Supreme Court clarifies tax exemption limits for charitable trusts under Section 11 (of Income Tax Act, 1961)

Case Name:

Commissioner of Income Tax vs. G.R. Govindarajulu & Sons

Civil Appeal No(s).4916/2006

Key Takeaways:

- Charitable trusts can claim full exemption on income actually spent for charitable purposes in a given year under Section 11(1)(a) (of Income Tax Act, 1961).

- They can also set apart and accumulate up to 25% of remaining income for spending in the next year, which is exempt from tax.

- The option to accumulate income must be exercised in the return itself before filing.

- Any accumulated income above 25% of total income is taxable in that year.

- The court clarified the correct interpretation of Section 11 (of Income Tax Act, 1961) provisions regarding exemption limits.

Issue:

What is the permissible extent of tax exemption for a charitable trust that sets apart income for spending in the next year, as per Section 11 (of Income Tax Act, 1961)?

Facts:

- The respondent trust (G.R. Govindarajulu & Sons) filed its return for AY 1994-95 declaring nil taxable income.

- It showed a total income of Rs. 99,41,221 including interest receipts, rental income etc.

- Out of this, Rs. 47,27,533 was spent on the trust's objects in that year.

- The trust set apart Rs. 32 lacs to be spent for charitable purposes in the next year.

- The Assessing Officer denied exemption for the Rs. 32 lacs set apart, as the option was not properly exercised before filing the return.

- The CIT(A), ITAT and High Court allowed the exemption, accepting that the option was validly exercised in the return.

Arguments:

- Income Tax Department's argument:

The trust did not validly exercise the option to set apart income before filing the return, so no exemption can be allowed on the Rs. 32 lacs.

- Trust's argument:

By mentioning the Rs. 32 lacs set apart in the return itself, the trust had validly exercised the option under Section 11 (of Income Tax Act, 1961), so exemption should be granted.

Key Legal Precedents:

- Section 11(1)(a) (of Income Tax Act, 1961):

Allows full exemption on income applied for charitable purposes in that year.

- Section 11(1)(a) (of Income Tax Act, 1961):

Also allows accumulating up to 25% of remaining income for spending next year, which is exempt.

- Additional Commissioner of Income Tax vs. A.L.N. Rao [1995 (6) SCC 625]: Explained the provisions of Section 11(1)(a) (of Income Tax Act, 1961) and 11(2) (of Income Tax Act, 1961).

Judgement:

The Supreme Court allowed the appeal by the Income Tax Department in part:

1) It agreed with the High Court that exercising the option to set apart income in the return itself is valid under Section 11 (of Income Tax Act, 1961).

2) However, it held that the CIT(A) and High Court erred in allowing full exemption on the Rs. 32 lacs set apart.

3) As per Section 11(1)(a) (of Income Tax Act, 1961), only up to 25% of total income (Rs. 24,85,305 in this case) could be allowed as exempt accumulation.

4) The court set aside the High Court order and directed the Assessing Officer to recompute the taxable income as per this judgement

FAQs:

Q1: What was the main issue decided by the Supreme Court?

A1: The court clarified the correct interpretation of Section 11 (of Income Tax Act, 1961) provisions regarding the extent of tax exemption allowed to charitable trusts on income set apart for spending in the next year.

Q2: Why did the court partially allow the Income Tax Department's appeal?

A2: While agreeing that the option to set apart income can be exercised in the return, the court held that full exemption cannot be allowed on amounts exceeding 25% of total income as per Section 11(1)(a) (of Income Tax Act, 1961).

Q3: What is the significance of this judgement?

A3: This judgement provides clarity on the exemption limits for charitable trusts under Section 11 (of Income Tax Act, 1961). It prevents trusts from claiming full exemption on unlimited amounts of income set apart, ensuring correct tax treatment.

Q4: Does this affect the exemption on income actually spent for charitable purposes?

A4: No, this judgement does not impact the full exemption available under Section 11(1)(a) (of Income Tax Act, 1961) on income that is actually applied and spent for charitable purposes in that year.

The respondent-assessee is a Public Charitable Trust. It filed its return for the Assessment Year 1994-95 declaring 'nil' taxable income. In the summary of total income filed by the assessee it had mentioned gross income

for the year in the sum of Rs. 99,41,221/- which represented interest receipts, rental income, bus collections, miscellaneous receipts and surplus in GRS hotel. It was further stated that out of this income the assessee had

applied and spent a sum of Rs. 47,27,533/- for the objects of the Trust. In the return it was also stated that it was setting apart a sum of Rs. 32 Lacs to be spent for charitable purposes in the following year. On that basis the

assessee claimed that it was entitled to have the deduction of the entire amount and for the purpose of taxation the income was 'nil' under Section 11 (of Income Tax Act, 1961) (hereinafter referred to as ‘the Act’). Before we proceed further and discuss as to how the Assessing Officer made the assessment, it would be necessary to take note of the provisions of Section 11 (of Income Tax Act, 1961) which are relevant for our purpose.

