Introduction
Trusts/institutions created for charitable purpose have been granted tax exempt status under the income tax laws with a view to promote welfare of the needy and upliftment of the society. The charitable purpose is defined in Section 2(15) as including relief of the poor, education, yoga, medical relief, preservation of environments/monuments and the advancement of any other object of General Public Utility (‘GPU’). Certainly, the charitable trusts/institutions do enjoy substantial income-tax benefits, but at the same these trusts/institutions are often subject to detailed scrutiny to ensure that commercial concerns are kept outside the boundaries of the tax-exempt status. Thus, a number of amendments have been made in the Income-tax Act to exclude commercial receipts of these institutes from the ambit of tax benefits.
Evolution of definition of charitable purpose and its judicial interpretation
Way back in 1922, the law provided that the business income of charitable entity would be exempt if it is inter alia earned in the course of actual carrying out the charitable purpose and is applied wholly for such purpose. Subsequently, in 1961, GPU purpose was qualified with the phrase ‘not involving the carrying on of any activity for profit’.
This phrase came up for interpretation before the Apex Court on myriad occasions. At first, the Apex court applied the phrase strictly and disentitled exemption in case there were no restrictions on profit yielding activity even if such activities are incidentally undertaken[1].
Thereafter, a more liberal approach was adopted by 5-member bench of the Apex Court in Surat Art Silk[2] by applying ‘pre-dominant test’. The Court observed that if the dominant object of a trust was charitable, the generation of profits or surpluses from the activities incidental to the dominant object will not undermine the charitable nature as long as the surpluses is feeding the dominant object.
Subsequently, the phrase ‘not involving the carrying on of any activity for profit’ was deleted by 1983 amendment in the statute. Thereafter, vide 2008 amendment, profit earning was again qualified for GPU entity by insertion of a proviso to Section 2(15). The proviso essentially restricted GPU entities earning business income in excess of the prescribed threshold (which is 20% of the total receipts presently) irrespective of its application. In 2015, the proviso was tweaked to provide that such business income should be earned in the course of actual carrying out the GPU object.
Even after the amendment made in 2008, the pre-dominant test was favourably applied by various High Courts while analysing the tax-exempt status of statutory corporations, statutory regulators, trade promotion bodies, non-statutory bodies, state cricket associations and private trusts. However, the tables have turned with the pronouncement of the recent Apex Court judgment in Ahmedabad Urban Development Authority (‘AUDA’)[3].
Apex Court decision in AUDA
The Supreme Court in AUDA noted that the Parliamentary intent while bringing amendments in the definition of charitable purpose was to deny exemption to GPU entities engaged in carrying out commercial activities. This meant that apart from other GPU entities, even a statutory corporation engaged in rendering service in the nature of a commercial activity will be ousted from the definition of charitable purpose, notwithstanding that the consideration is fixed under a law. The Court held that the test of predominant object, as laid down in Surat Art Silk, does not hold water after the legislative amendment made in 2008. The key parameters set by the Apex Court for checking eligibility for exemption for GPU entities are summarized below:
- Pure charity does not mean absence of consideration. So long as any GPU entity’s objects involve activities which generate profits (incidentally or while actually carrying out the objectives of GPU entity), it can be granted exemption, subject to satisfaction of threshold limit (i.e., 20% limit in proviso to Section 2(15)) which is to be applied on yearly basis.
- The prohibition against carrying on commercial activities does not apply on GPU entities which are engaged in activities that entails charging amounts only at cost or marginal mark-up over cost. Vice-versa, when GPU entities charge substantial amounts over and above costs, then exemption would be available subject to satisfaction of the threshold limit.
- Corporations, boards, trusts or authorities discharging essential services of GPU like providing water, distribution of food grains/medicines, maintenance of roads/parks etc. ought not to be characterized as being engaged in commercial activity because the overall receipts in such cases may exceed the threshold limit, resulting in taxation of the GPU entity, and consequently shifting the burden to the ultimate user/customer by charging higher considerations from them. However, if these entities charge substantial amounts over and above costs, the exemption will not be available.
Way forward
The Apex Court decision has brought a swirl for the GPU entities and their tax exemption status. Not only the predominant object test which has been applied so far has been discarded, but a new test of nominal consideration/substantial profits has been devised to determine whether the threshold limit would become applicable. Consequently, both the taxpayer and the Revenue Authorities will have to verify the material on record on a yearly basis, so as to determine whether the activities of the GPU entities amount to commercial activity and the corresponding receipts is within the threshold limit or not.
Although, the long-drawn tussle between the taxpayer and Revenue Authorities with respect to interpretation of GPU charities has come to an end, however, no set clarity on what constitutes as ‘nominal’ or substantially high mark-up may surface another round of litigation.
It is also worth mentioning that in the light of the Apex Court ruling in AUDA, the Revenue Authorities may seek to cancel registration granted under Section 12AB alleging breach of conditions mentioned in first proviso to Section 2(15). In such a case, the taxpayers may also be burdened with huge tax demands (computed by applying maximum marginal rate to the accreted income) in terms of Section 115TD. Considering the aforesaid, the GPU entities may to have re-visit the activities carried out by them and the pricing of sums charged in relation to such activities to analyse the impact of Apex Court ruling in AUDA.
[The authors are Principal Associate and Associate, respectively, in Direct Tax Team at Lakshmikumaran and Sridharan Attorneys, New Delhi]
[1] Sole trustee Loka Shikshana Trust v. CIT [1975] 101 ITR 234 (SC) and Indian Chamber of Commerce v. CIT [1975] 101 ITR 796 (SC)
[2] [1978] 121 ITR 1 (SC).
[3] Civil Appeal No. 21762 of 2017.
