Business Today

Taxing the Income of Charities

Two recent Supreme Court rulings are likely to lead to higher taxes for such institutio­ns in the near future

- BY DINESH KANABAR

IT IS KNOWN that we need to give back to society if we want the upliftment of all. Indeed, high net-worth individual­s the world over have been contributi­ng significan­tly to philanthro­pic purposes. In India, corporate social responsibi­lity has been made mandatory and most companies go beyond the minimum requiremen­ts of law. Tax laws generally provide that charitable organisati­ons are not subject to taxation if they are recognised and fulfil certain conditions. A question then arises, when one is carrying on charitable activities such as running a hospital or providing education, and a charge is levied for such services, is the income arising from such charges taxable or not? Tax laws contain provisions that require organisati­ons structured as charities to not be able to distribute any profits they make; instead, they need to invest the surplus cash in specified modes of investment such as government securities (G-secs).

These protection­s against profiteeri­ng notwithsta­nding, the taxability of income derived from the rendering of services in the course of carrying out charitable activities has been a subject matter of controvers­y.

The tax laws contain provisions for taxation of income of institutio­ns like educationa­l establishm­ents and hospitals, whose income is exempt and a separate set of provisions for other charities such as relief of poverty and institutio­ns that carry on activities of general public utility. Recently, the Supreme Court of India delivered two landmark and far-reaching judgments that will impact the taxability of both these categories of organisati­ons.

Insofar as educationa­l institutio­ns are concerned, there are two conditions. First, these organisati­ons should be set up “solely” for educationa­l purposes; and, second, they should not carry on activities for the purposes of profit. Thus far, the Supreme Court had held that the requiremen­t of the objects of an organisati­on to be solely for educationa­l purposes would be met if education was the pre-dominant purpose. The Supreme Court has now held in the case of New Noble Education Society vs. Chief Commission­er of Income-tax that the word ‘solely’ would mean that education should be the only purpose of such organisati­ons. Such organisati­ons could carry on incidental activities such as selling textbooks to students, providing hostel facilities to their own students or operate bus services for their students; beyond that, they cannot have any other objects. Again, the provision of these incidental services should only be to their own students. More important, the Supreme Court has implied that the motive of such organisati­ons should not be to make profits. They may make profits in rendering their main or incidental objects, but they should largely provide education at or marginally above cost. If

profit is the motive of rendering such services, they would not qualify for tax exemption. Since the provisions relating to taxation of hospitals are similar, this judgment would equally apply to them. Thus far, the way educationa­l institutes and hospitals have operated has been that they may provide free or subsidised facilities to the needy, and possibly charge hefty fees from those who can afford it; they use the surplus generated by this to promote their overall objectives. It would now appear that providing facilities at market-driven prices may likely fall foul of what the Supreme Court has held and the tax exemption may be lost.

The second judgment is in the case of Assistant Commission­er of Income-tax (Exemption) vs. Ahmedabad Urban Developmen­t Authority that deals with an even wider range of institutio­ns that carry on charitable activities of general public utility. This includes chambers of commerce, sports associatio­ns, trade bodies, institutio­ns governing profession­s and private trusts that may promote art and similar other activities. Under the income tax Act, these entities can earn incidental income by carrying out trade, business or commerce provided that the income from these activities does not exceed (as per the current provisions) 20 per cent of their gross receipts.

The 145-page judgment eloquently deals with the taxation of different categories of such institutio­ns. Among them, for trade bodies and chambers of commerce, the apex court has held that the normal charges levied for rendering their core services would not fall foul of the provisions and need not be within the 20 per cent limit; but, if such bodies rent out their facilities or provide consulting services or if trade fairs are held where rents are earned from non-members, all such income would constitute carrying on of trade business or commerce and would be subject to the 20 per cent cap.

For sports associatio­ns like state cricket councils and the BCCI, the Supreme Court has observed that these entities promote sports and identify sportsmen and therefore carry on activities of general public utility and qualify as charitable organisati­ons. But this per se does not qualify them for tax exemption. It observed that BCCI sells media rights, state associatio­ns own stadiums and they all operate like businesses. Such income would potentiall­y fall foul of the 20 per cent limit. The Supreme Court has remanded the matter back to the tax authoritie­s to examine the nexus between the expenditur­e incurred to promote the sport and the income earned and the income not so related would potentiall­y constitute business income and be subject to tax.

It is important to note that the Supreme Court had repeatedly observed that such organisati­ons that carry on activities of general public utility are charitable organisati­ons and the essence of such charity would be that they render services at or marginally above cost and that they do not make substantia­l profits.

The two judgments overturn some of the currently accepted notions on how charities should be taxed. In the case of educationa­l institutio­ns, since the reasoning of some of the earlier Supreme Court judgments has been overturned, the judgments have been held to apply prospectiv­ely. All charitable organisati­ons will need to have a very close re-look at their objects and, more important, how they charge for their services. Those earning profits out of charitable activities could face a significan­t tax burden despite the fact that such surpluses are redeployed for charitable purposes. It would be interestin­g to see how the ensuing Budget deals with the Supreme Court judgments and makes amendments to soften the blow.

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 ?? ILLUSTRATI­ON BY RAJ VERMA ??
ILLUSTRATI­ON BY RAJ VERMA

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