Taxation of Non-Profit Organizations, Mutual Associations and Clubs

1. Taxation of Non-Profit Organizations, Mutual Associations and Clubs 20th August, 2011 CA Mahesh Sarda Indore

2. TAXATION OF NON-PROFIT ORGANIZATIONS 2

3. �Charitable Purpose� defined in section 2(15): �Charitable purpose includes relief of the poor, education, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places of artistic or historic interest, and the advancement of any other object of general public utility.� A Trust, which contains general charitable objects for the benefit of the public, would normally qualify within the definition of charitable purpose. 3

4. First Proviso Provided that the advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade commerce or business, for a cess or fee or any other consideration , irrespective of the nature of use or application , or retention of the income from such activity 4

5. Second Proviso Provided further that the first proviso shall not apply if the aggregate value of the receipts from the activities referred to therein is ten lakh rupees or less in the previous year. 5

6. Relief of the Poor It is not necessary that the term �relief of the poor� means that the trust should provide something for nothing or something less than the cost. The Trust by its activities may benefit the public though such benefit is indirect and cannot be identified with the particular individual. E.g.: A Trust with the object of the promotion of Khadi and hand-woven cloth by poor local villagers is a charitable object. 6

7. Relief of the Poor � (Contd.) Further the principle of cross subsidisation will also not render a trust ineligible. E.g.: In an old age home, the home may have a different charge for wealthy individuals and the surplus may be utilised to subsidise the aged who are poor. Still the object would be relief of the poor. 7

8. Education The administering authorities of most state level legislations like the Bombay Public Trust Act interpret the term to mean class room instruction. Income Tax Act now interprets the term more liberally. Therefore, even cultural education would be entitled to exemption and the term need not be restricted only to scholastic instruction or classroom teaching. 8

9. Medical Relief The object of Medical Relief does not mean that it is necessary to provide free treatment or treatment on concessional basis to all. It is permissible if the medical institution charges the market price for patients who can afford that price and utilises the revenue to give free or subsidised medical relief to the poor and needy. 9

10. General Public Utility The term �any other object� of the General Public Utility would exclude a private gain of an industrial undertaking or business entity. The term is wide and has to be interpreted keeping in view the objects of the legislation. The object should be such as to benefit the public at large or section thereof. 10

11. Religious Purpose The term Religious Purpose is not defined in the Income Tax Act � it must be public in nature Temple / Mosque established by trust � would be public in nature � if the members of that religion have access as a matter of right to the religious place or place of worship Temple in private premise � access available only to a family � then the religious purpose would be private in nature 11

12. Categories of Exemption There are two categories of exemptions available to a public charitable trust: Specific Type of Trusts � u/s 10 General Public Charitable Trusts � u/s 11 12

13. Trust claiming exemption u/s 10 Any university or other educational institution existing solely for educational purpose, and not for the purposes of profit if, wholly or substantially financed by the government or [10 23c(iiiab)].� the aggregate annual receipts do not exceed the amount prescribed [Rs.1crore] [1023c(iiiad)]. If it is approved by the prescribed authority [CBDT] [Rule 2CA Form 56D] [10 23 c (vi)]. 13

14. (b) Any hospital or any other institution for the reception and treatment of persons suffering from illness mental defectiveness or for the reception and treatment of persons during convalescence of persons requiring medical attention or rehabilitation existing solely for philanthropic purposes and not for the purposes of profit and if it is wholly or substantially financed by the government [10 (23C)(iiiac)] aggregate annual receipt do not exceed the amount prescribed [Rs. 1 Crore] [10 (23C)(iiiae)] if it is approved by the prescribed authority [CBDT] [Rule 2CA form 56D] [10 23 (vi)] 14

15. (c) Any fund or institution established for charitable purposes which may be notified by the central government in the official gazette [10(23C)(iv)] (d) Any trust or legal obligation or institution wholly for public religious and charitable purposes which may be notified by the Central Government [10 (23C)(v)] 15

