Dr. N.C.Swain
Commissioner of Income Tax (Hqr)
(Exemptions), Delhi
nc.swain@incometax.gov.in
Disallowance for Violation of Section 13(1)(c) R.w.s.13(2)(b) of the Act- Denial of Entire Exemption, or Limited only to the Amount Diverted- Judicial Decisions
Dr.N.C.Swain is an IRS officer of 1993 batch currently posted as Commissioner of Income Tax (Headquarters) in Exemptions. He has a long experience in Income Tax Assessment, Investigation, Administration, Transfer Pricing, Appeals etc. He was a member of the Task Force on Subordinate Legislation for the Direct Taxes Code and also worked in CBDT, dealing with Media & Technical Policy. He was also posted in the Election Commission of India on deputation and extensively monitored Election Expenditure and Political Party Finance.
| Executive Summary
The article attempts to examine whether violation of the conditions laid u/s 13(1)(c), r.w.s 13(3) and 13(2)(b) would lead to only disallowance of monetary value of the benefit given to the prohibited person(s), or would result in denial of the entire exemption claimed by the assessee u/s 11 and 12 of the I.T. Act. |
1. Charitable entities can claim exemptions from tax as per sections 11 and 12 of the Income Tax Act. Section 13 of the Income Tax Act contains conditions, violation of which, can affect claim of such exemption u/s 11 and 12. Section 13(1)(c) prohibits use of trust property or income for direct or indirect benefit of the prohibited person(s).
2. Prohibited person(s) have been specified in section 13(3) of the Act, which include the author of the trust or founder of the institution, person who has made a substantial contribution to the trust, any trustee of the trust or manager, any relative of such author, founder or trustee or manager, or any concern in which any of these persons have substantial interest.
3. The main objective of section 13(1)(c) read with section 13(3) is to prevent the exploitation of the charitable institution by persons who are in a position to exercise control over the management of the institution. Section 13(2) enumerates the situations where it would be deemed that the income or property of the trust or institution has been used or applied for the benefit of a person referred to in section13(3) of the Act.
4. While the conditions stipulated in these provisions and restrictions are clear and unambiguous, its application has raised controversies, i.e. whether violation of the conditions would lead to only disallowance of monetary value of the benefit to the prohibited person(s), or would it lead to denial of the entire exemption claimed by the assessee u/s 11 and 12 of the Act.
5. The Hon’ble Supreme Court decision in the case of ‘DIT vs. Bharat Diamond Bourse’ (259 ITR 280) (2003) and the Karnataka High Court decision in the case of ‘CIT vs. Fr. Mullers Charitable Institution’ (2014) (Kar)(363 ITR 230) are the two important decisions on this issue. While ‘DIT vs. Bharat Diamond Bourse’ decision calls for denial of complete exemption, the Karnataka High Court in the case of CIT Vs. Fr. Mullers prescribes a softer approach by disallowance of only the extent the income is diverted.
6. Recently, vide decision dated 18.12.2018 in the case of CIT(E), Pune Vs. Audyogik Shikshan Mandal, Pune (101 taxguru.in 247) (Bom)(2019) the Hon’ble Bombay High Court has followed the decision in the case of Fr. Mullers Charitable Institutions, by observing that on a plain reading of sections 11 and 13 of the Act, it is clear that the legislature did not contemplate denial of entire benefit under section 11 of the Act to the trust. The Bombay High Court has held that the interpretation advanced by the Department would lead to grave injustice as any minor mistake involving small amount would lead to denial of benefit of the entire exemption claimed. The Hon’ble High Court further noted that SLP filed by the department against the decision of Karnataka High Court was dismissed. It is worth mentioning that while dismissing the SLP in the case of ‘CIT vs. Father Mullers Charitable Institutions’, the Hon’ble Supreme Court kept the question of law open ( SLP(C) No. 15907/2014).
7. However, Department has not accepted the decision of the Hon’ble Bombay High Court and has filed SLP against this decision. The facts of the case ‘CIT(E), Pune Vs. Audyogik Shikshan Mandal, Pune’ and issue involved are discussed hereinafter.
7.1 M/s Audyogik Shikshan Mandal, Pune, the assessee trust had purchased a Skoda car for Rs. 11.38 lakh in the name of trustee, that is it had applied its income/property for the benefit of a person referred to in sub-section (3) of section 13 of the Act. The Assessing Officer held that the assessee trust was not entitled to any exemption u/s 11 of the Act and he brought the entire income of the assessee trust to tax, including the amount spent for purchase of the car. The CIT(A) upheld the action of the A.O.
7.2 Revenue’s appeal before the ITAT took an interesting turn. The Hon’ble Accountant Member relied on the decision of Supreme Court in ‘Bharat Diamond Bourse’ (259 ITR 280) and following the ratio (Para 7 and Para 20 of the Hon’ble Supreme Court Decision) held that the assessee would lose the benefit of Section 11 and 12 of the Act. The Judicial member gave a dissenting order by holding that deeming provision of Section 13(2)(b) has been invoked beyond its scope, and that merely a property being made available to a person does not deem that it was also used by such person. Further, he held that the A.O. has erred in taxing the entire income of the trust by denying the benefit of section 11 in totality, even in respect of portion of income which was undisputedly applied towards the objects of the trust.
