Section 11 of the Income-Tax Act, 1961 excludes from the income of charitable or religious trusts to the extent applied towards the objects of such trusts. However there are several conditions lay down under section 11 of the Act, for the purpose of claiming exemption in respect of the income of a charitable or religious trust. To claim the exemptions, the provisions of section 13 are prominent one. The heading of section 13 is “Section 11 not to apply in certain cases”. Hence, Section 13 provides those exemptions under section 11 which are not available in cases of violation of the provisions of such section.

The violations under section 13 of the Act fall under section 13(1) (c) of the Act, whereas few violations also fall under section 13(1) (d) of the Act. Besides, section 13(2) lists conditions which are deemed to be violation under sections 13(1) (c) or 13(1) (d). As per section 13(2) of the Act, without prejudice to the generality of the provisions of section 13(1)(c) and section 13(1)(d), the income or the property of the trust or institution or any part of such income or property shall, for the purposes of that clause, be deemed to have been used or applied for the benefit of persons referred to in section 13(3), in situations listed under clauses (a) to (h) thereof.

Applied for the benefit of a person referred to in section 13(3)

Section 13 (2) provides the conditions,  when an income or property or any part of such income or property of the trust or institution is deemed to have been used or applied for the benefit of a person referred to in section 13(3)  in the following cases:

1. Interest free loan or loan without security:

Section 13(2)(a) provides that  if any part of the income or the property of the trust or institution is or continues to be lent to any person referred to in Section 13(3) for any period during the previous year without either adequate security or adequate interest or both.

2. Use of properties without charging adequate rent:

Section 13(2)(b) provides that  if any land, building or other property of the trust or institution is or continues to be, made available, for the use of any person referred to in section 13(3) for any period during the previous year without charging adequate rent or other compensation. Letting out of trust property to an interested person is a violation.   Where the trust property is let out to a partnership in which the trustee was a partner for a meagre rent, there is clear violation of the requirements of section 13(2)(b), so that the trust has to lose its exemption. [Ram Bhawan Dharamshala v State of Rajasthan (2002) 258 ITR 725 (Raj)]

3. Excessive payment for services:

Section 13(2)(c) provides that if any amount is paid out of the resources of the trust or institution to any of the persons referred to in section 13(3) for services rendered to the trust or institution but such amount is in excess of a reasonable sum payable for such services. Generally, This section leads to litigation because of sweet Interpretation of the law by the assessing officer. There can be three kinds of allegations which could be place. Such as Excessive Payment of Rent, Unreasonable salary & Contractual work. There is no bar in the law to avail the facilities by paying the reasonable rent, fee or charges. For payment of rent

a. Rent- For the proposition that transactions with specified persons alone will not attract the provisions of section 13(1) (c) of the Act, Delhi High Court in the case of DIT vs. Pariwar Seva Sansthan (118 Taxman 587) wherein the Delhi High Court held looking for the past record of the society, the year to year services rendered by Mrs. Sudha Tewari from its inception, we are satisfied that the salary, rent, etc., paid to her was reasonable and was not excessive and the learned Commissioner of Income-tax (Appeals) was justified in rejecting these as not valid grounds for rejecting the claim of exemption under Section 11 of the Act. Further Delhi High Court in DIT(E) vs. Span Foundation order dated 4.11.2008 in ITA Nos. 767 and 789 of 2008 opined that with regard to the benefit being derived by interested persons, adequacy is the only question of relevance. Further, referred the case of Rabhubir Saran Charitable Trust v. Income Tax Officer where the view was taken that if the rent charged by an assessee was higher than the standard rent, as computed under the rent control legislation, then the rent charged by the assessee should be considered as adequate.

b. Salaries – In this regard, the only requirement in law is that the salary paid should not be excessive or unreasonable having regard to services rendered. Reliance is placed on the following -decisions wherein various Benches of the Tribunal have consistently held that so long as payment made in the form of remuneration/ salary/ allowance, etc., to parties covered under section 13(3) are for the services rendered, there is no benefit so as to hold violation of section 13(1)(c) of the Act, It has further been held the onus is on the Revenue to prove that the payment made to the persons specified in section 13(3) of the Act is unreasonable by placing on record the material to show the market value, the services rendered and how the payment made is excessive and unreasonable:-

 -ITO vs. Virendra Singh Memorial Shiksha Samiti: (2009) 18 DTR (Luck) 502 (refer paras 17 and 18)

– Dr. D.Y. Patil Pratisthan: (2014) 61 SOT 48 (Pune) (refer paras 35 – 37)

