Understand The Tax Exemptions for Charitable Organizations in India

At its core, a ‘charitable purpose’ in India, as defined by Section 2(15) of the Income Tax Act, 1961, is quite broad. It includes:

• Providing relief to the poor and needy.
• Advancing education and promoting yoga.
• Offering medical aid.
• Preserving the environment (including forests, wildlife, and watersheds).
• Conserving monuments, places, or objects of artistic or historic interest.
• Any other activity for the advancement of general public utility.

It’s crucial to note a recent clarification: if an activity for general public utility involves trade, commerce, or business, or services related to them, it will not be considered a charitable purpose unless such activities are undertaken while actually carrying out the public utility objective, and their total receipts do not exceed 20% of the institution’s total receipts in that financial year. This ensures genuine charitable work isn’t diluted by commercial interests.

The Legal Framework for Exemptions: Key Income Tax Provisions

Tax exemptions for charitable trusts and institutions are primarily governed by Chapter III of the Income Tax Act, 1961, specifically Sections 11, 12, 12A, 12AA, and 13. These sections lay down the roadmap for registration, conditions for claiming benefits, and situations where exemptions might not apply.

• Registration Essentials (Section 12A & 12AB):To claim tax exemptions under Sections 11 and 12, a trust or institution must first register with the Principal Commissioner or Commissioner of Income Tax (PCIT/CIT). The process for this registration and subsequent re-registration is outlined in Section 12A and Section 12AB of the Income Tax Act. Initially, existing trusts needed to re-register every five years.
• Recent Update (Effective April 1, 2025): To ease the compliance burden, especially for smaller entities, the validity period for registration has been extended from five years to ten years for eligible small trusts and institutions. This applies if their total income (before applying exemptions) does not exceed ₹5 crores in each of the two previous years before applying for registration. This change reflects the government’s aim to streamline processes for non-profits.
• Conditions for Claiming Exemption (Section 11 & 12):These sections outline the fundamental requirements for income earned by property held for charitable or religious purposes to be excluded from total taxable income. A key condition is that the income must be applied or accumulated for such purposes.
• The 85% Rule: A charitable organization must apply at least 85% of its income towards its charitable or religious objectives in the previous year. If less than 85% of the income earned in a year is spent for these purposes, the shortfall usually becomes taxable.Voluntary Contributions: Any voluntary contributions or donations received by the trust that are not specifically instructed to be added to the trust’s permanent funds (corpus) are considered income derived from property held under the trust and are subject to the 85% application rule.
• Accumulation of Income:If a trust cannot spend 85% of its income for charitable reasons in a given year but intends to use the unspent amount for such purposes in the future, it can accumulate or set aside this excess beyond the 15% limit. However, certain conditions must be met:
  1. Form 10B Filing: A statement in Form 10B must be uploaded online by the due date for filing the income tax return (as prescribed under Section 139(1) of the Income Tax Act, 1961). This form informs the Income Tax Department about the amount being accumulated and the period for which it will be held. Failure to file Form 10B on time can lead to the accumulated income becoming taxable.
  2. Accumulation Period: The period for which the income is accumulated must not exceed five years.
  3. Mandatory Investment: The accumulated amount must be invested or deposited in specific modes as mentioned under Section 11(5) of the Income Tax Act, 1961.
• Investment Guidelines (Section 11(5)):To ensure financial prudence and prevent misuse, the Income Tax Act specifies permissible investment avenues for accumulated funds. These include:
  • Investment in Government Savings Certificates or other Central/State Government securities.
  • Deposit in a scheduled bank or cooperative society account.
  • Investment in units of Unit Trust of India (UTI).
  • Depositing in the savings bank of a Post Office.
  • Investment in debentures issued by or on behalf of a company/corporation where the principal and interest are fully guaranteed by the Central or State Government.

Compliance Requirements: Audit and Returns

Beyond registration, charitable organizations must adhere to ongoing compliance mandates to maintain their tax-exempt status:

• Audit Requirement: If the total income of the trust or charitable institution (before applying exemptions under Sections 11 and 12) exceeds the basic exemption limit (currently ₹2,50,000 for individuals, subject to changes based on annual budget, but often used as a benchmark for trusts) in any previous year, its accounts must be audited by a chartered accountant.
• Income Tax Return Filing: Under Section 139(4A) of the Income Tax Act, 1961, any trust or institution whose income (before exemptions) exceeds the basic exemption limit must file an Income Tax Return for that income. Note: The benefit of income accumulation may not be available if the income tax return is not submitted by the due date prescribed under Section 139(1).

