KAS Foundation Vs Director of Income Tax (Madras High Court)
Summary: The Madras High Court, in KAS Foundation v. Director of Income-Tax, Trichy, T.C.A. Nos. 337 and 338 of 2012, decided on 1 December 2025 for Assessment Year 2007-08, allowed the assessee’s appeals and held that a violation of the investment restrictions applicable to charitable institutions does not automatically result in denial of exemption under Section 11 of the Income-tax Act, 1961 on the entirety of the institution’s income. The Court ruled that, where income loses exemption because of a contravention of Section 13(1)(d), the maximum marginal rate contemplated by the proviso to Section 164(2) applies only to the income affected by that contravention. The judgment followed the jurisdictional High Court’s earlier decision in Commissioner of Income-Tax v. Working Women’s Forum, 365 ITR 353 (Madras), which had adopted the reasoning of the Bombay High Court in DIT(E) v. Seth Mafatlal Gagalbhai Foundation, 249 ITR 533 (Bombay).
The assessee, KAS Foundation, was a company registered under Section 25 of the Companies Act, 1956. For Assessment Year 2007-08, it claimed exemption under Section 11. The Assessing Officer, by an assessment order dated 24 December 2009, denied the exemption on the ground that the assessee had violated Section 13(1)(d). The Commissioner of Income-Tax (Appeals) modified that conclusion and held that contraventions of Sections 13(1)(c) or 13(1)(d) would expose only the relevant non-exempt portion of income to the maximum marginal rate. The remaining income would continue to qualify for exemption under Section 11. The Commissioner (Appeals) relied upon CBDT Circular No. 387 dated 6 July 1984 and the Bombay High Court’s decision in Seth Mafatlal Gagalbhai Foundation.
The Income Tax Appellate Tribunal reversed the order of the Commissioner (Appeals) at the instance of the Revenue and rejected the assessee’s cross-objection. The assessee consequently approached the High Court under Section 260A. The admitted substantial questions concerned whether the entire income could be subjected to the maximum marginal rate when the alleged violation of Section 11(5) was confined to a particular amount; whether exemption could be denied notwithstanding compliance by other investments and application of income; and whether the Tribunal had correctly interpreted Sections 13(1)(d), 13(2)(h), 164(2) and the applicable CBDT circular. The assessee also referred to the High Court decisions in Director of Income Tax v. SMG Foundation Trust and CIT v. Narinder Mohan Foundation.
Before the High Court, counsel for both sides agreed that the issues were covered by the Madras High Court’s decision in Working Women’s Forum. That decision had considered the interpretation of the proviso to Section 164(2) and the distinction between income forfeiting exemption and the total income of a charitable institution. The High Court reiterated that the statutory language refers to the relevant income or portion of income that has forfeited exemption because of a violation of Section 13(1)(d), rather than requiring the entirety of the institution’s income to be taxed at the maximum marginal rate. This interpretation was consistent with paragraph 28.6 of CBDT Circular No. 387, which addresses the consequences of contraventions of Sections 13(1)(c) and 13(1)(d).
The Court also recognised the distinction between eligibility for exemption and withdrawal or forfeiture of exemption because of a specific statutory contravention. A breach affecting a particular investment or income stream does not necessarily eliminate exemption in respect of all otherwise qualifying income. Concurring with the earlier decision in Working Women’s Forum, the High Court answered the substantial questions of law in favour of the assessee and against the Revenue. Both Tax Case Appeals were allowed, the connected miscellaneous petition was closed, and no costs were awarded.
Cases Discussed
1. Commissioner of Income-Tax v. Working Women’s Forum, 365 ITR 353 (Madras High Court) — Directly followed. The Court adopted the principle that a contravention of Section 13(1)(d) does not justify withdrawal of Section 11 exemption on the entire income of a charitable institution. The maximum marginal rate under the proviso to Section 164(2) applies only to the relevant income which has forfeited exemption. See also the TaxGuru discussion of the applicable judicial principles.
2. DIT(E) v. Seth Mafatlal Gagalbhai Foundation, 249 ITR 533 (Bombay High Court) — Relied upon through the decision in Working Women’s Forum. The Bombay High Court distinguished the relevant income that loses exemption from the whole income of a trust and interpreted the proviso to Section 164(2) accordingly. The reasoning is discussed in TaxGuru’s analysis of partial forfeiture of trust exemption.
3. Director of Income Tax v. SMG Foundation Trust, 249 ITR 253, as cited in the substantial questions of law — Cited by the assessee as supporting the proposition that tax consequences should be confined to the investment or income affected by the statutory violation.
4. CIT v. Narinder Mohan Foundation, 311 ITR 425 (Delhi High Court) — Cited by the assessee in the admitted substantial questions of law concerning the consequences of a violation of the investment restrictions. See the TaxGuru discussion of approved investment modes and Section 13(2)(h).
FULL TEXT OF THE JUDGMENT OF MADRAS HIGH COURT
These appeals are for Assessment Year 2007 – 08. The appellant is the assessee, a Section 25 Company, registered with the Registrar of Companies.