– ITO v. Human Resource Development and Management Trust: (2011) 47 SOT 85 (Cuttack) (refer para 23)

c. Contractual Work – section 13(1)(c) do not restrict any commercial transactions even with the specified persons, if such transactions are at an arm’s length and no ‘benefit’ is passed. Reliance be placed on the case in Shubhram Trust vs. DIT(E) [317 ITR (AT) 65] This decision of the Bangalore ITAT brings out that it is not the only fact that some rent was paid by the trust to the trustee which will disentitle the trust from exemption, but that the exemption can be forfeited only if such payment is established as unreasonable and in the nature of passing of any benefit to the specified person. Reliance be placed on the following-  Chandarkala Somani Charitable Trust vs. ITO (30 ITD 70) wherein the Tribunal observed that the word ‘benefit’ has to be interpreted as an advantage, profit, fruit or privilege and, in the context in which it is used in the present section, it has to be treated as an advantage of a pecuniary nature. Referring to the decision of Madras High Court in the case of Manickvasagam Chettiar (53 ITR 292) the Tribunal observed that the characteristic of a benefit is that it is real and not notional, concrete and not abstract, certain and not conjectural. The Tribunal held that in normal and popular conception, an advance of loan on commercial terms would not amount to a conferment of benefit. The Honourable Supreme Court again in Panipat Woollen & General Mills Co. Ltd.’s case (supra) has held that it is not open to the court to go behind the commercial expediency which had to be determined from the point of view of a businessman.

4. Services of trust without adequate remuneration:

Section 13(2)(d) provides that  if the services of the trust or institution are made available to any person referred to Section 13(3) without adequate remuneration or other compensation.

5. Purchase of property for trust for excessive consideration:

Section 13(2)(e) provides that  if any share, security or other property is purchased by or on behalf of the trust or institution from any person referred to in section 13(3) during the previous year for a consideration which is more than adequate.

6. Sale of trust property for inadequate consideration:

Section 13(2)(f) provides that if any share, security or other property is sold by or on behalf of the trust or institution to any person referred to in section 13(3) during the previous year for a consideration which is less than adequate.

7. Diversion of income or property exceeding Rs. 1,000:

Section 13(2)(g) provides that if any income or property of the trust or institution is diverted during the previous year in favour of any person referred to in section 13(3) provided the aggregate value of such income and property diverted exceeds `1,000.

8. Investment in substantial interest concerns:

Section 13(2)(h) provides that  if any funds of the trust or institution are or continue to remain, invested for any period during the previous year (not being a period before the 1.6.1971 in any concern in which any person referred to in section 13(3) has a substantial interest. [However, section 13(4) provides that where the aggregate of the funds invested in the said concern does not exceed 5% of the capital of that concern, the exemption under section 11 will be denied only in relation to such income as arises out of the said investment.

From the aforesaid provisions of section 13(2), it may be seen that in respect of various circumstances referred to in clauses (a) to (h) thereof, the income or property of the trust or institution or any part of such income or property shall, for the purposes of section 13(1)(c) and 13(1)(d), be deemed to have been used or applied for the benefit of the trustee, etc. It clearly implies that section 13(2) is nothing but an extension of section 13(1)(c)/13(1)(d).

Interested person by virtue of Section 13(3)

For the purposes of section 13, the following are interested persons:

i. the author of the trust or the founder of the institution;

ii. any person who had made a total contribution (up to the end of the relevant previous year) of an amount exceeding Rs. 50,000 (substantial contributor);

iii. any member of the HUF (or any relative of such member) where such author or founder or substantial contributor is a HUF;

iv. any trustee of the trust or manager (by whatever name called) of the institution;

v. any relative of such author, founder, substantial contributor, member, trustee or manager;

vi. any concern in which any of the persons referred to above has a substantial interest.

Relative by virtue of Explanation-1 to Section 13  

A “relative” in relation to an individual means:

a. spouse of the individual;

b. brother or sister of the individual;

c. brother or sister of the spouse of the individual;

d. any lineal ascendant or descendant of the individual;

e. any lineal ascendant or descendant of the spouse of the individual;

f. spouse of a person referred to in (b), (c), (d) or (e) above;

g. any lineal ascendant or descendant of a brother or sister of either the individual or of the spouse of the individual.

Substantial interest by virtue of Explanation-3 to Section 13

For the purposes of this section, a person shall be deemed to have a substantial interest in a concern,— in a case where the concern is a company, if its shares (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) carrying not less than 20% of the voting power are, at any time during the previous year, owned beneficially by such person or partly by such person and partly by one or more of the other persons referred to in sub-section (3); and  in the case of any other concern, if such person is entitled, or such person and one or more of the other persons referred to in sub-section (3) are entitled in the aggregate, at any time during the previous year, to not less than 20% of the profits of such concern.

No bar of Facilities to Specified Persons

As per Section 13(6), Charitable Trusts not to lose Exemption if Educational or Medical Facilities provided to Specified Persons Sections 12(2) and 13(6) provides that a charitable or religious trust running an educational institution or a medical institution or a hospital shall not be denied the benefit of exemption under section 11 or section 12, in relation to any income by reason only that such trust has provided educational or medical facilities to interested persons. Further , Sub-section (2) was inserted in section 12 with effect from the assessment year 2001-02 provides that the value of any medical or educational services made available by any charitable or religious trust running a hospital or medical institution or an educational institution to any interested person shall be deemed to be the income of such trust or institution derived from property held under trust wholly for charitable or religious purposes during the previous year in which such services are so provided and shall be chargeable to income-tax notwithstanding the provisions of section 11(1).

