TAXATION OF CHARITABLE TRUSTS
An analysis of provisions of section 10(23C)(vi) of Income-tax Act Governing Exemption of Income of Educational Institutions
This write-up makes an analysis of provisions of section 10(23C)(vi) of the Income-tax Act, 1961 governing exemption of income of educational institutions.
1. Recently, it is being observed that department is rejecting/ withdrawing approvals of educational institutions/hospitals which are required under section 10(23C)(vi)/(via) of the Income-tax Act, 1961 (‘the Act’). This is generally being done on the ground that these institutions are being run for profit. Though it may be true that in some of the cases view of the department may be correct, yet in most of the cases rejection of approval is not correct and is creating hardship. Keeping in view this background, an attempt is being made herein to analyse the provisions of the Act and the case law. The analysis is being done with reference to the provisions applicable to educational institutions. The legal position is same in respect of hospitals/medical institutions also.
2. An Analysis of Legal provisions
- Section 2(15) of the Act defines the term ‘charitable purpose’ and it, inter alia, includes education.
- Up to the assessment year 1998-99, section 10(22), was providing exemption from taxability of income of an educational institution. It was providing that income was exempt of an educational institution if it was existing solely for the educational purposes and not for the purposes of profit. Section 10(22) was providing no condition at all for granting exemption to an educational institution. In other words, there was no condition of spending of amount. There was no monitoring by any Government authority. Not even return of income was required to be filed. Even the income derived from any other source by an educational institution was exempt and same was required to be spent for educational purposes. Conditions provided in sections 11 and 13 of the Act were also having no application. Reference in this regard can be made to circulars of CBDT Nos. 712, dated July 25, 1995, 372, dated December 28, 1983 and 772, dated December 23, 1998.
- Section 10(23C) was amended with effect from April 1, 1999 simultaneously to omission of section 10(22) sub-clauses (iiiab) and (iiiad) of section 10(23C), however, provided exemption to educational institutions in the same manner as was available earlier under section 10(22). Above sub-clauses were applicable to educational institutions substantially financed by the Government and to educational institutions having annual receipts up to Rs. 1 crore. In respect of other educational institutions, however, exemption was available under sub-clause (vi) of section 10(23C). With reference to above sub-clause, certain conditions were provided with a view to monitor activities of such educational institutions. Second proviso to above section specifically provided for power of the Central Government to call for any information in order to satisfy itself about the genuineness of the activities of the educational institution. In this regard, reference can be made to circular of CBDT No. 779, dated September 14, 1999. With a view to keep monitoring, it was required that approval of the prescribed authority is to be obtained. In order to avail exemption by an educational institution under section 10(23C)(vi), following conditions are provided :—
(a) educational institution exists solely for educational purposes;
(b) it is not for purposes of profit; and
(c) it is approved by the prescribed authority.
Further, provisos to above section provide certain conditions, such as, income is to be applied up to 85 per cent of receipts towards educational purposes; in case accumulation is to be made in excess of 15 per cent, same would be only for a period of five years; investment of funds has to be in the modes prescribed in section 11(5); and books of account have to be maintained and audited and also report in the prescribed proforma is to be submitted with the return of income.
Section 11 provides for exemption of income of a charitable institution. These are general provisions applicable to every charitable institution, including an educational institution. Conditions provided for exemption under section 11 are that 85 per cent of receipt should be spent for charitable purposes, accumulation in excess of 15 per cent has to be made for the purpose of the institution for a period of five years, investment has to be made in the modes prescribed in section 11(5); and accounts have to be audited and report has to be submitted in the prescribed form. Section 13 further provides that exemption under section 11 will not be available in case any part of income has been used for the personal purpose or benefit of a person having interest in the activities of the charitable society including its founder, substantial contributor, trustees, etc.
- On the basis of above analysis of provisions of the Act governing exemption of income of a charitable institution and of educational institution, it is stated that after amendment of section 10(23C), by and large, conditions prescribed for an educational institution referred to in sub-clause (vi) of above section are the same as are applicable to a charitable institution in a normal course. Conditions provided under section 13, however, are still not specifically applicable to an educational institution, if covered under the above sub-clause.
