether income-tax is payable by the trust or the institution on its total income or not.
- Section 115TE provides for the levy of interest, in case of failure to pay tax within the time provided, at the rate of one per cent for every month and part thereof of such failure.
- Section 115TF provides that in case of failure of payment of tax, the principal officer or the trustee and the trust or the institution shall be deemed to be an assessee in default in respect of the amount of tax payable and all provisions of the Income-tax Act relating to recovery and collection of taxes shall apply to them.
- Accreted income shall be amount of aggregate of total assets as reduced by the liability as on the specified date. The method of valuation is proposed to be prescribed in rules. The asset and the liability of the charitable organisation which have been transferred to another charitable organisation within specified time will be excluded while calculating accreted income.
CRITICISMS:
The criticisms against the proposed amendment are levelled from two different aspects, i.e.; a) the period of payment of tax on accreted income upon cancellation and b) method of computation of additional levy
- Period of payment
The proposed Section 115TD provides under clause (5) that, the principal officer or the trustee of the trust or the institution, as the case may be, and the trust or the institution shall also be liable to pay the tax on accreted income to the credit of the Central Government within fourteen days from the date on which the order cancelling the registration is received by the trust or the institution in a case referred to in clause (i) of sub-section (3)[2]. Further, an interest of 1% every month or part thereof on the amount of such tax for the period beginning on the date immediately after the last date on which such tax was payable and ending with the date on which the tax is actually paid is levied under Section 115TE for failure to pay whole or any part of the tax on accreted income. This amendment is arbitrary and violative of the fundamental rights of the assessee. Eminent jurist SE Dastur expressed concern that, ‘the requirement that the trusts have to pay the tax within 14 days of the cancellation of registration under Section 12AA is impractical and would lead to great hardship. Mr. Dastur pointed out that it is common experience that the department revokes the registration of charitable trusts on flimsy and frivolous reasons. There are scores of judgements where the orders of cancellation of registration have been struck down. In such circumstances, requiring the trust to pay the tax and interest pending the appeal is unfair’[3].
When such a short period is allowed for the payment of tax, assuming assets have to be sold to pay the tax on income and the additional tax on accreted income, it would force a unsatisfactory sale on the assessee. The method of computation which is the final criticism levelled against the proposed amendment provides for market value of the assets taken into consideration. Hence to pay the additional tax on accreted income, such sale must yield such returns to enable the assessee to pay the same. However, it is impracticable to sell assets at market value at such a short notice especially when the prospective buyer becomes aware of the tax liability of the seller and the compelling situation that he is in. This would then result in an unsatisfactory compromise on the value of the asset in order to meet the tax liability which is an evident violation of the assessee’s fundamental right under Article 21 of the Constitution.
- Method of computation
Finally, the second and last aspect of criticism is the concept of accreted income introduced in the Chapter. Sub-section (2) of Section 115TD defines accreted income as, the accreted income for the purposes of sub-section (1) means the amount by which the aggregate fair market value of the total assets of the trust or the institution, as on the specified date, exceeds the total liability of such trust or institution computed in accordance with the method of valuation as may be prescribed. Cancellation of registration can be done when the Principal Commissioner or Commissioner is satisfied that any income or property is applied for the benefit of specified persons or its funds are invested in prohibited modes.[4] Section 115TD (3)[5] provides that when registration is cancelled by virtue of Section 12AA of the Act, it is deemed that the trust or institution has converted into a form not eligible for registration. When one single act of violation can result in cancellation, taxing them on their entire asset value is arbitrary in policy and violation of Article14 of Constitution of India.
Further, it is evident that only the assets of the trust or the institution are taken at market value while the liabilities are not. This would result in the accreted income being exorbitant especially in case of property held by the trust or institution. This would result in the additional tax being high and which when paid along with the tax on income would be an unreasonable burden on the assessee. It is however not disputed that stringent measures must be taken to bring entities trying to escape liability under the rigour of law.