2. For assessment year, 2007 – 08, a return of income had been filed and an order of assessment passed on 24.12.2009, wherein, the assessing authority, denies the benefit of exemption claimed under Section 11 of the Income-Tax Act, 1961 (in short, ‘the Act’) on the ground that there is a violation under Section 13(1)(d) thereof.
3. In appeal, the Commissioner of Income-Tax (Appeals), intervenes to the effect of holding that where the trust contravenes the provisions of Sections 13(1)(c) or 13(1)(d), maximum marginal rate would be applicable only in respect of that part of the income which is a violation and the entirety of the income, would not lose the benefit of exemption under Section 11.
4. The Commissioner of Income-Tax (Appeals) refers to Circular No. 387 dated 06.07.1984 issued by the Central Board of Direct Taxes applied by the Bombay High Court in the case of DIT (E) v Seth Mafatlal Gagalbhai Foundation1. The Tribunal, at the instance of Revenue, reverses the order of the Commissioner of Income-Tax (Appeals), and rejects the cross objection filed by the appellant, aggrieved by which, the present appeals has been filed by the assessee/appellant.
5. The following substantial questions of law have been admitted for consideration on 17.10.2012:-
“1.Whether on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the entire income of the trust is to be taxed at maximum marginal rate, even though undisputedly, violation of Section 11(5) was limited only to the amount borrowed from the Bank?
2. Whether on the facts and in the circumstances of the case, the finding and conclusion of the Tribunal is perverse, especially in the context of all other investments and application of income by the trust being in conformity with the objects of the trust and the provisions of the Act?
3. Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in reversing the order of the CIT (A) and denying exemption under Section 11 on the entire income without adverting to the contentions placed before it?
4. Whether the Tribunal was right in law in holding that the entire income of the trust is liable to be taxed in spite of the provisions of Section 11(2)(b) and proviso to Section 164(2), as also the Board Circular No. 387 dated 6.7.84, which mandates only the non-conforming portion of income as liable for taxation at the maximum marginal rate of tax?
5. Whether the Tribunal was correct in law in merely holding that there was violation of Section 13(2)(h) and deny exemption under Section 11, without any material and also assigning any reason for the same?
6. Whether the Appellate Tribunal was justified in rejecting the claim to tax only the alleged violative portion of investment, even though the High Court decisions in 249 ITR 253 – Director of I.T v SMG Foundation Trust and 311 ITR 425 – CIT v Narinder Mohan Foundation and also the Board Circular No. 387 dated 6.7.84 squarely apply on all fours to the facts of assessee’s case?”
6. Both Mr.Vasudevan, for the appellant/assessee and Mr.Narayanaswamy, appearing for the Department, are consensus ad idem on the position that the issue raised in these appeals stand covered by a decision of this Court in Commissioner of Income-Tax v Working Women’s Forum2. The question in that case as well, related to whether the denial of exemption under Section 11 should be only to the extent of income which is violation of Section 13(1)(d) of the Act.
7. In the case of Working Women’s Forum3, this Court has also noted the decision of the Bombay High Court in Seth Mafatlal Gagalbhai Foundation4 and, extracting the following paragraph and its agreement with the statement of the Bombay High Court therein, has rejected the revenue’s appeal. We may usefully extract the same paragraph below:-
“Under section 161(1A), which begins with a non obstante clause, it is provided that where any income in respect of which a person is liable as a representative assessee consists of profits of business, then tax shall be charged on the whole of the income in respect of which such person is so liable at the maximum marginal rate. Therefore, reading the above two phrases show that the Legislature has clearly indicated its mind in the proviso to section 164(2) when it categorically refers to forfeiture of exemption for breach of section 13(1)(d), resulting in levy of maximum marginal rate of tax only to that part of the income which has forfeited exemption. It does not refer to the entire income being subjected to maximum marginal rate of tax. This interpretation of ours is also supported by Circular No. 387, dated July 6, 1984 (see [1985] 152 ITR (St.) 1). Vide the said circular, it has been laid down in para. 28.6 that, where a trust contravenes section 13(1)(d) of the Act, the maximum marginal rate of income-tax will apply only to that part of the income which has forfeited exemption under the said provision and not to the entire income. We may also add that in law, there is a vital difference between eligibility for exemption and withdrawal of exemption/forfeiture of exemption for contravention of the provisions of law. These two concepts are different. They have different consequences. It is interesting to note that although the Legislature withdrew section 164(2) by the Direct Tax Laws (Amendment) Act, 1987, which provision was reintroduced by the Direct Tax Laws (Amendment) Act, 1989, the Legislature did not touch the proviso to section 164(2) which has been on the statute book right from April 1, 1985. The said proviso was inserted by the Finance Act, 1984. The proviso specifically refers to violation of section 13(1)(d) and its consequences.”
8. In light of the decision in Working Women’s Forum5, with which we respectfully concur, the questions of law are answered in favour of the assessee / appellant and adverse to the revenue.
9. These Tax Case (Appeals) are allowed in terms of this order. No costs. Connected miscellaneous petition is closed.
Notes:
1 249 ITR 533 (Bom)
2 365 ITR 353 (Madras)
3 Foot note supra 2
4 Foot note supra 1
5 Foot note supra 2