- Further, it can be observed on the basis of above analysis that the intention of the Government is always there to grant blanket exemption to income of an educational institution if it is solely for the purpose of carrying of education activities and not for the purpose of profit. While granting approval, a prescribed authority is also required to only satisfy itself to the genuineness of its activities. Section 10(23C)(vi), however, further provides for application of its income to the extent of 85 per cent, which condition was earlier not existing in section 10(22).
3. Conditions to be satisfied by Educational Institutions
- As has been shown hereinabove with reference to analysis of relevant provisions of the Act, in order to avail exemption by an educational institution under section 10(23C)(vi) it should be solely for the purpose of education and it should apply at least 85 per cent of its receipts during the year for educational purposes and it should be not for the purpose of profit.
- In view of above, it is necessary to examine with reference to the case law and clarification given by the CBDT, the scope and meaning of following terms :—
(ii) Solely for the purpose of education.
(iii) Not for the purpose of profit.
(iv) Application of income.
The term ‘Education’ has not been specifically defined in the Act. Accordingly, common meaning of above term has been adopted for the purpose of granting exemption to educational institutions. Commonly, it has been understood that an institution imparting education by way of classroom courses in schools, colleges, etc., including courses for professionals, lectureships, scholarships, fellowships and readerships and also grants in respect of researches, prized essays and other academic rewards is for promotion of education. The Apex Court in Sole Trustee, Loka Shikshana Trust v. CIT  101 ITR 234 enunciated the following principles while interpreting the expression ‘education’ in section 2(15).
“The sense in which the word ‘education’ has been used in section 2(15) in the systematic instruction, schooling or training given to the young is 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. Again, when you grow up and have dealings with other people, some of whom are not straight, you learn by experience and thus add to your knowledge of the ways of the world. If you are not careful, your wallet is liable to be stolen or you are liable to be cheated by some unscrupulous person. The thief who removes your wallet and the swindler who cheats you teach you a lesson and in the process make you wiser though poorer. If you visit a night club, you get acquainted with and add to your knowledge about some of the not much revealed realities and mysteries of life. 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 2. What education connotes in that clause is the process of training and developing the knowledge, skill, mind and character of students by normal schooling.” (p. 241)
Societies set up for extending financial assistance to educational institutions have also been considered for the purpose of education. Granting of loans, scholarships and grants for purchase of books and other educational requisites by a society have also been considered for educational purposes.
- The term ‘solely for the purpose of education’ has also come up for discussion before the Courts in certain cases. In this regard also, the Courts have taken a common man’s approach depending upon the facts and circumstances of each case and has taken a view that wherever receipts/income are being spent only for educational purposes, society is solely for educational purposes. In a case, however, only a small portion of income of trust was spent for educational purpose leaving a huge portion thereof for other charitable purposes and a part of income was also spent on religious purposes, therein it was held that trust was not existing solely for educational purpose so as to qualify for exemption under section 10(22) - Sri Rao Bahudur A.K.D. Dharmaraja Education Charity Trust v. CIT  182 ITR 80/ 47 Taxman 441 (Mad.). In another case where memorandum of an educational society provided for managing other allied or ancillary institutions also including an automobile workshop, driving school and printing press, etc., and it was provided that, if need be these ancillary institutions can be run on commercial basis in order to make them self-supporting, it was held by the Madras High Court that the clause of the memorandum providing to run these ancillary institutions on commercial basis was only to make them self supporting and the intention was to run them on a no profit no loss basis and, accordingly, this excluded the idea of any intention to earn profit by establishing such institution and, therefore, the society was solely for the purpose of education and not for the purpose of earning profit. CIT v. Bimetal Bearings Ltd.  152 ITR 85/ 16 Taxman 235 (Mad.). Accordingly, it is to be seen with reference to facts of each case that whether institution is solely for educational purposes or not. In the case of CIT v. Vidya Vikas Vihar  265 ITR 489 (Bom.), it was held that if an educational institution as per its objects undertakes construction of houses for poor out of its surplus income and profit earned therefrom is also to be used solely for the purpose of promoting education, it cannot be said that institution is not solely for the purpose of education and, accordingly, it was held to be eligible for exemption.