Violation of section 13(1) (d) cannot be applied on Total Income.

Karnataka High Court, in the case of CIT Vs Fr. Mullers Charitable Institutions [2014] 363 ITR 230 (Karn) held that perusal of section 13(1)(d) of the Act, makes it clear that it is only the income from such investment or deposit, which has been made in violation of section 11(5) of the Act, that is liable to be taxed and violation of section 13(1)(d) does not result in denial of exemption under section 11 to the total income of the assessee trust. The said judgement of Karnataka High Court is based on the judgement of Bombay High Court, in the case of DIT(E) Vs. Sheth Mafatlal Gagalbhai Foundation Trust [2001] 249 ITR 533 (Bom). Besides, a reference has also been made to the judgement of Delhi High Court, in the case of DIT(E) Vs Agrim Charan Foundation [2002] 253 ITR 593 (Del). In this context, the following observations of the Hon. High Court, on page 238 of the Report are very relevant:

“We are in respectful agreement that the views expressed by the Bombay High Court as well as the Delhi High Court for violating section 11(5) of the Act and the entire income of the Respondent trust cannot be assessed for the tax”

However in a bizarre instance, a very insignificant use of the income / property by a trustee, has been held to be a violation of section 13(1)(c) and as a result thereof, exemption under section 11 of the Act has been denied to the total income of the trust / institution. One such instance is provided by the judgement of Kerala High Court, in the case of Agappa Child Centre Vs CIT [1997] 226 ITR 211 (Ker). In this case, the trust purchased a refrigerator for its own use. However, before the completion of the trust buildings, the trust kept the said refrigerator at the residence of the managing trustee of the trust. The ITO refused exemption to the trust under section 11 of the Act, on the ground that use of refrigerator by the managing trustee was violation of the provisions of section 13(2)(b) of the Act. The aforesaid conclusion of the AO was upheld by the CIT(A), the Tribunal, as well as the High Court.

In the present context, the provisions of section 164, particularly section 164(2) and proviso thereto, are also relevant. It may also be stated here that in view of the proviso to section 164(2) and Circular No.387, dt.06.07.1984, issued by the CBDT, all the legal precedents applicable to the violations under section 13(1)(d) of the Act, will equally apply to the violations under section 13(1)(c) of the Act. As per the paragraph 28.6 of the Circular No. 387 , where such a trust contravenes the provisions of section 13(1)(c) or 13(1)(d) of the Act, the maximum marginal rate of income-tax will apply only to that part of income, which has forfeited exemption under the said provisions.

A judgement of the Allahabad High Court CIT Vs. Red Rose School [2007] 163 Taxman 19 (All.) inter alia, held in this case that the language used in section 12AA for the registration of a trust, only requires that activities of the trust or the institution must be genuine, which, accordingly, would mean that they are in consonance with the objects of the trust / institution and are not mere camouflage, but are real, pure and sincere and are not against the objects of the trust. The profit earning or misuse of the income derived by charitable institution from its charitable activities may be a ground for refusing exemption only with respect to that part of the income, but cannot be taken to be a synonym to the genuineness of the activities of the trust or institution [Paragraph 34 on pages 32 and 33 of the Report] Hence , the misuse of the income derived by the charitable institution from its charitable activities may be a ground for refusing exemption only with respect to that part of income and not the whole of the income of the trust / institution.

In view of the aforesaid legal precedents, it is clearly established that only the relevant income falling within the mischief of section 13(1)(c)/13(1)(d) will lose the benefit of exemption under section 11 of the Act and the balance of the total income of the trust will remain eligible for the benefit of exemption under section 11 of the Act.

Burden of proof of violation lies on the Revenue

It is noteworthy that burden of proof lies on the Revenue to prove that the provisions of section 13 apply in a case. It is not for the person against whom the averment is made to establish negatively that the state of affairs averred by the other person does not exist. Therefore, the exception has to be stated and established by the Revenue. In support of the aforesaid stand, reliance is placed on the following legal precedents :

1. Surat City Gymkhana Vs Dy.CIT [2002] 254 ITR 733 (Guj)

2. CIT Vs Kamala Town Trust [2005] 279 ITR 89 (All)

In the light of the aforesaid legal precedents, it is established that for the application of the provisions of section 13 of the Act, it is not sufficient on the part of the Assessing Officer to simply raise a doubt about the intended purpose of an expenditure incurred by the trust. The AO will have to prove to the hilt, on the basis of positive evidence brought on record, that the trust has committed a violation of the provisions of section 13 of the Act. If the AO is not able to discharge the burden of proof, which lies on him, then he cannot deny the benefit of exemption under section 11 to the trust, on the basis of alleged violation of section 13 of the Act.

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