Assessment of Charitable Trusts under the Income Tax Act, 1961

Charitable and religious trusts in India are vital institutions contributing to social welfare by promoting education, healthcare, relief to the poor, environmental protection, and religious advancement. Recognising their role, the Income Tax Act, 1961 provides various exemptions and incentives to such organisations. However, to ensure these benefits are not misused, the Act outlines detailed provisions for the assessment and regulation of these trusts.

This article explores the legal framework, procedural requirements, exemptions, and recent developments concerning the assessment of charitable trusts under the Income Tax Act.

Meaning: Charitable Purpose

The word ‘charity’ embodies the spirit of selflessness—an intention to serve others rather than oneself. It reflects a mindset of giving, both in thought and action.

Charity typically refers to voluntary assistance—whether in the form of money, services, or goods—offered to those in need. Across the globe, many Non-Governmental Organizations (NGOs) and non-profit entities engage in such work by forming institutions or trusts dedicated to public service.

These trusts may be established for charitable purposes, religious purposes, or a combination of both. Their work supports a wide range of causes including education, healthcare, poverty relief, and community welfare.

By reaching out at the grassroots level, these institutions play a vital role in advancing both economic development and social welfare goals. Their local presence allows them to better identify vulnerable sections of society and offer targeted support.

Recognizing the value of their contributions, the government extends tax benefits and exemptions to registered charitable institutions. In addition, individuals and organizations donating to such entities can avail themselves of deductions under Section 80G of the Income Tax Act, thus encouraging philanthropy and sustained public support.

Section 2(15) of the Income Tax Act defines “charitable purpose” to include:

• Relief of the poor,
• Education,
• Yoga,
• Medical relief,
• Preservation of the environment (including forests and wildlife),
• Preservation of monuments or places of artistic or historic interest,
• Advancement of any other object of general public utility.

The last category is restricted by a proviso: if the activity involves trade, commerce, or business, it must be incidental, and the aggregate receipts should not exceed 20% of total receipts.

In Additional Commissioner of Income-Tax v. Surat Art Silk Cloth Manufacturers Association (1979):

The Supreme Court held that a charitable trust pursuing the advancement of an object of general public utility does not lose exemption under Section 11 merely because it carries on an activity that yields profit, as long as profit-making is not the dominant objective. The test is whether the primary purpose is charitable and the activity for profit is incidental or ancillary.

The decision clarified the interpretation of “charitable purpose” under Section 2(15) of the Income Tax Act, emphasising that “not involving the carrying on of any activity for profit” qualifies only the fourth limb of charitable purpose, not the first three (relief of poor, education, medical relief).

Conditions and Procedure for Registration of Trusts under Sections 12A and 12AA of the Income Tax Act, 1961

Under the Income Tax Act, 1961, charitable or religious trusts seeking exemption under Sections 11 and 12 must comply with the provisions of Section 12A and the procedure laid out under Section 12AA. Here’s a simplified breakdown:

Key Conditions under Section 12A:

1) Mandatory Registration:

A trust must apply for registration in the prescribed form and manner to the Principal Commissioner or Commissioner.

Application must be made:

• Before 1st July 1973, or
• Within one year from the creation of the trust, whichever is later.
• From 1 June 2007 onwards, late applications no longer benefit from retrospective exemptions.

2) Modification of Objects:

If a registered trust modifies its objects, it must apply for fresh registration within 30 days of such modification to retain exemption.

Audit and Return Filing:

• If the total income (before exemption) exceeds the basic exemption limit:
• Accounts must be audited.
• Audit report must be furnished with the return of income.
• Return of income must be filed within the time limit under Section 139(4A).

Procedure under Section 12AA:

Verification Process:

The Principal Commissioner or Commissioner may call for documents and make inquiries to assess:

• The genuineness of activities, and
• The objectives of the trust.

Grant or Refusal of Registration:

• After evaluation, the authority will:
• Grant registration, or
• Refuse registration (only after giving the applicant a chance to be heard).
• Orders must be passed within 6 months from the end of the month in which the application was received.

Cancellation of Registration:

Registration may be cancelled if:

• Activities are not genuine or deviate from stated objectives, or
• Trust violates provisions of Section 13 (e.g., income used for benefit of specified persons).
• No cancellation without giving a reasonable opportunity to be heard.

Special Provisions:

Retrospective Benefit:

If registration is granted during pending assessments, the benefit of Sections 11 and 12 may be allowed for prior years.

Exclusions:

These benefits are not applicable if the registration was ever refused or cancelled.

Exemption under Sections 11 and 12

Income from property held under trust for charitable or religious purposes is exempt, provided:

• At least 85% of the income is applied for such purposes in India.
• Up to 15% can be accumulated without specific conditions.
• If more than 15% is accumulated, Form 10 must be filed specifying the purpose and duration (not exceeding 5 years).