- The term “not for the purpose of profit” has also been considered by the Courts in certain cases. It has been observed that overall facts and circumstances of each case have to be considered in order to decide whether institution is for the purpose of profit or not. In the case of Ereaut v. Girl’s Public Day School Trust Ltd.  15 TC 529 (HL) inspite of the facts that the society had issued preference shares to generate funds for the purpose of establishing the school and dividend was paid on preference shares, the House of Lords came to the conclusion that issue of preference shares and payment of dividend was only a method of raising funds for the purpose of funding the charitable religious organization. The dominant purpose of the institution was to run school as a charity. The purpose of making a profit was completely a subsidiary purpose. Accordingly, the institution was not for the purpose of making profit. Applying the above test, it has been held by the Andhra Pradesh High Court in the case of Governing Body of Rangaraya Medical College v. ITO  117 ITR 284, 287 that where no finding was recorded that any surplus arising from the operations of the institution was distributed by way of profit to any individuals, the assessee-trust, the sole object of which was managing and maintaining the medical college, was an educational institution without any motive of private or personal profit. It was also observed that “.....Merely because certain surplus arises from its operations, it cannot be held that the institution is being run for the purpose of profit so long as no person or individual is entitled to any portion of the said profit and the said profit is used for the purposes and for the promotion of the objects of the institution......” It was further held in the above case that merely because immovable properties had not been formally vested in the society, it would not be in any manner, deprived of its character of an educational institution existing solely for the purpose of educational purpose. However, in the case of Dharmaraja Educational Charity Trust (supra), it has been held that where only a small portion has been spent for charitable purpose it would not qualify for exemption as educational institution under section 10(22). Further, in the case of CIT v. Delhi Kannada Education Society  246 ITR 731/113 Taxman 503, the Delhi High Court held that merely for the reason that middle and higher secondary schools were being run at profit so as to subsidise the primary school it would not lose the exemption. Further, it has been held that income from dividend CIT v. A.M.M. Arunachalam Society  243 ITR 229/ 128 Taxman 285 (Mad.) and income from manufacture of furniture and stone crushing CIT v. Lal Bahadur Shastry Education Society  252 ITR 837/118 Taxman 374 (Raj.) would be exempt when societies are engaged in the activities of education and no profit is being distributed to any individual. Income from all the sources received by the assessee is exempt, provided the assessee is an educational institution existing solely for educational purposes - A.M.M. Arunachalam Educational Society’s case (supra); CIT v. Sree Narayana Chandrika Trust  212 ITR 456/81 Taxman 199 (Ker.); CIT v. Kshatriya Girls Schools Managing Board  245 ITR 170/ 101 Taxman 555 (Mad.); CIT v. Economic Entrepreneurship Development Foundation  188 ITR 540/59 Taxman 156 (Cal.); Director of Income-tax (Exemptions) v. A.M.M. Hospital & Medical Benefit Society  262 ITR 241/ 140 Taxman 81 (Mad.) and Trustees of Vanita Vishram v. CIT  280 ITR 345/ 148 Taxman 546 (Bom.).
- The term ‘application of income’ has also been repeatedly considered by the Courts and it has held by the Courts that application of income need not be equated with spending :—
- CIT v. Trustees of H.E.H. the Nizam’s Charitable Trust  131 ITR 497/7 Taxman 178 (AP).
- CIT v. Radhaswami Satsang Sabha  25 ITR 472 (All.).
- CIT v. St. George Forane Church  170 ITR 62/36 Taxman 42 (Ker.).
Expenditure incurred for capital purposes including construction of a building for charitable purpose and also repayment of loan borrowed for the purpose of construction of building would also be considered as application of income for charitable purposes and would, accordingly, qualify for exemption;
- Satya Vijay Patel Hindu Dharamshala Trust v. CIT  86 ITR 683 (Guj.)
- CIT v. St. George Forane Church  170 ITR 62/36 Taxman 42 (Ker.)
- CIT v. Janmabhumi Press Trust  242 ITR 457 (Kar.)
- CIT v. Kannika Parameswari Devasthanam & Charities  133 ITR 779 (Mad.)
