Levy of tax where charitable institution ceases to exist or converts into a non-charitable organization

A society or a company or 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. Under provisions of section 11 certain amount of income of prior period can be brought to tax on failure of certain conditions. However, there is no provision in the Act which ensure that the corpus and asset base of the trust accreted over 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. In the absence of a clear provision, it is always possible for charitable institutions to transfer assets to a non-charitable institution. There is a need to ensure that the benefit conferred over the years by way of exemption is not misused and to plug the gap in law that allows the charitable trusts having built up corpus/wealth through exemptions being converted into non-charitable organisation with no tax consequences.

In order to ensure that the intended purpose of exemption availed by trust or institution is achieved, a specific provision in the Act is required for imposing a levy in the nature of an exit tax which is attracted when the organization is converted into a non-charitable organization or gets merged with a non-charitable organization or does not transfer the assets to another charitable organisation.

Accordingly, As we all are aware that the Finance Act’ 2016 has brought in a new chapter after Chapter XII-EA of the Income-tax Act, with effect from the 1st day of June, 2016, namely CHAPTER XII-EB- SPECIAL PROVISIONS RELATING TO TAX ON ACCRETED INCOME OF CERTAIN TRUSTS AND INSTITUTIONS’.

Circumstances where Exit Tax is levied on charitable institution

Section 115TD prescribes circumstances under which exit tax is leviable. This tax is in addition to income-tax chargeable in hands of entity and leviable at the maximum marginal rate on the accreted income.

1) Trust is converted into any form which is not eligible for grant of registration under section 12AA. Trust or an institution shall be deemed to have been converted into any form not eligible for registration under section 12AA:

i) The registration granted to it under section 12AA has been cancelled or

ii) Trust has adopted or undertaken modification of its objects which do not conform to the conditions of registration and it:

    • has not applied for fresh registration under section 12AA in the said previous year.
    • has filed application for fresh registration under section 12AA but the said application has been rejected.

2) Trust is merged with an entity which is not having similar objectives and not registered u/s 12AA.

3) Trust failed to transfer upon dissolution all its assets to any other trust or institution registered under section 12AA or approved u/s 10(23C) within a period of twelve months from the end of the month in which the dissolution takes place.

The accreted income of the trust or institution is taxable in the above circumstances.

Method of Calculation of Accreted Tax:

This levy is in addition income-tax chargeable in hands of entity and is calculated as below:

Accreted Tax = Accreted Income * Maximum Marginal Rate (42.744% for AY 2020-21)

Meaning of Accreted Income:

Aggregate FMV of the total assets as on the specified date

Less:

Total liability of such trust computed as per the prescribed method of valuation (Rule 17CB inserted by the Income-tax (Eighth Amendment) Rules, 2017, w.r.e.f. 1-6-2016 prescribing method of valuation.)

Amounts to be excluded while calculating accreted income:

1) Accreted income related to any asset which is established to have been directly acquired by the trust or institution out of its agricultural income of the nature referred to in clause (1) of section 10. Liability in relation to such asset has also to be excluded.

2) Accreted income related to any asset acquired by the trust or institution during the period beginning from the date of its creation or establishment and ending on the date from which the registration under section 12AA became effective, if the trust or institution has not been allowed any benefit of sections 11 and 12 during the said period. Liability in relation to such asset has also to be excluded.

3) The assets and liabilities, if any, related to such asset, which have been transferred to any other trust or institution registered u/s 12AA or 10(23C) within the specified period to be excluded while calculating accreted income.

Important Points related to Accreted Tax:

  • The accreted Tax shall be at the Maximum Marginal Rate.
  • The accreted tax shall be in addition to any income chargeable to tax in the hands of the entity. There is no express provision for refund of accreted tax paid, even if it is held to be invalid. Thus, the institution will have to take recourse to constitutional remedies.
  • This tax shall be final tax for which no credit can be taken by the trust or institution or any other person.
  • This shall be leviable even if the trust or institution does not have any other income chargeable to tax in the relevant previous year.
  • The trust or institution shall be liable to pay the tax on accreted income to the credit of the Central Government within fourteen days from the date specified in section 115TD(5)
  • No deduction under any other provision of this Act shall be allowed to the trust or the institution or any other person in respect of the income which has been charged to tax or the tax thereon.

Interest payable for non-payment of tax by trust or institution:

Section 115TE:  If the trust fails to pay the tax on the accreted income referred in section 115TD (1), within the time allowed u/s 115TD (5), simple interest at the rate of one per cent for every month or part thereof on the amount of such tax will be payable.

Period of Interest: 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.

(Republished with Amendments)

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