The tax regime for charitable trusts has been undergoing transformative amendments in successive Union Budgets. This year too, several amendments have been proposed that makes compliance and taxation more stringent for the charitable trusts.

Mr. S. Ramanujam (Chartered Accountant) discusses the extant amendments proposed in the Finance Bill, 2023 with special emphasis on 'Exit Tax' i.e. taxability on lapse in re-registration. He analyses different situations in which Exit Tax can get attracted and underscores the retrospective implications of the proposed amendment. The author then analyses the possibility of challenging the Exit Tax on the grounds of Doctrine of Proportionality in the light of Supreme Court judgments. He also sheds light on incongruities noticed in the provisional registration certificates, thus, highlights the practical difficulties in running a charitable trust.

"Charitable Trust Amendments in Finance Bill 2023 - Road Full of Minefields!"

It is popularly believed that charitable trusts, true to their nature and inherent characteristics should spend their resources towards the objects for which they are set up and not fritter away these earmarked funds for administrative purposes – like having a registered office , A full time CEO /CFO and a host of subordinate staff to ensure full compliances with regulations rather than indulging in their core activities – of carrying out charitable activities . Many will recall the recent example of the country’s leading Industrial group restructuring the charitable Trusts associated with the group with a full time management Team , almost making it like an Organisation employing many people for peripheral work ! As far as the Finance ministry is concerned , it appears that they have constituted a permanent cell in their office only to start all over again, year after , to make more amendments to the existing provisions so that small charities become extinct and the total number of assessees in this category becomes miniscule. The proposals contained in the Finance Bill of 2023 are the most draconian in the recent times and many of them , are applicable with retrospective effect! 

Understanding the slew of amendments-through Memorandum explaining the provisions:

 To explain away the amendments , the memorandum Classifies the exemption provisions under two categories :

Regime 1 – Funds or institutions or trusts or university or educational Institution or any hospital or other medical Institutions covered under certain clauses of sec 10 (23C)

Regime 2 – Trusts registered under sec 12 AA/ or 1 2AB of the Act 

Summary Of amendments:

The Dangerous Road Ahead- Exit Tax

Although the Tabulation, to some extent makes sense – after its segregation into prospective and retrospective provisions , and , or into Regime one category and Regime 2 category, there are many thorny issues that need to be understood especially in the larger context of exit tax :

Some of them are:

1. Exit tax is applicable for procedural lases also – not filing the Return in time , without the option extended to other assessees who can rectify their lapses by filing updated returns under sec 139 (8A)

2. Exit tax is applicable even if one does not want to avail tax exemption in future

3. A provisional registration granted under automated system (CPC ) can never be considered as an application which is incomplete as it is normally expected that the Computer system designed would have ensured in the first place the relevant data to be keyed in for the purpose of granting provisional registration

4. Till now It is understood that any trust which loses tax exemption has to pay tax on its income as though it is an AOP; From now onwards , this will be deemed as conversion and additionally the trust need to pay exit tax too on the excess of market value of the assets over its liabilities

5. Assuming a trust in a rural area running a school- built 20 years ago at a cost of Rs 5 lacs. Due to certain procedural lapses , there has been a default in filing the Income tax Return , in time. . The trust will be liable for the exit tax on the market value of the property at maximum marginal rate 

6. The tax is payable within 14 days from the end of the previous year in which the registration expires and the principal officer or the trustee is liable to pay this tax .

7. Many provisions are retrospective and one need to understand their implications fully.

Taxability of Corpus under sec 115TD:

In the context of taxability of corpus forming part of the `accredited income one can look at the Government’s views at the time of introducing sec 115TD. This is clear from the CBDT circular issued at the time of explaining the provisions of the Finance Act 2016 .

An extract from the circular is reproduced below:

11.2 A society or a company or a trust or an institution carrying on charitable activity may voluntarily wind up its activities and dissolve or may also merge with any other charitable or non-charitable institution, or it may convert into a non-charitable organization. In such a situation, the existing law does not provide any clarity as to how the assets of such a charitable institution shall be dealt with. Under provisions of Section 11, certain amount of income of prior period can be brought to tax on failure of certain conditions. However, there was no provision in the Income-tax Act which ensured that the corpus and asset base of the trust accreted over period of time, with promise of it being used for charitable purpose, continues to be utilised for charitable purposes and is not used for any other purpose. In the absence of a clear provision, it was always possible for charitable institutions to transfer assets to a non-charitable institution. Therefore, there was a need to ensure that the benefit conferred over the years by way of exemption is not misused and to plug the gap in law that allowed the charitable trusts having built up corpus/wealth through exemptions being converted into non-charitable organisation with no tax consequences.

