Tax exemption for a not-for-profit organization
In order to promote the welfare of the society, the Income Tax Act, 1961 (“Act”), which is the principal legislation governing taxation laws of individuals as well as companies, includes provisions that exempt the income derived from a trust or a Section 25 Company or a society (together referred to as “Entities” and individually referred to as “Entity”) created for charitable or religious purposes.1 The present bulletin focuses on the conditions that are to be fulfilled by an Entity created only for charitable purposes to claim exemption under section 11 of the Act.2 Further, this bulletin attempts to explain the meaning of “Charitable Purpose” and the procedure involved in registration of such an Entity.
1.0 What is a Section 25 company?
A Section 25 Company is a limited company incorporated under section 25 of the Companies Act, 1956 (“Companies Act”) for promoting commerce, art, science, religion or charity.3 The profits made or the income earned by such a company is applied for the promotion of the object for which it is created, which is why it is strictly prohibited from distributing its dividend (if any) to its members. In order to ensure that the company does not deviate from its objects, the central government grants a license to such companies under certain terms and conditions, which if unfulfilled can lead to revocation of that license. For promoting charity, companies also receive benefits under law including exemption from various procedural provisions of the Companies Act, either fully or in part, and are also entitled to such other exemptions that the central government may accord through its orders.4 For instance, a Section 25 Company, though may be a limited company, is not required to include the word “limited” in its name and still enjoys the protection of limited liability. Further, the members of such companies are exempted from personal liability.
2.0 Conditions for exemption from income tax
The Act provides for exemption of income that is derived from a property held under a trust for a charitable or religious purpose. Exemption under section 11 of the Act is also available to a Section 25 Company or a society formed under the Societies Registration Act of 1860. In order to claim exemption under section 11 of the Act certain criteria are to be met by such Entities. These include:
- The income must be derived from a property5 held under the name of an Entity created for charitable or religious purposes which ensures benefit to the public in India;
- Income is (i) applied for charitable or religious purpose or (ii) accumulated for application to charitable or religious purposes in India and to the extent permitted to be accumulated, exempted from tax; and
- In case the income of the Entity exceeds the maximum amount which is not chargeable to income tax in the previous financial year, then such an entity will be required to get its accounts audited and file the audit report6 along with the return of income.7
3.0 What is “Charitable Purpose”?
Exemption from taxes can only be claimed if (a) the source of income is a property,
- such property is held under an Entity created for a charitable or religious purpose and
- such income is applied for the fulfillment of the charitable or religious purpose. As per section 2(15) of the Act, the definition of charitable purposes includes, “relief to the poor, education, medical relief, advancement of any other object of public utility”. From the definition it can be inferred that charitable purpose involves certain types of benefits to the community or a section of the community and not for the benefit of an individual. Though the definition of charitable purpose does include “relief to the poor”; however, that does not mean that an entity created for charitable purposes which does not cater to the interest or needs of the poor is not created for charitable purposes. For instance, a charitable trust created for advancement of education in a certain community will be deemed to be a trust created for charitable purpose as it benefits a community and is thus liable to claim exemption under section 11 of the Act.
4.0 Income exempted under section 11 of the Act
Even though the property may be held wholly for charitable purpose, only the income that is applied for charitable purpose in India shall be exempted from tax. Further, section 11 of the Act does not allow an Entity to accumulate more than 15% of the aggregate income from the Entity’s property and voluntary donations.8 In case the accumulated income of an Entity is more than the prescribed limit, then such income shall be liable to taxation. However, exemption can be granted in case the accumulation exceeds the prescribed percentage, if the authorized signatory of the Entity either (a) writes to the accessing officer seeking exemption from tax,9 or (b) invest or deposit the accumulated income as prescribed under the Act.10 In either case the Entity can only accumulate income for a period of five years, after which the income has to be applied to fulfill the Entity’s object. While calculating the taxable income, the necessary expenses incurred by the Entity for its functioning are excluded.11
5.0 Registration of Entity
In order to obtain exemption from tax under the Act, an Entity is required to make an application for it registration with Commissioner of Income Tax (“Commissioner”) in Form 10A. Along with the form, an applicant is required to submit the original document or a certified copy evidencing the creation of the Entity.12 In case the Entity has been in existence prior to the date of filing of registration application, then the applicant is required to also submit two copies of the accounts of the Entity for the prior financial years with the Commissioner office. Though the Income Tax Rules only request for the aforementioned documents, the Commissioner may request for such documents or information to satisfy himself of the genuiness of the activities carried out by such an Entity. Once the Commissioner is satisfied about the genuiness of the activities, he shall pass an order in writing registering the Entity.
It is important to understand the purpose for which an Entity claiming exemption under section 11 of the Act is required to register itself with the Commissioner. The registration is important as it establishes the identity of the Entity to claim benefits under section 11 of the Act. The registration does not guarantee exemption from income tax.
The legal framework in India recognizes activities that are for “the relief of the poor”, for advancement of education, to provide medical relief and for “the advancement of any other object of general public utility” as charitable purposes. To support a claim for exemption an Entity must show that the income that is derived from its property is applied for the fulfillment of its object(s). The word “applied” does not necessarily mean spent. It includes income that has been allocated (not to be confused with accumulated) and the actual payment of the allocated income is to be made subsequently for the fulfillment of the Entity’s object. Thus, in order for an Entity to continue enjoying the exemption granted under section 11 of the Act, it is pertinent for it to fulfill the conditions laid down in section 11 of the Act.
Authored by: Divij Kumar
1 Section 11 of the Act.
2 Section 11 also exempts Entities created for religious purposes from taxation. However, this bulletin shall focus only on the Entities created for charitable purpose.
3 Section 25(1)(a) of the Companies Act, 1956.
4 Section 25(6) of the Companies Act.
5 Property includes a business, a partners share in a partnership business etc.
6 Section 12A(b) of the Act requires an Entity to file the audit report in Form 10B
7 Section 12(A)(b) of the Act
8 Section 12 of the Act
9 Rule 17 of the Income Tax Rules of 1962)
10 Section 11(5) of the Act allows for investment and deposit of accumulated income in government prescribed saving schemes, Unit Trust of India, public sector companies etc
11 Necessary expenses include expense of maintaining the trust, legal expenses connected with the affairs of the trust, salaries, payment of income tax, payment of other taxes and other miscellaneous expenses.