Supreme Court of India’s verdict on eligibility of ‘educational institution’ for tax exemption u/s 10(23C)

The Supreme Court of India’s Bench of Chief Justice Uday Umesh Lalit, Justice S. Ravindra Bhat and Justice Pamidighantam Sri Narasimha has delivered a landmark judgement on 19^th October 2022 which will have far reaching consequences on ‘educational’ institutions claiming tax exemption under section 10(23C) of Income tax Act 1961.

The issues

The subject matter of the appeal before the Supreme Court was the rejection of the appellants claim for registration u/s 10(23C) as a fund or trust or institution or any university or other educational institution set up for the charitable purpose of education, under the Income Tax Act, 1961.

Additionally, the appellants were denied registration on the ground that they were not registered under the Andhra Pradesh Charitable and Hindu Religious Institutions and Endowments Act, 1987 as condition precedent for grant of approval.

What is education?

The Court has upheld that the sense in which the word “education” has been used in section 2(15) is the systematic instruction, schooling or training given to the young in preparation for the work of life. It also connotes the whole course of scholastic instruction which a person has received. The word “education”, in section 2(15), has not been used in that wide and extended sense according to which every acquisition of further knowledge constitutes education. What education connotes, in that clause, is the process of training and developing the knowledge, skill, mind and character of students by formal schooling.

The element of imparting education to students or the element of normal schooling where there are teachers and taught must be present so as to fall within the sweep of section 10(23C)(vi) of the Act. Such an institution may, incidentally, take up other activities for the benefit of students or in furtherance of their education. It may invest its funds or it may provide scholarships or other financial assistance which may be helpful to the students in pursuing their studies. Such incidental activities alone, in the absence of the actual activity of imparting education by normal schooling or normal conduct of classes, would not suffice for the purpose of qualifying the institution for the benefit of section 10(23C)(vi).

The Bench of the Supreme Court took the view that the subject of education is vast, even sublime. Yet, it is not the broad meaning of the expression which was involved in this particular case.

What is ‘education’ in the context of the Income Tax Act, is explained in Loka Shikshana Trust v. Commissioner of Income Tax in the following terms: “The sense in which the word “education” has been used in section 2(15) is the instruction, schooling or training given to the young in preparation for the work of life. It also connotes the whole course of scholastic instruction which a person has received. The word “education” has not been used in that wide and extended sense, according to which every acquisition of further knowledge constitutes education. According to this wide and extended sense, travelling is education, because as a result of travelling you acquire fresh knowledge. Likewise, if you read newspapers and magazines, see pictures, visit art galleries, museums and zoos, you thereby add to your knowledge. All this in a way is education in the great school of life. But that is not the sense in which the word “education” is used in clause (15) of section. What education connotes in that clause is the process of training and developing the knowledge, skill, mind and character of students by formal schooling.”

Thus, education i.e., imparting formal scholastic learning is what the IT Act provides for under the head of “charitable” purposes, under Section 2 (15).

The trust or educational institution, which seeks approval or exemption u/s 10(23C), should solely be concerned with education, or education related activities. If, incidentally, while carrying on those objectives, the trust earns profits, it has to maintain separate books of account. It is only in those circumstances that ‘business’ income can be permitted- provided, as stated earlier, that the activity is education, or relating to education.

Incidental business

What then is ‘incidental’ business activity in relation to education?

Imparting education through schools, colleges and other such institutions would be per se charity. Apart from that there could be activities incidental to providing education. One example is of text books.

However, where institutions provide their premises or infrastructure to other entities, trusts, societies etc., for the purposes of conducting workshops, seminars or even educational courses (which the concerned trust is not actually imparting) and outsiders are permitted to enroll in such seminars, workshops, courses etc., then the income derived from such activity cannot be characterized as part of education or ‘incidental’ to the imparting education. Such income can properly fall under the other heads of income. Providing hostel facilities to pupils would be an activity incidental to imparting education.

Supreme Court’s verdict

1. It is held that the requirement of the charitable institution, society or trust etc., to ‘solely’ engage itself in education or educational activities, and not engage in any activity of profit, means that such institutions cannot have objects which are unrelated to education. In other words, all objects of the society, trust etc., must relate to imparting education or be in relation to educational activities.
2. Where the objective of the institution appears to be profit-oriented, such institutions would not be entitled to approval under Section 10(23C) of the Income Tax Act. At the same time, where surplus accrues in a given year or set of years per se, it is not a bar, provided such surplus is generated in the course of providing education or educational activities.
3. The seventh proviso to Section 10(23C), as well as Section 11(4A) refers to profits which may be ‘incidentally’ generated or earned by the charitable institution. In the present case, the same is applicable only to those institutions which impart education or are engaged in activities connected to education.
4. The reference to ‘business’ and ‘profits’ in the seventh proviso to Section 10(23C) and Section 11(4A) merely means that the profits of business which is ‘incidental’ to educational activity i.e., relating to education such as sale of text books, providing school bus facilities, hostel facilities, etc.
5. The reasoning and conclusions in American Hotel and Queen’s Education Society so far as they pertain to the interpretation of expression ‘solely’ are disapproved. The earlier judgments are accordingly overruled to that extent.
6. While considering applications for approval under Section 10(23C), the Commissioner or the concerned authority as the case may be, under the second proviso is not bound to examine only the objects of the institution. To ascertain the genuineness of the institution and the manner of its functioning, the Commissioner or other authority is free to call for the audited accounts or other such documents for recording satisfaction where the society, trust or institution genuinely seeks to achieve the objects which it professes. The observations made in American Hotel suggest that the Commissioner could not call for the records and that the examination of such accounts would be at the stage of assessment. Whilst that reasoning undoubtedly applies to newly set up charities, trusts etc., the proviso under Section 10(23C) is not confined to newly set up trusts – it also applies to existing ones. The Commissioner or other authority is not in any manner constrained from examining accounts and other related documents to see the pattern of income and expenditure.
7. It is held that wherever registration of trust or charities is obligatory under state or local laws, the concerned trust, society, other institution etc. seeking approval under Section 10(23C) should also comply with provisions of such state laws. This would enable the Commissioner or concerned authority to ascertain the genuineness of the trust, society etc. This reasoning is reinforced by the recent insertion of another proviso of Section 10(23C) with effect from 01.04.2021.