Taxation of Non Profit Organisations- Chapter VI under the Revised Direct Tax Code

DIRECT TAXES CODE 2009

REVISED PAPER FOR DISCUSSION

TAXATION OF NON PROFIT ORGANISATIONS- CHAPTER VI

Concerns and suggestions:

1. NPO classification-Religious/ Mixed/charitable –Para 3 (b) (c)

• The revised proposal differentiates between religious, mixed and wholly charitable institutions. The term “religious” is not defined in the code. It is suggested that the term “religious” be defined in the code itself for the purposes of the DTC.
• There is no provision as to what happens if a wholly charitable trust spends a small part of its income for activities akin to religious practices or for religious purposes. It is suggested that outgoings up to 10 % of the gross receipts of a charitable trust for religious activities be permitted without changing its character to religious trust.
• The criteria to determine predominant character of an NPO be specified so there is a clear cut understanding amongst the NPO and the tax authorities. There are Supreme Court judgments which  have ruled  that one or two clauses of religious nature does not change the character of the institution and that  what is required to be seen is the paramount intention and nature of the activities of the trust to determine whether it is religious or charitable.

2. Basic Exemption: (Para 3-(g))

The proposal mentions about basic exemption limit to be provided for working out taxable surplus but the percentage of this basic exemption is not mentioned.   It is suggested that the basic exemption of 15 % of the gross income as per the present law be retained.

3. Accumulation: Para 3 (d):

• As per the revised proposal, accumulation for a period up to 3 years -maximum limited to 10 % of gross receipts or 15 % of the surplus which ever is higher- will be permitted. It is not clear whether the surplus means the amount arrived at after deduction of the basic exemption or before. It is suggested that permissible accumulation   be fixed with reference to the gross receipts and not with reference to the surplus at all.
• The provision permitting accumulation of 10% of gross receipts or 15% of the surplus is too harsh. At present the law provides for exercise of option u/s.S.11 (1) Explanation clause 2  to spend the entire  surplus in the next financial year and/or  accumulate the  entire surplus  for a specific purpose up to 5 years subject to  conditions of about investments  and intimation etc. u/s,S.11 (2). This power of the trustees has been taken away by restricting the accumulation only to the extent of 10% of gross receipts or 15% of surplus. This power should be restored as per the present law.
• Under the code income of the NPO is also subjected to TDS which is 10% of the income from each income receipts. In that case the permitted 10 % accumulation will not be available either for accumulation or for spending. It is suggested that the  gross receipt should there fore  be  the net amount  actually received by an NPO in its hands after TDS   and the TDS amount should be treated as receipt  of the year in which TDS is actually  refunded to the NPO or alternatively the NPO should be exempted from TDS provisions as their  liability  to pay tax is contingent on their “ non spending”.

4. Computation of Surplus: Para 1.2(b)-outgoings: The proposals does not provide for deduction of provision for earmarking of the income for any “Earmarked funds” such as Endowment Funds, Scholarship Funds, Education Loan Funds, Natural Calamities Funds, Building Funds, Equipment Funds, Asset Replacement Funds, Heavy Repairs and Renovations Funds, Expansions Funds, Maintenance Funds, Loans Repayment Funds, Sinking Fund etc which is a commonly required to be done. It is necessary that   NPO are allowed   to provide for any providence or future needs of the trust activities, for maintenance and expansion. The proposed code compel them to spend what ever is received in the year of receipt or within three years. It is suggested that “permitted Earmarked funds” be listed and  “outgoings” should also include the transfer of income to the “Permitted  Earmarked Funds”.

• The provision for “outgoings” should also include transfer of interest earned on investments of its “Permitted Earmarked Funds” to the respective “Permitted Earmarked Fund Account”.
• The amount of outgoing should include depreciation on investment assets to enable NPO  to provide for   replacement of its investment  assets other than financial asset.
• The proposal provides that the investment asset which is a “financial asset” is not “deductible outgoing” for computing the taxable surplus of the NPO.  However the term “financial asset” is not defined in the proposed code although all other terms such as “Capital asset” “Business trading asset”. “Business capital asset” and “investment asset” are defined. It is suggested that the term “Financial Asset” be also defined to avoid any ambiguity.
• The term “investment asset” is a misnomer as it covers all assets whether they are in the nature of investments to earn income  thereon or not. So even a hospital building or a college building and furniture fixtures etc will also be termed as Investment Asset although there is no intention of investments as such.
• “Deficit”  which is  excess of outgoing over income of the NPO be allowed to be carried forward and set off  against future income and  be treated as the outgoing of the next financial years – provision similar  the carry forward and  set off of  the losses in case of business undertaking.
• Out goings as listed for deductions does not include payments like contribution to the charity commissioner, tax liabilities, etc.

5. NPO of public importance as exempt entity: Para 3 (i)

NPO already approved u/s.10 (23) (C) (iv) be permitted to continue as an exempt entity under the category of “NPO of public importance.”.

6. EXEMPTION OF  NPO  FROM TDS (u/s.200 of the DTC Bill) :

The criteria for levying tax on NPO is their “not spending the income        within the prescribed time” and the tax liability of the NPO is thus contingent. Therefore the income of their financial asset ( interest etc) should not  be subjected to TDS at the point of earning. The present procedure requiring  “No Deduction Certificate” from tax authorities creates lot of inconveniences and increases the departmental work. It is suggested that NPO registered by the Income tax authorities be exempted from TDS provisions on their investment incomes as they are primarily  accepted as “tax exempt entities”  while registering them under the code.

7. Disqualification of NPO-   Consequences (S. 94 of the Bill.)

• What exactly means by “ Ceased to be an NPO” is not specified.
• The code provides for consequences if an NPO ceases  to be an NPO in any year and had also been ceased  in the  two out of four year preceding financial year. There is no clarification as to who finally decides   “ceased to be   NPO” issue each year. Is it the Assessing authorities? If so is there any appeal against such decision?
• the consequences provided are extremely  harsh. It provides  for 30 % tax on the market value of the net asset  of the NPO  when it disqualifies as NPO  third time. An entity ceasing to be  may be taxed on its income at normal rate for the year in which it disqualifies to be an NPO.
• S.94 (1) (a) as proposed provides a window for a scam as   all the states are not having laws to governing  NPO and allowing an NPO to convert itself into a non NPO would only defeat the purpose of  bona fide donations given by the donors.

It is suggested that the S.94 needs a serious review.

8.      The code as proposed in revised paper for discussion differentiates between a religious public charity and non religious public charity and this will only encourage more religious public charities being formed for the benefit of religion based caste systems. This will lead the country away from being “secular nation”.

Author : Shirish Thakkar