Excess expenditure incurred by a trust/charitable institution in earlier years can be allowed to be set off against income of subsequent years

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.

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:
  1. Purchase of capital asset
  2. Repayment of loan for purchase of capital asset
  3. Revenue Expenditure
  4. 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:
  1. Income is applied for charitable purpose in India in the year of receipt or in the immediate succeeding year.
  2. 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:
  1. Such income is applied in above mentioned charitable purposes in the immediately succeeding year.
  2. 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 accumulated or set apart is invested or deposited in the forms or modes specified in Section 11(5)

Let us refer to the case of CIT (E) v. Subros Educational Society (2018), where the main issue under consideration was whether, any excess expenditure incurred by the trust/charitable institution in earlier assessment year could be allowed to be set off against income of subsequent years by invoking Section 11 of the Income-tax Act, 1961?

Facts of the Case:

• Assessee was a charitable institution registered under Section 12A of the Income Tax Act.
• In the previous year in which the depreciation was claimed, the entire expenditure incurred for acquisition of capital assets was treated as application of income for charitable purposes under Section 11(1)(a).
• The view taken by the Assessing Officer (AO) in disallowing the depreciation which was claimed under Section 32 was that once the capital expenditure was treated as application of income for charitable purposes, the assessee had virtually enjoyed a 100% write off of the cost of assets and, therefore, the grant of depreciation would amount to giving double benefit to the assessee.

Proceedings of Appellate Authorities:

The CIT (Appeals) had affirmed the view, but the ITAT reversed the same and the High Court (HC) accepted the decision of the ITAT thereby dismissing the appeals of the Income Tax Department.

Proceedings of the Supreme Court (SC)

• SC was of the opinion that the view taken by the HC correctly stated the principles of law and there was no need to interfere with the same.
• It was further observed by SC that the legislature, realising that there was no specific provision in this behalf in the Income Tax Act, has amended Section 11(6) of the Act vide Finance Act No. 2/2014 which became effective from the Assessment Year 2015-2016.
• SC affirming the view observed that the HC had rightly held that the said amendment was prospective in nature.
• It was specifically stated that once assessee was allowed depreciation, he shall be entitled to carry forward the depreciation as well.
• SC thus confirmed the view of the HC and dismissed departmental appeal.

What happened after the SC judgement?

However, an application was filed by the Income-tax Department wherein it was stated that one questions was left out with regards to excess expenditure being set off in subsequent year.

What was the issue before the SC?

The only issue raised in the miscellaneous application was whether any excess expenditure incurred by the trust/charitable institution in earlier assessment year could be allowed to be set off against income of subsequent years by invoking Section 11 of the Income-tax Act, 1961.

Observations of the SC

Affirming Delhi High Court’s view, in Subros Educational Society, that any excess expenditure incurred by the trust/charitable institution in earlier assessment year could be allowed to be set off against income of subsequent years, the Supreme Court dismissed the Miscellaneous Application of the Revenue.

Thus, the above decision suggests that it is possible for the charitable institution to carry forward deficit to subsequent years.

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