“11. (1) Subject to the provisions of sections 60 to 63, the following income shall not be included in the total income of the previous year of the person in receipt of the income—

[(a) income derived from property held under trust wholly for charitable or

religious purposes, to the extent to which such income is applied to such purposes in India; and, where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of [fifteen] per cent of the income from such property;

Explanation.—For the purposes of clauses (a) and (b),— (1) in computing the

[fifteen] per cent of the income which may be accumulated or set apart, any such voluntary contributions as are referred to in section 12 (of Income Tax Act, 1961) shall be deemed to be part of the income;

(2) if, in the previous year, the income applied to charitable or religious purposes in India falls short of [eighty-five] per cent of the income derived during that year from property held under trust, or, as the case may be, held under trust in part, by any amount—

(i) for the reason that the whole or any part of the income has not been received during that year, or

(ii) for any other reason,

(2) [Where [eighty-five] per cent of the income referred to in clause (a) or clause (b) of sub-section (1) read with the Explanation to that sub-section is not applied, or is not deemed to have been applied, to charitable or religious purposes in India during the previous year but is accumulated or set apart, either in whole or in part, for application to such purposes in India, such income so accumulated or set apart shall not be included in the total income of the previous year of the person in receipt of the income, provided the following conditions are complied with, namely:—]

(a) such person specifies, by notice in writing given to the [Assessing] Officer in the prescribed manner, the purpose for which the income is being accumulated or set apart and the period for which the income is to be accumulated or set apart, which shall in no case exceed ten years;

[(b) the money so accumulated or set apart is invested or deposited in the forms or modes specified in sub-section (5)]:]”

This provision has come up for interpretation in Additional Commissioner of

Income Tax vs. A.L.N. Rao [1995 (6) SCC 625] and the legal position contained therein was explained in the following manner:

“A mere look at Section 11(1)(a) (of Income Tax Act, 1961) as it stood at the relevant time clearly shows that out of total income accruing to a trust in the previous year from property held by i wholly for charitable or religious purpose, to the extent the income is applied for such religious or charitable purpose, the same will get out of the tax net but so far as the income which is not so applied during the previous year is concerned at least 25% of such income or

Rs.10,000/- whichever is higher, will be permitted to be accumulated for charitable or religious purpose and will also get exempted from the tax net. Then follows sub-section (2) which seeks to lift the restriction or the ceiling imposed on such exempted accumulated income during the previous year and also brings such further accumulated income out of the tax net if the conditions laid down by sub-section (2) of Section 11 (of Income Tax Act, 1961) are fulfilled meaning thereby the money so accumulated is set apart to be invested in the Government securities etc. as laid down by clause (b) of sub-section (2) of

Section 11 (of Income Tax Act, 1961) apart from the procedure laid down by clause (a) of Section 11(2) (of Income Tax Act, 1961) being followed by the assessee-trust. To highlight this point we may take an illustration. If Rs.1,00,000/- are earned as the total income of he previous year by the trust from property held by it wholly for charitable and religious purposes and if Rs. 20,000/- are actually applied during the previous year by the said trust to such charitable or religious purposes the income of Rs.20,000/- will get exempted from being considered for the purpose of income tax under first part of Section 11(1) (of Income Tax Act, 1961). So far as the remaining Rs.80,000/- are concerned if they could not be actually applied for such religious or charitable purposes during the previous year then as per Section 11(1)(a) (of Income Tax Act, 1961) at least 25% of such total income from property or Rs.10,000/- whichever is higher will also earn exemption from being considered as income for the purpose of income tax, that is, Rs.25,000/- will thus get excluded from the tax net. Thus out of the total income of Rs.1,00,000/- which has accrued to the trust Rs.25,000/- will earn exemption from payment of income tax as per Section 11(1)(a) (of Income Tax Act, 1961) second part. Then follows sub-section (2) which states that the ceiling or the limit or the restriction accumulation of income to the extent of 25% of the income or

Rs.10,000/-, whichever is higher for earning income tax exemption as engrafted under Section 11(1)(a) (of Income Tax Act, 1961) will get lifted if the money so

accumulated is invested as laid down by Section 11(2)(b) (of Income Tax Act, 1961) meaning thereby out of the total accumulated income of Rs.80,000/- accruing during previous year and which could not be spent for charitable or religious purposes by

the Trust balance of Rs.55,000/- if invested as laid down by sub-section (2) of Section 11 (of Income Tax Act, 1961) will also get excluded from the tax net. But for such investment and if Section 11(1) (of Income Tax Act, 1961) alone had applied Rs.55,000/- being he balance of accumulated income would have been covered by the tax net.