16. Requisites for Notified Trusts Apply their income or accumulate it exclusively for purposes it was established. Invest or deposit their funds within the modes prescribed by section 11(5). Accumulate their income with effect from assessment year 2002-2003 only for a period of five years. If the income of the notified trusts / trusts requiring approval under sub clauses (iv), (v), (vi) or (via) exceeds the maximum amount not chargeable to tax , without giving effect to the sub clauses such trusts must get their accounts audited and submit an audit report in the prescribed form. 16

17. Application for Approval If the trust or institution requires an approval then the application must be made in Form 56D before 30th September of the relevant assessment year for which the exemption is sought. The approval must be granted in writing or an order rejecting the application shall be passed within a period of 12 months from the month in which the application is received by the income tax department. 17

18. Issues w.r.t. Exemption u/s 10 Would collecting of donations at the time of admission of students by an educational Institution amount to carrying out an activity for profit? Is an administering body, which runs colleges and hospitals entitled to exemption U/s 10 (23C)? 18

19. Trust claiming exemption u/s 11 In respect of a person who has obtained registration u/s 12A/12AA the following income shall not be includible in the total income � Income derived from the property held under trust for charitable or religious purposes to the extent It is applied for such purposes in India. It is accumulated and set apart for application up to 15% of such income. (11)(1)(a) 19

20. If the trust is created before the commencement of this Act [1/4/62] and the trust is partially for such purpose. To the extent of application of income for such purposes in India. It is finally set apart for application to such purposes to the extent of 15% of such income. (11)(1)(b) 20

21. For income applied outside India The trust is created after 1/4/1952 in respect of income applied for charitable purposes, which tend to promote international welfare in which India is interested. If the trust is created before 1/4/1952, then income applied outside India for charitable purposes. Income in the form of voluntary contributions made with a specific direction that they should form part of the corpus of the trust or institution. 21

22. Issues w.r.t. exemption u/s 11 Do specific directions have to be in writing for donations / contributions to enjoy exemption u/s 11(1)(d)? Can a building fund be a corpus? What is �Corpus�? Can funds collected as corpus donations be spent? 22

23. Application of Income Income will include voluntarily contributions referred to section 12 - explanation 1 to sec. 11(1). Generally to be eligible for exemption 85% of the income must be applied for charitable or religious purposes. However if the income could not be applied for the reason that it was not received then it may be applied in the year of actual receipt or the succeeding year. for any other reason then it may be applied in the previous year immediately succeeding the previous year in which it was derived. In both cases an option is to be exercised by the assessee before the time limit prescribed u/s 139(1) i.e the due date for filing of the Income tax return 23

24. If an assessee fails to abide by the option exercised, then the income not applied will be treated as the income of the previous year succeeding the previous year in which the income was received or derived, depending on the reason for exercising the option [section 11(1B)]. The assessee trust may also accumulate income for a specific purpose for a period of 5 years if, A specific notice to that effect is given to the assessing officer. The money so accumulated is invested or deposited in any of the modes specified u/s 11(5) (section 11(2)). 24

25. Accumulation In respect of accumulation the Trust has to file the application for accumulation in Form No. 10 along with return of income accompanied by a resolution of the trust. The purposes of accumulation should be specific and capital in nature to the extent possible. If the purpose specified for accumulation cannot be achieved then the purpose can be amended by a specific application [section 11(3A)] 25

26. Issues w.r.t. Application of Income Is an accumulation application required to be filed each year or is it possible to file a single application for the succeeding five years? When can an accumulation application be filed? Is it necessary to file it along with the return of income? If the expenditure on objects results in a deficit, can it be set-off in the succeeding years? Is expenditure on administration of a trust treated as expenses on objects of the trust? 26

27. Issues w.r.t. Application of Income�contd. The Act requires 85% of �Income� to be applied on objects of the Trust. How does one interpret the term �Income�? If an income is exempt under any other provision of the Act (other than section 11 to 13) does it have to be considered for the purposes of computing the limit of 85%? Is it possible to claim depreciation in respect of assets utilised for objects of the Trust? 27