11.3 In order to ensure that the intended purpose of exemption availed by trust or institution is achieved, a specific provision in the Act is required for imposing a levy in the nature of an exit tax which is attracted when the organisation is converted into a non-charitable organisation or gets merged with a non-charitable organisation or a charitable organisation with dissimilar objects or does not transfer the assets to another charitable organisation.

11.4 Accordingly, a new Chapter XII-EB consisting of Sections 115TD, 115TE and 115TF has been inserted in the Income-tax Act. This chapter contains specific provisions for levy of additional income-tax in case of conversion into, or merger with, any non-charitable form or on transfer of assets of a charitable organisation on its dissolution to a non-charitable institution.

Illustration:

To understand this issue ,a small illustration is considered : Assume a rich man (author of the Trust ) , after completing a career in an MNC at avery senior post , is setting up a charitable Trust with his post retirement savings . He initially infuses a corpus of Rs 50000and opens a bank account in the name of the trust . After scrutinising the application, the principal CIT approves the trust and Grants 12 AA registration immediately, within one month. Thereafter, the Author transfers Rs 10 Lacs to the trust with a specific direction that this should form part of corpus. (Exempt under sec 11 (4)) Few years later the registration is cancelled and the Trust loses its exemption> According to the section, Exit tax isapplicable on the Fair market value of the assets even when they had been sourced out of the Corpus funds as well . Though the author of the Trust contends that it is Tax suffered money that he has infused into the trust , because it formed part of the Trust Funds, exit tax gets attracted on account of 115TD , if there is a breach of any legal condition The amount that will be taxed is only R 10 lacs as the earlier 500000is infused prior to getting the approval under sec 12AA .(This viewis not accepted by the Department !)

Even for Trusts which have received Government Grants and invested in the assets , exit tax will be leviable if sec 15TD is attracted on the fair market value of assets 

Whether The amendments can be challenged by referring to Doctrine of Proportionality ?

Many are of the view that applying exit tax on trusts even for small inadvertent errors will be going against the Doctrine of Proportionality as propounded by the Hon’ble S C in various cases-refer Modern Dental College & Research & ors v State of MP &ors -2016 (SC), and other cases -discussed in detail in Justice Putt swamy V Union Of India . (SC-)dated 26-09-2018

In Modern Dental College & Research Centre’s case, four subcomponents or proportionality which

need to be satisfied were taken note of. These are:

(a) A measure restricting a right must have a legitimate goal (legitimate goal stage).

(b) It must be a suitable means of furthering this goal (suitability or rationale connection stage).

(c) There must not be any less restrictive but equally effective alternative (necessity stage).

(d) The measure must not have a disproportionate impact on the right holder (balancing stage).

The SC in another case has noticed the three important components of the proportionality test.

(a) First, the measures adopted must be carefully designed to achieve the objective in question. They must not be arbitrary, unfair or based on irrational considerations . In short , they must be rationally connected to the objective.

(b) Secondly, the means, must not only be rationally connected to theobjective in the first sense, but should impair as little as possible the right to freedom

in question

(c) Thirdly, there must be 'proportionality' between the effects of the measures and the objective.

One may conclude that the reliance on this Doctrine of Proportionality may be a good argument to challenge the validity of provisions and their ultimate impact on persons endowed with thoughts to help out others through charities.

Some Incongruities noticed in the provisional Registration certificates already granted :- (extracted from a certificate) :

 The provisional registration is granted subject to the following conditions:

 The Trust/ Society/ Non Profit Company shall maintain accounts regularly and shall get these accounts audited in accordance with the provisions of the section 12A(1)(b) of the Income Tax Act, 1961

 Separate accounts in respect of each activity as specified in Trust Deed/ Memorandum of Association shall be maintained. A copy of such account shall be submitted to the Assessing Officer.

A public notice of the activities carried on/ to be carried on and the target group(s) (intended beneficiaries) shall be duly displayed at the Registered/ Designated Office of the Organisation.

 No asset shall be transferred without the knowledge of Jurisdictional Commissioner of Income Tax to anyone, including to any Trust/ Society/ Non-Profit Company etc.

Many felt that these conditions are unworkable when charities are established and run by individuals without any office but operate from their home , helping poor and needy children for their education and other needs . To display in the house, public notice of the activities carried out and the targe ted beneficiaries will be not only nuisance to others and can also create law and order situation if a crowd swells at the door steps of the Author of the trust . Likewise , one can visualise many unworkable situations in respect of few of the conditions extracted above . 

Conclusion:

After looking at all these provisions , the view that emerges is –

Carrying on a charitable activities in terms of Income tax act provisions is like climbing mount Everest – if one has resources , he can go ahead ! but the risk of falling or ( failing ) is always there for uninitiated climbers !