Charitable institution and trusts in India enjoy certain tax exemptions and benefits for income generated from property held for charitable or religious purposes.
However, any income derived from business activities is treated differently under the Income Tax Act. Sections 11(4) and 11(4A) specifically deal with the taxation of charitable institutions.
What is the Business Income of a Charitable Institution?
A charitable trust or institution can engage in any form of business activity as long as the business itself is considered the ‘property’ of the trust. This means even if the business generates profits and income, it can be argued that such uncertain income cannot be immediately applied for charitable objectives.
However, the assessing officer has the power to determine if the income disclosed in the accounts of the charitable institution is lower than the actual income earned from the business. In such cases, any excess income identified by the AO will not be deemed as having been applied for charitable or religious purposes.
Taxation of Charitable Institutions for Direct Income u/S 11(4)
Section 11(4) of the Income Tax Act deals with the direct business income of a charitable institution. If the AO finds that income from business exceeds the amounts reflected in the accounts, such surplus or excess income will be taxed as per the general provisions under ‘Chapter IV-D’ of the Act.
This means the excess income will not be eligible for exemption under sections 11 and 12 which relate to charitable trusts. Instead, it will be taxed at normal applicable rates as per IT Act.
Additionally, it is important to note that only the income disclosed in the accounts is considered for exemption under section 11(1). The permitted accumulation of 15% of income will also be calculated on the basis of this accounted income only.
Taxation of Charitable Institutions for Incidental Business Income u/s 11(4A)
Section 11(4A) covers the taxation for charitable institutions for income generated from business activities that are incidental or ancillary to the actual charitable objectives of the trust or institution.
The income from such incidental business will be eligible for exemption under sections 11 and 12 only if two conditions are met:
- The business should be incidental to the attainment of the objectives of the trust or institution
- Separate books of account are maintained for such incidental business
Why is Business Considered ‘Property’ of the Trust?
An important basis for exempting business income under section 11(4A) is that ‘business’ itself is considered a ‘property’ that can be held under trust for charitable purposes.
The term property has a broad legal meaning that includes business activities and their assets, unless the law specifically states otherwise. This interpretation has been upheld in several court judgments.
For instance, in the Privy Council case of ‘Re: Trustees of Tribune’, it was held that the newspaper business of Tribune was considered property held under a valid charitable trust.
Requirement of Maintaining Separate Books of Account
To claim tax exemptions, charitable institutions must maintain separate and accurate books of account for all business activities. This mandatory requirement has been reinforced through various judgments, such as the Supreme Court’s ruling in ‘Thanthi Trust vs CIT‘ in 2001. The Court denied exemption to the trust solely because it failed to maintain separate account books for its business as stipulated in law.
Charitable Purpose in Context of Trust Business
An important consideration is whether a trust registered for ‘general public utility’ purposes can undertake business activities and still claim benefits under section 11(4) or 11(4A).
The answer is yes, if the business itself furthers the charitable objectives of the trust. The income will be exempt if it satisfies the conditions under section 11(4A) pertaining to incidental business income.
However, any business unrelated to the aims of the trust will not qualify for exemptions under section 11(4) or 11(4A).
For instance, in ‘CIT vs Birla Education Trust‘, the Court held that the excess income determined by AO under section 11(4) relates to the gross income of the business, not just net income. This allows due taxes to be calculated if business income is not fully exempt.
Evolution of Legal Provisions for Taxation of Charitable Institutions
The taxation of charitable institutions has evolved over the years through amendments and case laws. Some key developments in the field of taxation of charitable institutions are:
- Introduction of section 13(1)(bb) in 1975 to restrict exemption if business is not aligned to objectives. Later omitted in 1983.
- Deletion of ‘not for profit’ requirement from charitable definition under section 2(15) in 1983.
- Judicial rulings like Radhaswami Satsang Sabha upholding wide scope of charitable activity.
- Affirmation by courts in 1990s that business can be considered property held in charitable trusts.
- Finance Act, 2008 introduced new proviso to section 2(15) limiting general public utility activities.
Recent Case Laws on Taxation of Charitable Institutions’ Business Income
Some significant rulings in recent years that have shaped interpretation of provisions for trust business income include:
- P. Krishna Warrior (Supreme Court, 2008) – Business can be ‘property’ under trust.
- Bharat Diamond Bourse (Supreme Court, 2003) – Charitable purpose is key, incidental business allowed.
- Birla Education Trust (Bombay HC) – Section 11(4) permits AO to determine excess income.
- Radhaswami Satsang Sabha (Allahabad HC) – Wide scope for activities under charitable trusts.
Taxation of Charitable Institutions for Non-Exempt Income under Section 164
Section 164(3) provides the mechanism for taxation of charitable trust derived from:
- Property held for religious or charitable purposes
- Voluntary contributions [covered u/s 2(24)(iia)]
- Business income u/s 11(4A)
Such non-exempt income will be taxed either on the “whole” or “aggregate” basis at maximum marginal tax rates, after allowing for exempted amounts.
For instance, if net income from property held under trust is Rs 100 of which Rs 60 is exempt under section 11; then tax will be charged on Rs 40 at the rate applicable as if this Rs 40 was the total income.
Final Words
The taxation of charitable institutions involves detailed provisions under Sections 11(4), 11(4A) and Section 164 of Income Tax Act. The law aims to balance fiscal revenues and interests of charitable trusts undertaking business, with conditions for claiming exemptions.
Recent case laws have also endorsed a liberal interpretation, confirming that businesses aligned with charitable aims can enjoy exemptions. However, maintenance of separate accounts remains an important prerequisite. With the evolving nature of charitable activities, the provisions and jurisprudence of taxation of charitable institutions also continues to develop.