CONCLUSION:
Charity, as Sir William Grant (the Master of Rolls) justly observed, in its widest sense, denotes all good affections men ought to bear towards each other; in its more restricted and commonsense, relief of poor[6]. The origin of exemption from tax for charitable institutions has been a long source of tradition, as scholarship indicates; the ancient worlds of Egypt, Sumeria, Babylon and Persia forgave priests and temples their taxes[7]. Examining such ideals from a jurisprudential point of view, English common law also recognized the service which many religious institutions provided, and beginning with the Reformation, this area of the law granted tax exemptions to those who “disposed of certain responsibilities that would otherwise fall to the government”[8]. Thus it can be rightly understood that such exemptions were given as an incentive for institutions which advanced charity to the public. However, such exemptions must not be utilised to escape by the rigour of law by taking advantage of its lacunae.
In light of such malpractices, the proposed amendment is indeed a commendable piece of legislation. However, a piece of legislation as much as it should be stringent must not be unreasonable. The proposed amendment although aims at curbing the mischief of such entities which would convert itself into non-charitable entities with the benefit of exemption availed since the inception of the institution, is also a arbitrary with respect to those trust or institutions which err by chance. A trust or institution established for over a century would get destroyed even in case of an inadvertent error as its entire assets would be taxed. In such a scenario, it will become irretrievable even if the order is reversed at the appellate stage. The following proposals are made with a view make the best out of this laudable attempt by the legislature.
Proposal 1: Section 115TD (4) provides for the time period to pay the tax on accreted income to the credit of the Central Government, i.e. 14 days from the date of such circumstances as prescribed under sub-section (3). Interestingly, the proposed amendment allows a longer period for such trust or institution which voluntarily backs out of charity or fails to register itself to claim exemption while is extremely unreasonable and arbitrary for cases governed by clause (i) of sub-section (3). Such an act is arbitrary and is an extreme measure imposed upon such trust or institution. While the assessee has the right appeal with a period of 60 days from the date of order of the Commissioner, a 14 day period to pay the tax cannot be imposed as it would result in frustrated sale. Further, an impending danger awaits under Section 115TF wherein, if the assessee fails to pay such tax, then, he or it shall be deemed to be an assessee in default in respect of the amount of tax payable by him or it and all the provisions of this Act for the collection and recovery of income-tax shall apply. When finality has not been reached with respect to the proceedings, an assessee would suffer irreparable loss if the order is found to be erroneous by the tribunal on appeal.
Thus, it is suggested that, the time period with respect to cases governed by clause (i) of sub-section (3) of Section 115TD must be allowed until finality of appeal proceedings is reached.
Proposal 2: With respect to the method of computation criticised, it is suggested that a the income applied to non-charitable purpose should be taxed as business income at maximum marginal rate as prescribed.
Therefore these proposals aim at striking a balance between strict compliance by and available exemptions to charitable trusts and institutions. By instituting such changes in the proposed amendment, genuine trusts and institutions would be saved from being imposed with unreasonable restrictions which would result in unintended consequences.
AUTHORS
| Name | Contact No. | Email Id. |
| CA. S. BALACHANDRAN
(Professor) |
9442359192 | santhanambalachandran@gmail.com |
| S. SANJITH
(Assistant Professor) |
9884835957 | manjunair828@gmail.com
|
| S. VARSHA
(Student, X Semester B.A., LL.B.(Hons.)) |
9176420185 | varshasuresh93@gmail.com |
ADDRESS: School of Law, SASTRA University, Thanjavur – 613401
[1] https://taxguru.in/income-tax/budget-2016exhaustive-analysis-income-tax-provisions.html on 15th March, 2016
[2] Finance Bill, 2016
[3] http://www.itatonline.org/info/index.php/eminent-jurist-s-e-dastur-explains-important-nuances-of-the-finance-bill-2016/ on 15th March, 2016
[4] Direct Tax Laws,27th Edition 2016, T.N.Manoharan & G.R.Hari, Snow White Publication
[5] Finance Bill, 2016
[6] Commentaries on Equity Jurisprudence, 1st Edition, Hon Mr Justice Story LLD at CHAP XXXII, 786
[7] Erika King, Tax Exemptions and the Establishment Clause, 49 SYRACUSE L. REV. 971, 973-74 (1999)
[8] RFRA, Churches and the IRS: Reconsidering the Legal Boundaries of Church Activity in the Political Sphere, 43 HARV. J. ON LEGIS. 145, 180 n.14 (Winter, 2006) at 147