Learned counsel for the Revenue submitted that the investment as contemplated by sub-section (2) (b) of Section 11 (of Income Tax Act, 1961) must be investment of all accumulated income in Government securities etc., namely, 100% of the accumulated income and not only 75% thereof. And if that is not done then only the invested accumulated income to the extent of 75% will get excluded from income tax assessment. But so far the remaining 25% of the accumulated income is concerned it will not earn such exemption. It is difficult to appreciate this contention. The reason is obvious. Section 11 (of Income Tax Act, 1961), subsection (1) (a) operates on its own. By its operation two types of income earned by the trust during the previous year from its properties are given exemption from income tax, (i) that part of the income of previous year which is actually spent for charitable or religious purposes in that year; and (ii) out of the unspent accumulated income of the previous year 25% of such total property income or Rs.10,000/- whichever is higher can be permitted to be accumulated by the Trust, remarked for such charitable or religious purposes. Such 25% of the income or Rs.10,000/- whichever is higher will also get exempted from income tax. That exhausts the operation of Section 11(1)(a) (of Income Tax Act, 1961). Then follows sub-section (2) which naturally deals with the question of investment of the balance of accumulated income which has still not earned exemption under sub-section (1) (a). So far as that balance of accumulated income is concerned, that also can earn exemption from income tax meaning thereby the ceiling or the limit of exemption of accumulated income from tax as imposed by sub-section (1) (a) of Section 11 (of Income Tax Act, 1961) would get lifted if additional accumulated income beyond 25% or Rs.10,000/- whichever is higher, as the case may be, is invested as laid by Section 11(2) (of Income Tax Act, 1961) after following the procedure laid down therein. Therefore, sub-section (2) only will have to operate qua the balance of 75% of the total income of the previous year or income beyond Rs.10,000/- whichever is higher which has not got the benefit of tax exemption under sub-section (1) (a) of Section 11 (of Income Tax Act, 1961). If learned counsel for the Revenue is right and if 100% of the accumulated income of the previous year is to be invested under sub-section (2) of Section 11 (of Income Tax Act, 1961) to get exemption from income tax then the ceiling of 25% or Rs.10,000/- whichever is higher, which is available for accumulation of income of the previous year for the Trust to earn exemption from income tax as laid by Section 11(1)(a) (of Income Tax Act, 1961) would be rendered redundant and the said exemption provision would become otiose. It has to be kept in view that out of the accumulated income of the previous year an amount of Rs.10,000/- or 25% of the total income from property, whichever is higher, is given exemption from income tax by Section 11(1)(a) (of Income Tax Act, 1961) itself. That exemption is unfettered and not subject to any conditions. In other words it is an absolute exemption. If subsection (2) is so read as suggested by the learned counsel for the Revenue, what is an absolute and unfettered exemption of accumulated income as guaranteed by Section 11(1)(a) (of Income Tax Act, 1961) would become a restricted exemption as laid down by Section 11(2) (of Income Tax Act, 1961). Section 11(2) (of Income Tax Act, 1961) does not operate to whittle down or to cut

across the exemption provisions contained in Section 11(1)(a) (of Income Tax Act, 1961) so far as such accumulated income of the previous year is concerned. It has also to be appreciated that sub-section (2) of Section 11 (of Income Tax Act, 1961) does not contain any non obstante clause like " notwithstanding the provisions of sub-section (1)".

Consequently it must be held that Section 11(1)(a) (of Income Tax Act, 1961) has full play and if

still any accumulated income of the previous year is left to be dealt with and to be considered for the purpose of income tax exemption, sub-section (2) of Section 11 (of Income Tax Act, 1961) can be pressed into service and if it is complied with

then such additional accumulated income beyond 25% or Rs.10,000/-, whichever is higher, can also earn exemption from income tax in compliance which the conditions laid down by sub-section (2) of Section 11 (of Income Tax Act, 1961). It is true that

sub-section (2) of Section 11 (of Income Tax Act, 1961) has not clearly mentioned the extent of the accumulated income which is to be invested. But on a conjoint reading of the aforesaid two provisions of Sections 11(1) and 11(2) this is the only

