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November 17, 2020

List of Assets a Trust can invest and park funds. Know consequences for not adhering to rule

by CA Shivam Jaiswal in Income Tax

List of Assets a Trust can invest and park funds. Know consequences for not adhering to rule

Charitable organization is a kind of institution or a business that falls under the category of NPO or non-profit organization and can be based on providing educational, religious or public interest activities. There are different kinds of activities of the charitable organizations. Some of them offer relief to the needy people who are in distress, poverty or are underprivileged. There are also some who are related to educational, scientific or religious affiliations.

Some of the activities of charitable organization also include the creation of public building and monuments and take care of them. All these are done by the donations that a charitable organization gets. Due to their distinct organisation and objective entire income of such charitable or religious trusts are taxed as per the provisions of section 11-13 of the Income Tax Act, 1961, which provides for various tax benefits to them. Let us learn about this in detail below:

What do you mean by a trust?

A trust is an association/ union of members constituted for a charitable or religious purpose not intending to do any commercial activity. As per the Trust Act, a Trust is an arrangement where a person transfers some property to another person within his acceptance for the benefit of any third person or a group of persons or society. Trust in India can be registered in any of the two ways i.e. by forming a Public Trust or a Private Trust.

  • Private Trust: A trust formed with the fundamental goal of protecting the interest of its beneficiaries who are limited in number or limited to a specific group.
  • Public Trust: A trust formed to benefit a large group or the general public. It captures the interest and benefit of public groups and is generally formed for scientific, religious, educational or charitable purposes.

What benefit under income tax is provided to trusts?

Trust formed for charitable or religious purposes which are not intended to do commercial activities are allowed various benefits under the Income-Tax Act, inter-alia, exemption under section 11.

What do you mean by religious or charitable purpose?

The term religious purpose is not defined under the Income-Tax Act. Section 2(15)​ of the Income Tax Act defines “charitable purpose” to include relief of the poor, education, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest, and the advancement of any other object of general public utility.

However, 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, fee or any other consideration, irrespective of the nature of use or application, or retention, of the income from such activity, unless:

  • such activity is undertaken in the course of ​​carrying out of such advancement of any other object of general public utility and
  • the aggregate receipts from such activity or activities during the previous year, do not exceed 20% of the total receipts, of the trust or institution undertaking such activity or activities, of that previous year

How is income from property held for charitable or religious purposes by is trust, taxed?

According to Section 11 of the Income Tax Act, the following income from property held for charitable or religious purposes shall not be included in the total income of the previous year

  • income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied to such purposes in India; and
  • where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of 15% of the income from such property

In simple words,

15% of gross receipts from such trust property – Exempt

85% of gross receipt from such trust property

  • Income Applied for Charitable Purposes in India – Exempt to the extent to which applied for the following purposes:
    • Purchase of capital asset
    • Repayment of loan for purchase of capital asset
    • Revenue Expenditure
    • Donation to trust registered u/s 12AA or u/s 10(23C)
  • In case whole or part of income is not received during that year in which it is derived. Income deemed to be applied for charitable purpose in India and exempt shall be:
    • Income is applied for charitable purpose in India in the year of receipt or in the immediate succeeding year.
    • Assessee submits a declaration to the AO on or before the due date of filling of return as per section 139(1) that such income shall be applied for such purpose in the year of receipt or succeeding year.
  • In any other case exempt income shall be:
    • Such income is applied in above mentioned charitable purposes in the immediately succeeding year.
    • Assessee submits a declaration to the AO on or before the due date of filling of return as per section 139(1) that such income shall be applied for such purpose in the immediate succeeding year.

What will be the effect when 85% of the income is not applied, or is not deemed to have been applied, to charitable or religious purposes in India during the previous year?

When 85% of the income is not applied, or is not deemed to have been applied, to charitable or religious purposes in India during the previous year, but is accumulated or set apart, either in whole or in part, for application to such purposes in India, such income so accumulated or set apart shall not be included in the total income of the previous year of the person in receipt of the income, provided the following conditions are complied with:

  • such person specifies, by notice in writing given to the AO in the prescribed manner, the purpose for which the income is being accumulated or set apart and the period for which the income is to be accumulated or set apart, which shall in no case exceed 10 years;
  • the money so accumulatedor set apart is invested or deposited in the forms or modes specified in Section 11(5)

What are the modes in which income shall be accumulated for specific purpose as mentioned in Section 11(5)?

