Discover in-depth insights into Sections 11, 12, 12A, 12AA, and 12AB of the Income Tax Act, 1961. Get expert guidance from trust tax consultant or CA about tax exemptions, registration, and compliance for charitable organizations.
Provisions for Trusts and Charitable Organizations under the Income Tax Act, 1961
The Income Tax Act, 1961, provides specific provisions for trusts and charitable organizations under Sections 11, 12, 12A, 12AA, and 12AB. These provisions govern their tax exemptions, registration requirements, and compliance obligations. Get expert guidance from trust tax consultant or CA , trust deed and tax exemptions, registration, and compliance for charitable organizations Below is an in-depth explanation of these provisions, conditions, and examples to clarify their application.
1. Meaning of “Charitable Purpose”
Under Section 2(15) of the Income Tax Act, the term “charitable purpose” encompasses activities that provide benefits to society. It includes:
- Relief of the Poor: Activities aimed at alleviating poverty by providing basic necessities such as food, clothing, shelter, or healthcare.
- Education: Establishing and maintaining educational institutions to promote literacy and skill development.
- Medical Relief: Offering free or subsidized medical treatment to the public.
- Preservation of the Environment: Efforts for conserving natural resources, including forests, wildlife, and water.
- Preservation of Monuments or Places of Historical or Artistic Interest: Maintenance and restoration of culturally significant sites.
- Advancement of General Public Utility: Activities serving a broader public interest, such as promoting sports, providing public infrastructure, or raising social awareness. However, if these activities involve business-like operations and generate income exceeding ₹20 lakhs in a financial year, such activities are subject to taxation.
2. Section 11: Exemption of Income from Property Held for Charitable or Religious Purposes
Section 11 provides exemptions on income derived by a trust, subject to compliance with specified conditions.
Key Conditions
- Application of Income:
- At least 85% of the income derived from property held under trust must be applied to charitable or religious purposes during the financial year.
- Example: If a trust earns ₹100 lakhs in a year, it must apply at least ₹85 lakhs towards its objectives (e.g., running schools, hospitals).
- Accumulation of Income:
- If the trust cannot apply 85% of its income in the same financial year, it can accumulate the unutilized amount by filing Form 10 with the Income Tax Department.
- The accumulated income must be used for specific objectives within five years.
- Example: A trust accumulating funds for constructing a hospital must utilize them within the specified period. Failure to do so will render the income taxable.
- Investment of Funds:
- The income must be invested in modes specified under Section 11(5), such as:
- Government securities.
- Fixed deposits in scheduled banks.
- Units of specified mutual funds.
- Example: A trust earning rental income of ₹20 lakhs must invest unspent funds in government-approved instruments to retain tax exemption.
Non-Application of Funds
Income is deemed not applied for charitable purposes if:
- It is used for purposes outside India without prior approval from the Central Board of Direct Taxes (CBDT).
- It benefits prohibited persons, such as trustees or their relatives, under Section 13(1).
3. Section 12: Income of Trusts or Institutions from Voluntary Contributions
Section 12 outlines how voluntary contributions are treated as income for trusts or institutions.
- Voluntary Contributions as Income:
- Contributions, including donations, are considered income unless they are designated as corpus donations.
- Example: A donation of ₹10 lakhs for running a school is taxable, whereas a specific donation of ₹5 lakhs for constructing a school building (corpus donation) is exempt.
- Corpus Donations:
- Corpus donations are contributions specifically earmarked for the corpus or capital fund of the trust.
- Such donations must only be used for long-term purposes and not for routine expenses.
4. Sections 12A, 12AA, and 12AB: Registration of Trusts
Trust registration is mandatory for availing tax exemptions under Sections 11 and 12. These sections detail the registration process and its requirements.
Registration Process
- Form 10A:
- For new trusts seeking registration.
- For existing trusts applying for renewal under Section 12AB.
- Form 10AB:
- For re-registration or converting provisional registration into regular registration.
Validity and Renewal
- Provisional Registration: Valid for three years.
- Regular Registration: Valid for five years.
- Renewal applications must be filed within six months of the expiry date.
Conditions for Registration
- The trust must adhere to its stated objectives.
- Activities must not benefit any individual trustee or related party.
- All income must be applied or accumulated for charitable purposes.
- The application must be filed within three months of the trust’s establishment.
Example
A trust established in April 2023 must apply for registration under Section 12AB by July 2023 using Form 10A.
5. Use of Trust Funds and Conditions for Denial of Exemption
Prohibited Use of Funds
- Private Benefits:
- Trust funds should not benefit trustees or their relatives.
- Example: Payment of a trustee’s personal expenses from the trust account violates conditions.
- Non-Charitable Activities:
- Funds used for purposes outside the trust’s objectives are not eligible for exemption.
- Example: A trust running a school cannot use funds to sponsor an unrelated business venture.
- Unutilized Income:
- Failure to apply or accumulate 85% of income will lead to taxation.
- Example: A trust earning ₹50 lakhs but applying only ₹40 lakhs will lose the exemption for the remaining ₹10 lakhs unless proper accumulation procedures are followed.
Taxability of Misused Funds
Income diverted for non-charitable purposes is subject to taxation at the maximum marginal rate.
6. Clarifications Under Section 11(1)
- Excess Application of Income:
- If a trust applies more than 85% of its income, the excess amount can be carried forward for future years.
- Example: A trust earning ₹80 lakhs but spending ₹90 lakhs on education can carry forward the excess ₹10 lakhs.
- Accumulation Rules:
- Income accumulation beyond five years is taxable unless Form 10 is filed and conditions are met.
Filing of Form 10
- The trust must file Form 10 to specify the purpose of accumulation.
- Failure to file Form 10 results in the accumulated income being taxed.
7. Practical Steps for Trusts
To ensure compliance and retain tax benefits, trusts should:
- Timely Filing:
- File Forms 10A and 10AB within prescribed timelines.
- Submit Form 10 for income accumulation.
- Investment Compliance:
- Invest unutilized funds in specified modes under Section 11(5).
- Maintain Proper Records:
- Maintain accurate records of income, expenditure, and investments to demonstrate compliance.
- Periodic Review:
- Regularly review the trust’s objectives and activities to ensure alignment with Section 11 requirements.
Conclusion
The provisions under Sections 11, 12, 12A, 12AA, and 12AB ensure that trusts and charitable organizations operate transparently and align their activities with public welfare. Adherence to these regulations allows trusts to avail tax exemptions while contributing to societal development. Trustees must remain vigilant in meeting compliance requirements, as non-compliance can lead to significant tax liabilities and loss of credibility. Get expert guidance from trust tax consultant or CA , trust deed and tax exemptions, registration, and compliance for charitable organizations.