Violation of Section 13 of the Income Tax Act – Denial of Full Exemption vs. Partial Exemption

Introduction

The Income Tax Act 1961 (‘IT law‘) provides various benefits for trusts set up for charitable or religious purposes and registered under the IT Act. Sections 11 and 12 of the Information Technology Act are the substantive provisions regarding the exemptions available to religious and charitable trusts. The exemption provided for in Articles 11 and 12 is however subject to certain restrictions provided for in Article 13 of the said law. The author of this article would discuss the implications of Section 13 which purports to deny the exemption available in certain scenarios.

Provisions under the Computer Act regarding the exemption for trusts

Sections 11 and 12 of the Computer Act provide an exemption for certain income earned by charitable or religious trusts. The following income earned by these trusts is not taxable if certain conditions are met:

  1. any income from property held in trust wholly for charitable or religious purposes to the extent that such income is applied to such purposes in India.
  2. any income in the form of voluntary contributions made with a specific direction that they will form part of the body of the trust or institution.

The phrase ‘for charitable purposes‘ is defined in Section 2(15) of the Computer Act to include poor relief, education, yoga, medical relief, preservation of the environment, and the advancement of any other purpose of utility general public. Derogations granted under articles 11 and 12 of the IT law are subject to the conditions mentioned in article 12A.

Considering that trusts claim an exemption under Section 11 of the Information Technology Act, it is important to understand the implications of Section 13 claiming to deny the exemption available in certain scenarios. The prohibition in Article 13(1) is that the income or property of the trust must not be used directly or indirectly for the benefit of specified persons[1]. Subsection 13(2) lists certain specified circumstances in which the income or property of the trust is deemed to be used or applied for the benefit of specified persons.

Section 13(3) defines specified persons which include the settlor of the trust, the founder of the trust, any person who has made a substantial contribution to the trust or institution, etc. Therefore, if a trust carries out a transaction directly or indirectly for the benefit of the specified persons mentioned in Article 13(3), then that trust will run the risk of losing the exemption provided for in Articles 11 and 12 of the Computer Law.

Refusal of exemption – Total or partial?

A long-standing question regarding Section 13 is whether an offense under Section 13(1) or 13(2) would result in the denial of a partial or full exemption under Sections 11 and 12. This question arises since the wording employed in Article 13 potentially opens up two possible interpretations – one that the exemption in its entirety is to be denied and the other that only the exemption for the respective income which infringes the provisions of Article 13 must be refused.

In order to resolve the difficulty regarding this issue, an amendment has been made to Article 13(1)(c)/(d). The said amendment provides that only the part of the income which has been applied in violation of the provisions of Article 13 is liable to be included in the total income. It is essential to note that said modification will come into effect from April 1, 2023. Therefore, said modification will be applicable prospectively from AY 2023-24. In addition, Section 115BBI was also introduced by the Finance Act 2022 to tax income in violation of Section 13 at special rates, which would also come into effect on April 1, 2023.

In the light of said amendments, the theoretical question is what would be the position of said problem for AYs before April 1, 2023 (i.e. AY 2023-24), i.e. for the periods prior to the express entry into force of the amendment.

Refusal of total exemption

Delhi High Court at DIV (Exemption) v. Charanjiv Charitable Trust[2] addressed the issue of whether the assessee breached Article 13(1)(c)(ii) read together with Article 13(3) of the IT Act, with respect to the transactions of the assessee with an APIL. The assessee was a charitable trust which was registered under Section 12A of the Information Technology Act. The assessee, in pursuit of its objectives to open a school, entered into agreements with APIL during the 2003-04 financial year for the purchase of land and an advance was also made. It was an acknowledged fact that APIL was a specified person under Section 13(3)(e) of the Computer Act. The payment made was treated as an application of revenue (for charitable purposes) in said financial year. The assessee changed his mind for various reasons and the agreements were cancelled, and the amount of the advance paid by the assessee was reimbursed to him during the financial year corresponding to YY 2006-07. In deciding on the assessment for the 2003-04 financial year regarding YY 2004-05, it was noted by the AO that the amount of the advance remained at APIL throughout the financial year without any progress in the transaction. No interest or compensation was stipulated for the delay in the sale of the land and no deed of sale has been signed for more than a year. The Revenue Authority argued that if the Trust was serious enough in pursuing its goals of running the schools/dispensaries, it should have insisted on surrendering the land within a reasonable or at least stipulated time for interest or adequate compensation or damages for failure. to honor the alleged deal. He was further satisfied by the tax authorities that the funds had remained with APIL for a longer period without any interest or collateral. The Court accepted the tax authorities’ assertions that the assessed person’s real motive was to advance his excess funds to APIL without charging interest and since APIL was a prohibited person within the meaning of Article 13(3), he was found that the assessee had breached the provisions of Section 13 of the Information Technology Act and therefore the trust was not eligible for the total exemption under article 11 of the computer law.[3]

The High Court of Kerala at Agappa Children’s Center v. ICT[4] dealt with a similar problem. The Rated, a public charitable trust, purchased a refrigerator and kept it at the home of its managing trustee. As the trustee benefited from the use of trust property, the ITO held that the provisions of section 13 applied. The Court observed that from a simple reading of the provisions, it can be deduced that the legislative emphasis is placed on availability for use by any person referred to in Article 13(3) and that also for any period in the previous year without charging adequate rent or compensation. The Court held that the management trustee was one of the prohibited persons within the meaning of Article 13(3). Therefore, the Court held that the total exemption trust must be denied.

Refusal of partial exemption

The High Court of Karnataka at ICT v. Prof. Mullers Charitable Institutions[5] dealt with a similar problem. The assessee was a charitable trust that ran a large number of institutions. During an investigation, the assessor noticed that the assessee-trust had advanced a sum of INR 80,000,000 to ‘J’ Ltd who ran a Kannada daily newspaper for the purposes of advertising, printing, etc The AO found that the advance of such a huge amount was contrary to Article 11. Therefore, the assessee was not entitled to an exemption for said amount. The Court observed that Article 13(1)(d) makes it clear that only the income from such an investment or deposit made in violation of Article 11(5) is liable to tax and that this violation under of section 13(1)(d) does not amount to a denial of the full exemption under section 11 on the total income of the assessee’s trust.

The Bombay High Court at ICT v. Audyogik Shikshan Mandal[6] referring to the above-mentioned decision of the Karnataka High Court held that when the funds of the assessed-trust were used for the purchase of a car in the name of its trustee, there was a violation of Article 13 , however denial of exemption under Section 11 should be limited only to the amount that was misappropriated in violation and not the entire exemption under Section 11 of the Technology Act some information.

In addition to the legal precedents discussed above, it may also be of interest to refer to the language used in Section 164 of the Information Technology Act. If the exemption under section 11 is not available due to the application of section 13, the income of the trust is taxable under section 164 of the IT Act. ‘information. Section 164 provides that when “all or part of the relevant income” is not exempt under section 11 or 12, tax shall be levied on the relevant income at the maximum marginal rate. The use of the expression “all or part of the relevant income” in Article 164 gives the meaning that the denial of the total exemption is not envisaged in Article 13.

Conclusion

We can also take that of the Memorandum to Finance Act, 2022 which specifically provides that the denial of full exemption to the trust, for a small amount of income applied in violation, creates difficulties for trusts and institutions. Therefore, even though the beneficial amendment to Article 13(1)(c)/(d) will not come into effect until April 1, 2023, the author is of the opinion that the denial of the The entire breach exemption may be too harsh on trusts run for charitable/religious purposes for AYs prior to AY 2023-24.

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