When Tax Exemption Is Not Granted

There are specific situations where the income of a charitable trust or institution will not qualify for tax exemption under Sections 11 and 12, leading to taxation at the applicable rates:

• Private Religious Purposes: If the entire income from property held under trust is for private religious purposes that do not benefit the public at large.
• Specific Community Benefit: If the entire income directly or indirectly benefits individuals of a specific caste or religious community, rather than the general public.
• Application Outside India: If the income used or accumulated for charitable purposes is applied in countries other than India, unless specifically permitted by the Central Board of Direct Taxes (CBDT).
• Benefit to Specified Persons: If any part of the income or assets of the trust directly or indirectly benefits certain “specified persons.” These include the author or founder of the trust, substantial contributors, trustees or managers, and their relatives. Benefits could range from lending property, providing services, purchasing assets at inflated prices, or selling assets at undervalued prices to such individuals.
• Non-compliance with Investment Rules: If the unapplied income (the portion below the 85% application threshold that is intended to be accumulated) is not invested as required under Section 11(5).
• Business Income (Non-Incidental): If the trust earns income, profits, or gains from a business that is not incidental to achieving its charitable objectives, or if it fails to maintain separate books of accounts for such a business.
• Belated Filings: As mentioned, delayed filing of the Income Tax Return and the Audit Report in Form 10B can lead to the denial of tax exemptions.

In any of these scenarios, the exemptions will not apply, and the income will be subject to income tax at the appropriate rates.

FAQs

Q1: What types of entities can claim tax exemptions for charitable purposes in India?

Generally, charitable trusts, societies registered under the Societies Registration Act, 1860, and Section 8 companies registered under the Companies Act, 2013, can claim tax exemptions if they fulfill the conditions laid down in the Income Tax Act.

Q2: What is Form 10B, and why is it important?

Form 10B is an audit report that certain charitable trusts and institutions must file. It’s crucial because it details how the trust has utilized its income and confirms compliance with the Income Tax Act’s provisions for claiming exemptions, especially for accumulated income. As of Assessment Year 2023-24, its applicability has been expanded to include trusts with total income exceeding ₹5 crores, or those receiving foreign contributions or applying income outside India.

Q3: Can a trust lose its tax exemption status?

Yes, a trust can lose its tax exemption status if it fails to comply with the various conditions stipulated in the Income Tax Act, such as not applying 85% of its income, not investing accumulated funds as prescribed, benefiting specified persons, or failing to file returns and audit reports on time.

Q4: Is there a limit to the amount of income a trust can accumulate?

A trust must apply at least 85% of its income for charitable purposes. The remaining 15% can be accumulated without any conditions. If more than 15% is accumulated, it can be done for a maximum period of 5 years, provided the specific conditions regarding intimation (Form 10B) and investment (Section 11(5)) are met.

Q5: What are the consequences of not complying with the investment requirements for accumulated income?

If the accumulated income is not invested in the prescribed modes under Section 11(5), the exemption for that accumulated amount will be denied, and it will be taxed as regular income of the trust in the relevant financial year.

Q6: Are donations received by a trust considered taxable income?

Voluntary contributions or donations, unless they are specifically instructed by the donor to be part of the trust’s corpus (permanent fund), are generally treated as income of the trust. This income, like other income, needs to be applied for charitable purposes according to the 85% rule to qualify for exemption.

Conclusion

While the government provides significant tax exemptions to encourage philanthropic activities, these benefits are contingent upon strict adherence to rules regarding registration, application of income, accumulation, and investment. Recent amendments reflect an ongoing effort to streamline processes and enhance the ease of doing business for genuine charitable organizations. For any charitable entity, ensuring timely filings, proper record-keeping, and aligning operations with the defined charitable purpose are paramount to maintaining tax-exempt status and continuing their invaluable work for public welfare. It is always advisable to seek professional guidance from tax experts specializing in trusts and NGOs to ensure complete compliance and optimize tax benefits.

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