Capital Gains Deemed as Applied to Charitable or Religious Purposes: Section 11(1A)

For the purposes of claiming exemption under Section 11(1), the following rule applies when a capital asset held under trust wholly for charitable or religious purposes is transferred:

(a) If the net sale consideration (proceeds minus expenses) from the transfer is used to acquire another capital asset that will also be held for charitable or religious purposes, then the capital gains from such transfer will be treated as applied to those purposes, as explained below:

(i) If the entire net consideration is used to acquire the new capital asset, then the entire capital gain is considered to be applied for charitable or religious purposes.

(ii) If only a part of the net consideration is used to acquire the new capital asset, then the amount of capital gain deemed to be applied will be equal to the amount by which the amount utilised exceeds the original cost of the asset that was sold.

Sources of Income for Trusts

1. Voluntary Contributions: These are treated as income, unless received with a specific direction to form part of the corpus.
2. Business Income: Exempt only if incidental to the trust’s objectives and separate books are maintained [Section 11(4A)].
3. Capital Gains: Can be exempt if reinvested properly.
4. Anonymous Donations: Taxed at 30% under Section 115BBC (except in the case of wholly religious trusts).

When Section 11 Exemption Does Not Apply – Restrictions under Section 13 of the Income Tax Act, 1961

Section 13 of the Income Tax Act outlines circumstances under which the tax exemptions provided under Sections 11 and 12 are denied to trusts and institutions. These provisions ensure that only genuinely charitable and religious entities benefit from tax relief and that the benefits do not serve private interests or violate specified investment norms.

1. Private Religious Trusts Not for Public Benefit [Section 13(1)(a)]

Exemption under Sections 11 and 12 is not available if the income is from a trust established for private religious purposes that does not benefit the public at large.

2. Trusts Created for the Benefit of a Particular Religious Community or Caste [Section 13(1)(b)]

If a charitable trust or institution (established after the commencement of the Act) is set up to benefit a particular religious community or caste, then its income is not eligible for exemption.

3. Income Used for the Benefit of Specified Persons [Section 13(1)(c)]

Exemption is denied in cases where:

• The trust or institution’s rules allow its income to be used, directly or indirectly, for the benefit of specific persons (as defined under Section 13(3)).
• Any income or property is actually used during the previous year for such persons.

Exceptions:

• For trusts created before the Act’s commencement, application for the benefit of specified persons is allowed if it complies with mandatory terms of the trust.
• Similarly, such use is permissible for periods before 1 June 1970 in the case of older trusts.

4. Improper Investment of Funds [Section 13(1)(d)]

Exemption is also denied if the trust or institution:

• Invests or deposits funds (after 28 February 1983) in modes not approved under Section 11(5).
• Continues to hold unapproved investments made before 1 March 1983 beyond 30 November 1983.
• Holds shares in a company, except:
• Shares in a Public Sector Company, or
• Shares specifically prescribed under Section 11(5)(xii).

Assessment Procedure

Charitable trusts are assessed like other taxpayers but under a specialised framework:

1. Filing of Return:

• Required if total income (before exemption) exceeds the basic exemption limit.
• Must file ITR-7 as per Section 139(4C).

2. Audit Requirement:

• If total income (before exemption) exceeds the exemption limit, the accounts must be audited [Section 12A(1)(b)].
• Audit report to be submitted in Form 10B.

3. Scrutiny Assessment:

The Assessing Officer (AO) may conduct a detailed scrutiny to verify the application of income and compliance with statutory requirements.

Taxation in Case of Violations

• If exemption is forfeited, entire income (not just misused portion) is taxed at the maximum marginal rate (MMR).
• Misuse includes benefit to specified persons or diversion of funds to non-charitable purposes.

CBDT Clarified Tax Treatment of Inter-Trust Donations under Finance Act 2023

CBDT, via Circular No. 3/2024 dated 6 March 2024, clarified that only 85% of donations made by one trust/institution to another (excluding corpus donations) will be considered as application of income under the Income Tax Act, 1961. Concerns regarding the remaining 15% have been addressed, confirming that it is eligible for accumulation and not treated as taxable, despite being disbursed. The clarification includes illustrative examples for better understanding.

 Budget 2025-26 Eases Compliance for Charitable Trusts

1. Extended Registration Validity: The registration period for small charitable trusts/institutions (with income below ₹5 crore) has been increased from 5 years to 10 years, reducing the compliance burden.
2. Rationalisation Measures: The change is aimed at simplifying regulatory procedures and promoting voluntary compliance among smaller charitable entities.
3. Focus on Ease of Compliance: The measure is part of broader efforts to encourage timely registration and continuity of operations for eligible trusts and institutions under the Income Tax Act, 1961

References

[1] Income Tax Act, 1961

[2] Additional Commissioner of Income-Tax v. Surat Art Silk Cloth Manufacturers Association AIR 1980 SC 387

[3] Finance Act 2023

[4] Budget 2024-2025