Impact of Finance Act 2023 on grant-making

On March 31, 2023, the Ministry of Law & Justice, Government of India notified the Finance Act 2023. A number of grant-making organizations have still not understood what really has changed? Some even fear there will be loss of tax exemption and subsequent tax liabilities. Such beliefs are misplaced. To dispel doubts and misunderstanding here is a simplified explanation.

‘Inter-charity’ donations still allowed

To begin with, inter charity donations (i.e. one tax exempt charitable trust or institution donating to another tax exempt charitable trust or institution) continues to be allowed even from 1^st April 2023, but with various restrictions.

Restrictions on inter-charity donations have been in existence since two decades. Let’s observe the trend.

The Trend

Under an Amendment brought in by Finance Act 2002 (twenty-one years ago), one charitable organization could donate to another charitable organization but not from its ‘accumulated income’.

What did this mean?

As we are aware one of the key conditions for tax exemption given to charitable organizations is applying or spending at least eighty five per cent of the total income every financial year. The balance fifteen per cent can be taken as unrestricted reserves. However, if the organization is unable to spend this minimum amount (eight five per cent of the total income) it has the option to accumulate the same for up to five years by exercising option u/s 11(2) of Income tax Act and filing online Form No. 10. However, this accumulated amount must be spent by the organization on its own activities and cannot be donated to another charitable organization.

Later, the Finance Act 2017 disallowed charitable organizations from giving donation to another charitable organization, whether from its accumulated or current year’s income towards the corpus of another charitable organization.

Latest change

Now under the amendment brought in by the Finance Act 2023 in addition to the earlier restrictions, if one tax exempt charitable organization donates to another tax exempt charitable organization, only eighty five per cent of such donations given will be considered as application of income for the donor charitable organization.

In other words if Trust A donates a sum of INR 100,000/- to Trust B, in the books of account of Trust A while INR 100,000 will reflect as given or spent, only INR 85,000/- will qualify as ‘application of income for charitable purpose’.

This will prove to be a potential setback for purely grant making organizations unless of course they spend one hundred per cent of their total income every year and not avail benefit of stashing away fifteen per cent towards reserve after applying eighty five per cent of the income.

Minimal impact on implementing trusts and institutions

In our opinion, tax exempt charitable trusts and institutions that carry out all activities on their own will have nothing to worry. They can continue to apply at least eighty-five per cent of their total income (on overheads, programs and activities) and happily stash aside fifteen per cent every year as unrestricted reserves.

Here’s an example:

Let assume that ABC Trust/Society/Section 8 Company has total income of INR One crore

It spends INR ten lakhs on admin and overheads.

It spends INR seventy five lakhs on programs and activities on its own as per its objects.

Since it has spent eight five lakhs (i.e. at least eighty-five of its total income of INR One Crore) it can carry INR fifteen Lakhs (fifteen per cent of the total income) as unrestricted reserve to its Balance Sheet.

Thus, this particular amendment under Finance Act 2023 will have minimal effect on implementing agencies that carry out charitable activities on their own. The only indirect effect may be that some grant-making foundations may decide to become Implementing Foundations and as a consequence funding received through grants from grant-making foundations could suffer.

Effect on grant-making Foundations

Borrowing from the earlier example, let assume that ABC Foundation which could be either a Trust, Society or Section 8 Company has total income of INR One crore

It spends INR ten lakhs on admin and overheads.

It spends INR seventy five lakhs by giving grants to other charitable trusts, societies and section 8 companies.

Now, under the recent amendment only eighty five per cent of the seven five lakhs (i.e. INR 63.75 Lakhs) given by way of grant to other organizations will be considered as application of income for ABC Foundation.

Thus, INR 10 Lakhs plus INR 63.75 Lakhs comes to INR 73.75 Lakhs or INR 12.75 short of spending the mandatory eighty-five per cent.

So, what is the solution?

The INR 15 Lakhs that it could have stashed away as reserves must also be used.

It has two options with the INR fifteen lakhs:

1. Use on its own and still manage to take INR 2.25 Lakhs to its reserve fund;
2. Grant INR 15 Lakhs to other organizations and once again since only 85% of the INR 15 Lakhs or INR 12.75 will be considered as application of income it will still cover the shortfall in applying minimum 85% of its income during the fiscal year, but, leaving nothing for reserves.

Noshir H. Dadrawala