Only amounts ‘spent’ will qualify as ‘application of income’
Public memory is short and while the current focus is on the proposed Finance Bill 2023 let us not lose track of what changed under Finance Act 2022 and is applicable for the current fiscal year ending on 31st March 2023.
As we are aware, in any financial year a trust or institution is required to apply at least eighty-five per cent of its income. The term ‘application’ means what is spent or paid. In other words, income of a trust or institution shall be considered as ‘applied’, only when actually paid or spent.
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.
Cash system recommended
Cash system of accounting lets an organisation record income and expenses only when cash is actually received or paid. Accrual accounting involves tracking income and expenses as they are incurred (i.e., when an invoice is sent or a bill received) instead of when money actually changes hands.
According to the amendment under Finance Act 2022, ‘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.