In this regard reference can also be made to case of CIT v. Kamla Town Trust  217 ITR 699/84 Taxman 248 in which case the dispute travelled up to the Supreme Court on the issue whether a trust with the object of constructing residential quarters for poor workers was having object of general public utility. It was, however, an accepted position that construction of quarters was application of income.
4. In connection with exemption of income in the cases of educational institutions broadly following controversies have arisen for the reason that exemption has been refused by the Assessing Officer’s or approval required under section 10(23C)(vi) has been rejected on the basis of these contentions :—
(a) Exemption is available to educational institution and not to the trust/society running the educational institution.
(b) Objects of trust/society include other objects also and, therefore, it is not solely for educational purposes.
(c) Activities have resulted in surplus and, therefore, it cannot be said that society is being run not for the purpose of profit.
These issues have arisen for consideration before the Courts in a number of cases and the Courts have been taking the view that exemption is available in respect of income of educational institution and it is immaterial whether exemption is being claimed in the assessment of educational institution, i.e., school or college or in case of a society running the educational institution. Similarly, as regards second controversy, the Courts have taken the view that the educational institution for which exemption is being claimed should be solely for the purpose of education. It may be that there are other charitable objects also being carried on by the same assessee. In such a case, exemption is not available in respect of receipts from other objects. It has also been the view of the Courts that it would make no difference if there are objects other than education also in the memorandum, but, in fact, only object of education is being pursued by the assessee-society. Similarly, as regards the third controversy regarding surplus of income also, the Courts in number of decisions have observed that exemption will not be denied simply for the reason that there has been surplus from the running of educational institution in case same is used for educational purposes only. In fact, the Supreme Court in the case of Addl. CIT v.Surat Art Silk & Cloth Mfrs. Association  121 ITR 1, 26/ 2 Taxman 501 observed that “.....where the predominant object of the activity is to carry out the charitable purpose and not to earn profit, it would not lose its character of a charitable purpose merely because some profit arises from the activity. The exclusionary clause does not require that the activity must be carried on in such a manner that it does not result in any profit. It would indeed be difficult for persons in charge of a trust or institution to so carry on the activity that the expenditures balances the income and there is no resulting profit. That would not only be difficult of practical realization but would also reflect unsound principle of management......” Further, the Hon’ble Supreme Court in the case of Aditanar Educational Institution v. Addl. CIT  224 ITR 310/90 Taxman 528, 534 observed that “......We may state that the language of section 10(22) is plain and clear and the availability of the exemption should be evaluated each year to find out whether the institution existed during the relevant year solely for educational purposes and not for the purposes of profit. After meeting the expenditure, if any surplus results incidentally from the activities lawfully carried on by the educational institution, it will not cease to be one existing solely for educational purposes, since the object is not one to make profit. The decisive or acid test is whether on an overall view of the matter, the object is to make profit.....” In fact, all the three legal controversies mentioned hereinabove were elaborately discussed by the High Court of Calcutta in the case of Birla Vidhya Vihar Trust v.CIT  136 ITR 445/ 7 Taxman 391. In the above case, the High Court had also reproduced a circular of the CBDT No. F. No. 194/16-17II(AI), wherein the CBDT had, in fact, expressed its view in respect of all the three legal controversies mentioned above after taking note of the fact that a number of instances have come to the notice of the Board that exemptions were not being allowed to educational institutions and hospitals under sections 10(22) and 10(22A). It was clarified that an educational institution may be owned by the trust or society. Further, where all the objects of the trust are educational and the surplus is used only for educational purposes, it cannot be said that institution was not existing solely for educational purposes and for the purpose of profit. Further, it was stated that if surplus can be used for non-educational purposes, then only it could be said that institution is not existing solely for educational purposes. If profit of an educational institution can be diverted for the personal use of the proprietor, then income of the educational institution will be subject to tax. In view of aforesaid circular of the CBDT as well as large number of the Courts’ decision on the subject including the decisions of the Supreme Court, these legal controversies could have been settled and no further dispute ought to have been raised on these grounds. It has, however, not happened so and controversies are being raised even now. At times even the counsels representing the department before the Courts with a view to pursue the