28. Anonymous Donation Section 115BBC introduced w.e.f. 01st April 2007 (A.Y. 2007-08) provides that where total income of the assessee being a person in receipt of income on behalf of any institution referred to in Clause (iiia), (iiie)), (vi) or (via) of section 10(23C) any trust or institution referred to in sub-clause (iv) and (v) of Section 10(23C) or Any trust or institution referred to in Section 11 Includes any income by way of anonymous donation, then 28

29. ..the income tax payable shall be aggregate of amount of income tax calculated at the rate of 30% on the aggregate of anonymous donations received in excess of the higher of the following, namely: 5% of total donations received by the assessee; or One lakh rupees, and Amount of Income tax with which the assessee would have been chargeable, had his total income been reduced by the aggregate of anonymous donations received. 29

30. Issues w.r.t. Anonymous Donations Would the amount of anonymous donation be considered for application of 85%? If the trust records the name and address which are subsequently found to be false what would be the implications? Would the income tax liability in respect of anonymous donations received by the trust be treated as an application of income? 30

31. Registration of Trust, Maintenance of Accounts and Audit The application for the registration of the trust shall be made, before 1/7/73 or one year from the establishment of trust whichever is later. The registration shall be u/s12AA by way of an order passed by the Commissioner, which shall be passed within 6 months from the end of the month in which application is received. An order passed u/s 12AA is appealable before the appellate tribunal u/s 253 (1)(c) The application for registration has to be submitted in form 10A. The department normally insists on proof of registration of the trust under the relevant state legislation where such legislation exists (Bombay Public Trust Act in State of Maharashtra). 31

32. Audit is required if income is in excess of the maximum amount which is not chargeable to income tax . This is an audit necessary under the Income Tax Act and is distinct from an audit, which may be necessary under the Bombay Public Trust Act or a similar statute under the relevant State law. An audit has to be conducted under the Income tax Act and an audit report furnished in form 10B. While computing the limit for conducting an audit, exempt gross receipts have to be considered 32

33. Issues w.r.t. Registration and Audit of Trust What is the extent of examination that a commissioner has to undertake before granting registration u/s 12AA? What is the effect of change of objects by Charitable Institution on the registration granted u/s 12AA? Can a section 25 company be registered u/s 12A of the Income Tax Act? Is registration under any other Act required? 33

34. Denial / Withdrawal of Exemption Entire Income of the trust will be denied exemption if- the income of the trust is for private, religious purposes i.e. income which does not ensure for the benefit of the public. In a charitable trust if any income applied for the benefit of any particular religious community or caste. In case of a trust for charitable or religious purposes, if any part of the income ensures or is applied directly or indirectly for the benefit of any person referred to in sub section (3). 34

35. Denial / Withdrawal of Exemption�Contd. Part of the income will be denied exemption if If medical or educational services are rendered to any person who is connected with the trust and specified u/s 13(3) then the value of any benefit in respect of medical or educational services rendered to such person shall be chargeable to tax {section 12(2)} If any income is invested in any of the modes not specified in section 11(5) then income representing such investments will be denied the exemption. 35

36. Actions amounting to benefit for a person within the meaning of section 13(3) Lending funds without adequate security or interest. Land, building other property made available without adequate compensation. Salary / remuneration in excess of reasonable amount. Services of the trust made available without adequate compensation. Sale or purchase of shares or security for other than market value. Income diverted in favour of the person. Funds invested in a concern in which the person has a substantial interest. 36

37. Withdrawal of recognition granted u/s 10(23C) The Act now provides that in respect of a Trust notified by the prescribed authority, if the trust or institution does not apply its income, or accumulates it for more than 5 years , or the activities are not genuine or the conditions subject to which it was notified or approved are being violated, the prescribed authority may rescind the notification or withdraw the approval. 37

38. Liability to file a return and consequences of failure Charitable trust claiming exemption u/s 11 � Return to be filed u/s 139(1) Institutions claiming exemption u/s 10(23C) � Return to be filed u/s 139(4C) Prescribed Form � ITR7 � to be filed physically along with audited financial statements, tax audit report, application for accumulation, resolution, list of trustees Due Date - 30th September following the end of the financial year. In case, the delay occurs in filing of the return and the Trust does not have reasonable cause for the delay, then in that case, the Trust will be liable for a penalty of Rs. 100/- per day for every day of the default. {Section 272A(2)(e)}. 38

