Delhi High Court: Higher Payment to Trustee Does Not Automatically Disqualify Trust from Tax Exemption
Short Summary: In a recent decision in the case of CIT Vs IILM Foundation, the Delhi High Court addressed the validity of exemption denial under Sections 11 and 12 of the Income Tax Act, 1961, to IILM Foundation, a registered charitable trust, on grounds of salary payment to its Chairperson, Ms. Malvika Rai. The Revenue had argued the excessive payment to a related party violated Section 13(1)(c), warranting loss of exemption. However, after considering evidence of Ms. Rai’s services and experience, both the Commissioner (Appeals) and ITAT found the remuneration reasonable. The High Court reaffirmed that only excessive or unreasonable payments to related parties justify exemption denial, and not every payment per se. The Court distinguished previous case law and dismissed the Revenue’s appeals, upholding the trust’s entitlement to exemption.
1. Facts of the Case
The case concerns IILM Foundation (formerly Ram Krishna Kulwant Rai Charitable Trust), a trust registered under Section 12A of the Income Tax Act, 1961 and engaged in educational activities through various institutions. For Assessment Year (AY) 2009-10, the trust paid its Chairperson, Ms. Malvika Rai, an annual salary of ₹ 16,20,000, which the Assessing Officer (AO) partly disallowed, deeming it excessive and not commensurate with her qualifications and experience. The AO invoked Section 40A(2)(a), disallowed 30% of the payment, and treated the trust as an Association of Persons (AOP) for taxation, denying exemption under Sections 11/12 after the trust’s registration was retrospectively cancelled. Subsequently, this cancellation was set aside by the ITAT, restoring the trust’s eligibility for exemption.
2. Arguments Made
By Revenue:
The crux of the Revenue’s argument lay in the interpretation of Sections 13(1)(c) and 13(2)(c) of the Income Tax Act. The counsel of the Revenue asserted that any payment made by the trust to a related party, in this case, Ms. Malvika Rai (the Chairperson), amounted to a violation of the conditions required to claim exemption under Sections 11 and 12. Revenue kept reliance on the decision in the case of Director of Income Tax (Exemption) v. Charanjiv Charitable Trust: 2014 SCC OnLine Del 7776, emphasizing that even a single instance of income or property being directly or indirectly used for the benefit of a person listed under Section 13(3) would cause the trust to lose its entire exemption for that year—regardless of the payment’s reasonableness or the services actually rendered.
By Assessee:
In response, the Assessee’s counsel argued that the statutory language of Section 13(2)(c) is precise: only amounts paid to specified persons that are “in excess of what may be reasonably paid for such services” would result in a denial of exemption. The Assessee provided substantial evidence of Chairperson’s two-decade experience in the education sector and active involvement in the trust’s affairs, including participation in key events, alumni meet, academic functions, and institutional management. The Assessee also highlighted that the authorities (CIT(A) and ITAT in prior years) as well as departmental officers in subsequent years had accepted the reasonableness of the quantum of salary paid. The defense further distinguished the facts of the Charanjiv Charitable Trust case (Supra), pointing out that the question of excessiveness had not been established by the Revenue, nor had any material been placed on record to demonstrate that the remuneration exceeded reasonable limits for Ms. Rai’s services. Detailed documentary evidence—including brochures, event records, and alumni publications—was presented to substantiate the scale and nature of Ms. Rai’s contributions to the educational institutions run by the trust.
3. Decision of the Hon’ble HC
The court clarified that the salary paid to Ms. Rai was neither excessive nor unreasonable, given her qualifications and contributions, which had been affirmed by the ITAT and not contested by the Revenue. The Revenue’s challenge focused solely on the interpretation of Section 13 of the Income Tax Act, arguing that any income of a trust benefitting a person specified in Section 13(3) renders the entire income taxable, thereby disqualifying it from exemptions under Sections 11 and 12. However, the court held that such exemption is not universally voided but denied only to the extent that the income is applied for the benefit of specified persons. In other words, if part of the income is diverted directly or indirectly for such benefit, that part alone loses the exemption.
Further, the judgment interpreted clause (c) of Section 13(2) to clarify that payments made to specified persons are not automatically considered misuse unless they are in excess of what may reasonably be paid for services rendered. If compensation is fair and commensurate with the services, it does not amount to diversion of trust income, even if paid to a prohibited person. The court emphasized reading the clause holistically, noting that only excessive payments trigger disqualification. It also distinguished the precedent in Charanjiv Charitable Trust(supra), limiting its applicability to its facts. Accordingly, the legal question was resolved in favor of the assessee, with the ruling extending to the assessment years 2010–11 and 2011–12 due to similar factual grounds.
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