7.3 The matter was referred to Third Member. The Third Member observed that the car had been purchased in the exclusive name of the trustee, who had complete control over the car and had no personal car of his own, and that there was no resolution passed by the trust in writing. He held that there was violation of provisions of section 13(2)(b) r.w.s. 13(3) of the Act. With regard to quantum of exemption, he noted that the ‘Bharat Diamond Bourse’ case fell within ambit of section 13(a) r.w.s. 13(1)(c) of the Act. He also noted that in Fr. Mullers case (363 ITR 378), the Hon’ble Supreme Court rejected SLP by affirming the view of Hon’ble Karnataka High Court wherein it was said that in the event of violation of section 13(1)(d), it was only the income or investment or deposit which has been made in violation of section 11(5), that will be liable to tax. The Third Member relied on Fr. Mullers case, as it was a latter judgment of the Apex Court, and held that denial of exemption under section 11 should be limited to the amount which was diverted (i.e. car purchased in the name of prohibited person in violation of section 13(2)(b) of the Act).
7.4 On appeal filed by the department, the Hon’ble Bombay High Court has noted that the Apex Court decision in Bharat Diamond Bourse is not clear whether it is only to the extent of income diverted or the entire income that is to be denied exemption. The Court further noted that the decision of Karnataka High Court in Fr. Mullers case deals with the very issue and held that benefit of section 11 will not be available only in respect of the amount of diverted income. The Hon’ble High Court also noted that the Karnataka High Court in Fr. Mullers case had placed reliance on decision of Mumbai High Court in Sheth Mafatlal Gaganbhai Foundation (249 ITR 533), and Delhi High Court decision in Agrim Charan Foundation (253 ITR 593). The Hon’ble High Court observed that if the interpretation sought to be advanced by the Revenue is accepted, it would lead to grave injustice as for any mistake, however minor, the consequence would be denial of benefit of exemption to entire income.
8. Thus the legal issue involved is whether the AO is correct in denying entire exemption claimed u/s 11 of the Act, or, should the disallowance be restricted only to that income of the Trust which was used/applied directly or indirectly for the benefit of the prohibited persons. The issue involved is quite significant and has huge tax implications. In several cases, appeals are pending before High Courts and the Supreme Court.
9. There is a general perception that the Hon’ble Supreme Court has held different views in the two judgments. It is perceived that while Bharat Diamond Bourse case has been decided in favour of the revenue, by dismissing the SLP filed by the department against the Karnataka High Court decision in Fr. Mullers case, which is a subsequent decision, the Apex Court apparently reversed its stand. However, this perception is not correct and the facts of both the cases and the provision of the Act involved are different. Moreover, even in the latter case the Apex Court while dismissing the SLP filed by the department kept the question of law open. This cannot be construed as reversing its earlier stand involved in the Bharat Diamond Bourse case, or that the issue has been adjudicated and reached finality.
10. In the case of Bharat Diamond Bourse,(259 ITR 280), the assessee had advanced a sum to one of its members, being a prohibited person within the meaning of Section 13(3)(a) r.w.s 13(1)(c)(ii) of the Act. There was contravention of Section 13(2)(a), and therefore, the Hon’ble High Court held that the assessee is not entitled to exemption u/s 11. In para 7 of the judgement, the Hon’ble Apex Court has approved complete denial of exemption u/s 11 and has reiterated the same view in Para 20 of the judgement. On the other hand, in Fr. Muller case, before the Karnataka High Court, the fact involved was advancing of huge amount by the assessee trust to other parties as loans in violation of Section 11(5) of the Act, and thereby attracted Section 13(1)(d) of the Act. The question was whether the entire income of the trust was taxable, and secondly whether maximum marginal rate of tax was leviable u/s 164 of the Act on the entire income. The Karnataka High Court decided in favour of the assessee, and SLP filed against this decision has been dismissed by the Supreme Court, without adjudicating on the questions raised, and keeping the question of law open.
CONCLUSION
11. Section 13 of the I.T. Act stipulates restrictions, subject to which the trust should function; and violation of which would affect the exemption claimed by the assessee. These conditions/restrictions guarantee safeguards against misuse of trust property/income by the trustees or other persons who are in a position to misuse their power. Therefore, violation of any of such conditions may result in denial of the complete exemption and also attracts maximum marginal rate of tax u/s 164(2) of the Act.
ACKNOWLEDGEMENTS
1. Satish Sharma, CIT(Exemptions), Mumbai
2. S.S. Meena, CIT(Exemptions), Pune
3. O/o Pr. CCIT(Exemptions), Delhi
[The opinion expressed in this article is that of the author only. This should not be considered as representing the view of the Ministry of Finance, Government of India.]
Source- CBDT Taxalogue Magazine Jul – Oct 19 | Volume 1 | Issue 1