39. Status in which Assessment to be made Normally, the Trust would be taxed as an association of persons or an individual. The tax rate in both cases is currently the same. However there is some controversy as to whether the Trust should be assessed as an Association of Persons or as an individual. E.g. Whether the benefit of basic exemption is available to the trust? 39

40. Tax Rate Normally, the Trust will be liable to tax at the rate applicable to individuals or Association of Persons considering the normal slab. However, if the income is taxed on account of section 13(1)(c) or S. 13(1)(d), being attracted then in that event, the relevant income would be taxed at the maximum marginal rate. 40

41. Capital Assets When a capital asset is transferred and , then the entire net consideration is applied for acquiring a new capital asset to be held for charitable purposes then entire capital gains shall be deemed to have been applied for such purposes. When a part of net consideration is utilised for acquiring a new asset then excess of the cost of the new asset over the cost of the original asset will be treated as capital gain applied for charitable purposes. It may be noted that purchase of assets for the objects of the trust is treated as application for the objects of the trust. 41

42. Business held under Trust Income from business held under a trust shall be taxed as business income unless business is incidental to the attainment of the objects of the trust and separate books are maintained. {Section 11(4A)}. 42

43. Computation of Income Income to be computed on commercial principles � in accordance with generally accepted accounting principles Various exemptions are not to be considered at the time of computing the income, but are to be applied only thereafter E.g.: Dividend exempt u/s 10(35) will first have to be included in gross receipts for considering whether the test of applying 85% of the income is satisfied - Only if it is found that after applying such a test, some income is chargeable to tax, then one can resort to exemption u/s 10(35) 43

44. Computation of Income�Contd. Depreciation - the current judicial decisions have held that even though capital expenditure is considered as application of income, depreciation is also available to the Trust. 44

45. Recognition u/s 80G Application for Approval u/s 80G � Form No. 10G {Rule 11AA} If the Trust is recognised u/s 80G, then donations to such a trust are deductible u/s 80G in the hands of the donor. All charitable Trusts would be entitled to recognition and the only bar is contained in S. 80G(5B) which provides if the Trust spends more than 5% of its income for religious purpose, it will not be entitled to recognition u/s 80G. The requirement of renewal has been done away with by Finance Act 2009, in respect of any recognition which expires after 1st October 2009. 45

46. Taxation of Non-Profit Organizations � under the Direct Taxes Code Bill, 2010 46

47. Definitions Religious trusts � not qualified as Non-Profit Organizations (NPO) NPO defined � section 314(169): Not for the benefit of any particular caste or religious community Established for benefit of general public or for benefit of scheduled castes, scheduled tribes, backward classes, women or children Established for carrying on charitable activities Not established for benefit of any of its members; General public � defined in s.103(c) � body of people at large sufficiently defined by some common quality of public or impersonal nature 47

48. Scheme of Taxation Total income of charitable activity - gross receipts reduced by outgoings � both terms defined Computation of trusts on cash basis � Section 25 company on mercantile basis Spending can be postponed to the extent of 15% of total income or 10% of gross receipts, whichever is higher � No accumulation permitted Income taxed at special rates in First Schedule 48

49. Changes Mode of computing income � Gross Receipts less Outgoings Accumulation NPOs taxed @ 15% Net worth to be taxed @ 30% Business Income 49

50. Accumulation 15% of total income or 10% of gross receipts can be accumulated and will be treated as �Outgoings� The same to be invested in specified modes of investment Such sum can be invested for a period not exceeding 3 years from end of the relevant financial year The same will be deemed as income if not utilized for the purpose for which it was accumulated or ceases to be invested in approved manner Hence, NPOs now cannot accumulate, as even above accumulation needs to be spent in 3 years 50

