Demystifying Impact of Finance Bill 2022 on Charitable Trusts & Institutions
Last night we posted our analysis of the Impact of Finance Bill 2022 on Charitable Trusts & Institutions. Some said they were still ‘confused’ while many asked the simple question: ‘is it good or bad’?
For a change we are pleased to state that while what is proposed in the Bill seems verbose, intimidating, complex and confusing, it is not so bad!
Here’s why we think the proposed amendments are not so bad:
Cancellation of tax exemption
It is proposed that the Principal Commissioner may, after giving adequate opportunity of being heard, cancel the registration of an approved charitable institution (for tax exemption) if it is found to have violated any of the following conditions:
- The income is applied towards objects other than for which it is established;
- It has earned profits from a business which is not incidental to the attainment of its objects;
- It has not maintained separate books of account for a business activity which is incidental to the attainment of its objects;
- It has applied any part of its income for the benefit of any particular religious community or caste;
- It has undertaken any activity that is not genuine or has not adhered to the conditions subject to which it was registered.
In our opinion, this amendment is not so bad as it only clarifies the violations for which the Principal Commissioner may, after giving adequate opportunity to the institution of being heard, cancel the registration granted under section 12AB (earlier 12AA).
What part of income would be taxed if tax exemption is denied?
Professionals were often in doubt whether Income tax authorities would tax the total income of a trust or institution, as reduced by expenses or otherwise, in case tax exemption is denied in any assessment year on account of violation of some provision of the Income tax Act 1961. This ambiguity has now been cleared and clarified.
For example, an institution enjoying tax exemption but falling under the category “any other object of general public utility” has business income in excess of twenty per cent of its income and is therefore denied tax exemption for that particular assessment year, would the tax be on the total income without allowing for expenses incurred during that year by the institution on advancing or furthering the objects? This doubt has now been cleared.
It is proposed that in case tax exemption is denied, the taxable income of the institution shall be its income as reduced by expenses provided such expenditure:
- is not a capital expenditure;
- is not paid from the opening balance in the corpus account;
- is not funded by any loan or borrowing;
- is not in the form of any contribution or donation.
In our opinion, this amendment has brought it clarity on this vexed issue.
Penalty for unreasonable benefit
As we are aware Section 13 of the Income tax Act disallows benefit to specified persons such as founders, trustees and their relatives from deriving benefit.
Now after 1st April 2022, if any specified persons such as founders, trustees or their relatives derives any ‘unreasonable benefit’, the offence would attract a penalty which would be one hundred per cent of the amount of unreasonable benefit passed on to the specified person where the violation is noticed in a financial year for the first time and two hundred per cent of the amount of unreasonable benefit passed on to the specified person where the violation is noticed in any subsequent financial year.
In our opinion, this amendment is not so bad either.
Tax liability in case exemption is denied
In case of violation of any provision of the income tax as applicable to a tax-exempt institution (e.g., investing funds in modes not specified u/s 11(5) or a trustee deriving unreasonable benefit etc.) the tax would be restricted only to:
- The amount of funds not invested in modes specified u/s 11(5) of Income tax (e.g., investing the institution’s funds in shares or stocks);
- The amount of unreasonable benefit provided to specified persons (e.g., a trustee or a trustee’s relative);
This amendment, in our opinion is not bad at all!
Tax on Accumulated Income
To begin with let us understand what is accumulated income.
In any given financial year, the tax-exempt institution must apply at least eighty-five per cent of its total income. The balance fifteen per cent is unfettered and may be booked as a reserve fund and this would not be considered as accumulated income.
However, in case the institution is unable to spend at least eighty-five percent of its income, it has the option to file online Form No. 10 and accumulate the unspent income for up to five years. Such accumulation must be for a specified charitable purpose.
The amendment under Finance Bill 2022 proposes that on failure to apply such accumulated income for the purpose for which it is accumulated within the period of five years, would make the institution liable to pay tax on such unapplied amount in the fifth year.
This amendment, in our opinion, is not so bad!
Follow cash system of accounting
To reiterate, tax-exempt institutions are required to apply at least eighty-five per cent of the total income during any fiscal year. However, the method of such application is not defined under the Act and accordingly, it is determined on the method of accounting i.e., cash or accrual system followed by the institution.
The amendment proposes that ‘application of income’ for the purpose of the Income tax Act shall mean actual payment following cash system of accounting and shall not include expenses accrued but not paid during the year.
This amendment, in our opinion is reasonable and not so bad!
Maintaining ‘Books of Account’
It is proposed that from 1st April 2022, charitable trusts and institutions shall be required to maintain books of account as may be prescribed (later under the Income Tax Rules).
While accounts of charitable trusts and institutions are audited there is no specific provision under the Act to maintain ‘Books of Account’. The Income Tax Rules will soon prescribe these and how these should be maintained.