The forms and modes of investing or depositing the money shall be the following, namely:

  • investment in savings certificates as defined in section 2(c)of the Government Savings Certificates Act, 1959, and any other securities or certificates issued by the Central Government under the Small Savings Schemes of that Government
  • deposit in any account with the Post Office Savings Bank;
  • deposit in any account with a scheduled bank or a co-operative society engaged in carrying on the business of banking (including a co-operative land mortgage bank or a co-operative land development bank).
  • investment in units of the Unit Trust of India established under the Unit Trust of India Act, 1963;
  • investment in any security for money created and issued by the Central Government or a State Government
  • investment in debentures issued by, or on behalf of, any company or corporation both the principal whereof and the interest whereon are fully and unconditionally guaranteed by the Central Government or by a State Government
  • investment or deposit in anypublic sector company. However, that where an investment or deposit in any public sector company has been made and such public sector company ceases to be a public sector company:
    • such investment made in the shares of such company shall be deemed to be an investment made under this clause for a period of three years from the date on which such public sector company ceases to be a public sector company;
    • such other investment or deposit shall be deemed to be an investment or deposit made under this clause for the period up to the date on which such investment or deposit becomes repayable by such company;]
  • deposits with or investment in any bonds issued by a financial corporation which is engaged in providing long-term finance for industrial development in India and[which is eligible for deduction under section 36(1)(viii)];
  • deposits with or investment in any bonds issued by a public company formed and registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in India for residential purposes and[which is eligible for deduction under section 36(1)(viii)];
  • deposits with or investment in any bonds issued by a public company formed and registered in India with the main object of carrying on the business of providing long-term finance for urban infrastructure in India. (long-term finance means any loanor advance where the terms under which moneys are loaned or advanced provide for repayment along with interest thereof during a period of not less than 5 years);
  • investment in immovable property. Immovable property does not include any machinery or plant (other than machinery or plant installed in a building for the convenient occupation of the building) even though attached to, or permanently fastened to, anything attached to the earth;
  • deposits with the Industrial Development Bank of India established under the Industrial Development Bank of India Act, 1964
  • any other form or mode of investment or deposit as may be prescribed.

What will be the consequences of not investing in the modes as specified in Section 11(5)?

Any income which:

  • is applied to purposes other than charitable or religious purposes as aforesaid or ceases to be accumulated or set apart for application thereto, or
  • ceases to remain invested or deposited in any of the forms or modes specified, or
  • is not utilised for the purpose for which it is so accumulated or set apart during the period or in the year immediately following the expiry thereof,
  • is credited or paid to any trust or institution registered under section 12AA or to any fund or institution or trust or any university or other educational institution or any hospital or other medical institution referred to in sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via) of section 10(23C),

shall be deemed to be the income of such person of the previous year in which it is so applied or ceases to be so accumulated or set apart or ceases to remain so invested or deposited or credited or paid or, as the case may be, of the previous year immediately following the expiry of the period aforesaid.

In simple words, Failure to invest the income in circumstances as explained will amount to forfeiture of the exemptions that are available under section 11. Such income is chargeable to tax as per the slab rates which are applicable to an individual (not being a senior citizen or super senior citizen).

Surcharge shall be as follows:

  • The amount of income-tax shall be increased by a surcharge at the rate of 10% of such tax, where total income exceeds Rs 50 lakhs but does not exceed Rs 1 crore. However, the surcharge shall be subject to marginal relief.
  • The amount of income-tax shall be increased by a surcharge at the rate of 15% of such tax, where total income exceeds Rs 1 crore. However, the surcharge shall be subject to marginal relief.

Education Cess: The amount of income-tax and the applicable surcharge, shall be further increased by health and education calculated at the rate of 4% of such income-tax and surcharge.

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