51. Tax Rate - NPO Up to Rs.1,00,000 Nil In Excess of Rs.1,00,000 15% Anonymous Donations 30% Rate for S.25 company which is NPO? No MAT exemption for S.25 company 51

52. Taxation of Net Worth � Sec 101 Taxable at 30% of net worth if: Converts into any form of organisation not qualifying as NPO; Merges with any form of organisation not qualifying as NPO; Fails to transfer upon dissolution all its assets to any other NPO within 3 months from end of month of dissolution Net worth to be computed on date of conversion/merger/ dissolution Net worth defined - total assets of NPO as reduced by liabilities of NPO computed in accordance with prescribed valuation rules 52

53. Taxation of Mutual Associations / Clubs 53

54. Concept of Mutuality No man can make a profit out of himself Mutuality postulates Complete Identity between the contributors and participants. i.e. all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund. Contributors� right of disposal over surplus is a must. 54

55. Concept of Mutuality�Contd. For the concept of mutuality, it is not necessary that members contributing to the fund and members enjoying the benefits should be identical individuals but it is sufficient if members are identical as a class . The fact that temporary or honorary members may go out of the scheme and other new members may come in will not make any difference to the principle. � Darjeeling Club Ltd (1985) 153 ITR 676 (Cal) 55

56. Mutuality under Income Tax Act Income Tax Act recognizes the principle of mutuality in sec 2(24) & sec 28(iii) 2(24)(vii) Profits and gains of any business of insurance carried on by a mutual insurance company or by a co-operative society� ( sec.44 r.w First Schedule) 2(24)(viia) the profits and gains of any business of banking (including providing credit facilities) carried on by co-operative society with its members. 28(iii) income derived by a trade, professional or similar association from specific services performed for its members. ( Sec.44A) 56

57. Transactions with Members Income derived by the club for supply of drinks, refreshment or other goods as also letting out of building for rent or the amounts received by way of admission fees, periodical subscription etc from the members of the club, not tainted with commerciality - exempt under Mutuality. Bankipur Club Ltd (1997) 226 ITR 97 (SC) It is not only the surplus from the activities of the business of the club but even the annual value of the club house , as contemplated in Sec.22, to which the principle of mutuality applies. Chelmsford Club (2000) 243 ITR 89 (SC) 57

58. Transactions with Non-Members Principle of mutuality can be claimed in respect of receipts from members but not in respect of receipts from non-members ( 1992) 196 ITR 137 (Pat)(FB) Rental income from letting marriage hall to non-members who were made temporary members only for the purpose of such letting- not covered under principles of mutuality. � Trivendrum Club (2006) 282 ITR 505 (Ker). 58

59. Interest, Dividend earned � Diverse Judicial Pronouncements Interest on fixed deposit and investments by a club does not form part of the principle of mutuality � Amar Singh Club Vs UOI (2009) 184 Taxman 481, Coimbatore Cosmopolitan Club (2010) 34 DTR 62, ITI Employees Death & Superannuation Relief Fund (1998) 234 ITR 308 (Ker) Interest on Deposit with member bank � Principle of mutuality not applicable � Bangalore Club (2006) 287 ITR 263 (Kar) 59

60. Interest, Dividend earned�Contd. Income earned by Assessee Society by way of interest and dividend by making investment of surplus fund which is wholly contributed by members is governed by the principles of mutuality � Canara Bank Golden Jubilee Staff Welfare Fund. (2009) 308 ITR 202 (Ker) [Also, All India Oriental Bank of Commerce Welfare Society (2003) 130 Taxman 575 (Del)] 60

61. Mutuality, Charity or Both? Mutuality and Charity whether mutually exclusive? Whether exemption can be claimed both under Mutuality as well as under Sec 11? 61

62. In Conclusion Charitable entities under greater scrutiny by the Department Refrain from using charitable entities for collateral purposes Under DTC application of income on regular basis imperative � failure to do so results in chargeability to tax 62

63. In Conclusion�contd. Clubs should reconcile themselves to claiming exemption qua mutuality � Charitable status may not continue for long Mutuality will be given restrictive meaning � Revenue generation from sources unrelated to members would be chargeable 63

64. 64