contention taken by the Assessing Officer do not provide desirable assistance to the Courts and decisions in such circumstances may be rendered by the Courts without correctly noticing the correct legal position. One such example, which has created a serious controversy/difficulty in the matters of charitable institutions is the decision of the Uttarakhand High Court in the case of CIT v. Queens’ Educational Society and St. Paul Sr. Secondary School  319 ITR 160/177 Taxman 326. In the above case the assessee-societies were running educational institutions and had claimed exemption under section 10(23C)(iiiad). The Assessing Officer rejected the exemption on the ground that there were surpluses from gross receipts though after taking into consideration expenditure on fixed assets there were losses in some of the years and in some of the years there were minor surpluses. The Commissioner (Appeals) as well as the Tribunal upheld the claim of the assessee societies. The High Court, however, set aside the order of the Tribunal and affirmed the order of the Assessing Officer. The High Court while rendering the decision had not noticed that there was no condition for applying a particular percentage of income under section 10(23C)(iiiad). It has already been held in various cases that in order to avail exemption under section 10(22), the only requirement has been that the educational institution should be solely for the educational purposes and not for the purpose of profit. As mentioned hereinabove, it has also been held by the Courts, including the Supreme Court that in case whole of the income is being applied for educational purposes only and no amount is diverted for personal benefit of any person, it cannot be said that institution was being run for the purpose of making profit. It was also not noticed that as per general provisions of section 11 as well as provisions of section 10(23C)(vi) also, accumulation up to 15 per cent of gross receipts is permitted and even accumulation in excess of above limit can be made for a limited period of five years (earlier ten years). Further, expenditure incurred on purchase of capital asset is also an application of income. After the aforesaid decision of the Uttarakhand High Court, the department started rejecting the approvals under section 10(23C)(vi) and also rejecting the claims for exemption of income in assessments of educational institutions even if surplus of income over expenditure has been within the limit of 15 per cent. The CBDT ought to have appreciated the correct position and should have issued clarification to its officers so as to avoid harassment to educational institutions. Number of cases by way of writ petitions had to be filed before the Courts by such educational institutions and the Courts have been burdened by such cases. Recently, the High Court of Punjab and Haryana vide its decision dated 29-1-2010 disposed of 21 writ petitions, which were filed against similar orders of the Chief Commissioners of Chandigarh and Ludhiana passed on being inspired by the view taken by the Uttarakhand High Court. The Punjab & Haryana High Court has discussed quite in detail the legal position and whole case law on the subject and has after dissenting with the view expressed by the Uttarakhand High Court summarized the legal principles in regard to the matter as have been laid down by the Supreme Court in earlier decisions. Accordingly, orders passed by the Chief Commissioners were quashed with the direction to pass fresh orders after taking into consideration propositions of law culled out by the High Court in its order.
In regard to the matter, it would also be relevant to refer to the decision of the Supreme Court in the case of American Hotel & Lodging Association, Educational Institute v. CBDT  301 ITR 86/170 Taxman 306. In the above case, the issue that came up before the Supreme Court was also regarding approval of an educational institution under section 10(23C)(vi). The Supreme Court analyzed the relevant provisions quite in detail and held that at the stage of granting prior approval scope of the authority is restricted to examine whether the institution has the necessary stipulation for the compliance of the conditions. Actual compliance of the conditions has to be examined subsequently. Accordingly, at the time of granting the approval, the authority has to satisfy that institution existed solely for educational purposes and not for profit. The questions regarding application of income, accumulation of income or investments in specified assets, etc., have to be examined at the time of assessment and in case the institutions do not fulfil the condition, exemption can be denied and approval earlier granted can be withdrawn. In the light of aforesaid decision of the Supreme Court also, approval in terms of section 10(23C)(vi) should be granted considering the objects of the institutions.
It may be added that legal position discussed hereinabove in the context of educational institutions is equally applicable in respect of hospitals and other institutions carrying on activities solely for philanthropic purposes, to which institutions provisions of section 10(23C)(iiiae) or 10(23C)(via) are applicable.
5. In conclusion, it is submitted that the revenue should not raise controversies, which have already been settled by the Courts and CBDT should issue necessary instructions in regard to the matter so as to avoid harassment to the assessees and also to develop confidence of the assessees in the department. The legal position needs to be settled in the interest of encouraging charitable activities also.