result which can follow. It is also to be kept in view that under the earlier Income Tax Act of 1922 exemption was available to charitable trusts without any restriction upon the accumulated income. There was a change in this respect under the present Act of 1961. Under the present Act, any income accumulated in excess of 25% or Rs.10,000/- whichever is higher, is taxable under Section 11(1)(a) (of Income Tax Act, 1961), unless the special conditions

regarding accumulation as laid down in Section 11(2) (of Income Tax Act, 1961) are complied with. It is clear, therefore, that if the entire income received by a trust is spent for charitable purposes in India, then it will not be taxable but if there

is a saving, i.e. to say an accumulated of 25% or Rs.10,000/- whichever is higher, it will not be included in the taxable income. Section 11(2) (of Income Tax Act, 1961) quoted above further liberalizes and enlarges the exemption. A combined reading of

both the provisions quoted above would clearly show that Section 11(2) (of Income Tax Act, 1961) while enlarging the scope of exemption removes the restriction imposed by Section 11(1)(a) (of Income Tax Act, 1961) but it does not take away the exemption allowed by Section 11(1)(a) (of Income Tax Act, 1961). On the express language of Sections 11(1) and (2) as they stood on the Statute Book at the relevant time no other view is possible.”

To put it in nutshell, the exemption/deduction from the income can be

taken in three stages which are as under:

i) The assessee would be entitled to have the deduction of entire amount which has actually been spent and applied for charitable purposes i.e. in furtherance of the objects of the Trust.

ii) The assessee is entitled to set apart 25% of the total income for charitable purposes even if not spent in the year in question and when the option is exercised in this behalf stating that income up to 25% which is set apart would be spent in the succeeding year;

iii) The assessee would be entitled to deduction of the remaining amount, by virtue of sub-section (2), to the extent it is invested in the Government securities as mentioned in sub-section(5).

Following the aforesaid principles laid down in Section 11 (of Income Tax Act, 1961), the Assessing Officer found that the assessee had actually spent a sum of Rs.47,27,533/. Deduction to this effect was given by the Assessing Officer

and there is no dispute about it. Insofar as second issue is concerned, as

mentioned above, the assessee set apart a sum of Rs.32 Lacs. This was, however, denied by the Assessing Officer on the ground that no option for this purpose was exercised by the assessee before the filing of the return.

Though the assessee had stated so in the return itself, that was not treated as exercising the option in a valid manner. Admittedly, in the present case, no amount is invested in any Government securities and, therefore, the Assessing Officer held that there was no question of giving any further deduction on the balance income. In this manner taxable income was assessed.

The assessee filed the appeal against the aforesaid order before the Commissioner of Income Tax (Appeals). The submission was that since it has set apart Rs.32 Lacs in terms of Section 11A (of Income Tax Act, 1961) Explanation-II, by exercising this option in the return itself that should be treated as valid option. The CIT (Appeals) accepted this contention, which view has been upheld by the Income Tax Appellate Tribunal as well as the High Court.

Insofar as this aspect, viz, exercising the option in the return filed by the assessee is concerned, we are of the opinion that the High Court and the Authorities below are right in their approach. The law does not mention

any specific mode of exercising the option. The said option has to be exercised before filing of the return. According to us, if the option

is exercised when the return is filed, that would be treated as in conformity and comply with the provisions contained in Section 11 (of Income Tax Act, 1961).

However, we find that thereafter CIT (Appeals) went wrong. As per the provisions of Section 11(1)(a) (of Income Tax Act, 1961) the amount which is actually applied for and spent towards the objects of the Trust is to be allowed. Actual expenditure which was made for Rs. 47,27,533/- was allowed by the Assessing Officer also. The aforesaid provision also entitled the assessee

to set apart further amount if not spent in the same year and option is exercised in that behalf. However, where CIT (Appeals) has gone wrong is that he ignored the provision which entitled the assessee to exercise such an option only to the extent of 25%. In the instant case, the assessee had exercised the option of setting apart an amount of Rs.32 lacs which was more than 25%. The total income was Rs. 99,41,221/- and 25% thereof would be Rs.24,85,305/-. Thus, the entire amount of Rs. 32 lacs could not have been allowed as directed. This aspect has not been noticed by the High Court as well. No further amount could be allowed as deduction and we do not understand as to how the entire income is treated as exempted from income tax.

We, accordingly, allow this appeal by setting aside the order of the High Court and direct the Assessing Officer to recompute the taxable income in accordance with this judgment.

[A.K. SIKRI]

[ROHINTON FALI NARIMAN]

NEW DELHI;

SEPTEMBER 03, 2015.