Himanshu SinhaPartner
Aditi GoyalCounsel
Bhuwan DhooparSenior Associate
Key Developments
-
Supreme Court holds that ‘solely’ means ‘exclusively’; educational institutions must exclusively engage in educational activities to enjoy income tax exemption
On 19 October 2022, the Supreme Court in a batch of appeals led by M/s New Noble Educational Society v CCIT, held that charitable educational institutions seeking tax exemption under Section 10(23)(vi) of the (Indian) Income Tax Act, 1961 (ITA) must ‘solely’ carry out educational activities. Such institutions must not have any objectives that are unrelated to education.
Under Section 10(23)(vi) of the ITA, income received by educational institutions existing ‘solely’ for educational purposes (and not for purposes of profit) is exempt from tax, provided such institutions are approved in the prescribed manner and comply with other stipulated conditions.
In the present case, the key issue before the Supreme Court was the rejection of the taxpayer’s application for approval for income tax exemption under Section 10(23)(vi) on the ground that it did not solely exist for educational purposes. The taxpayer contended that the term ‘solely’ must be interpreted liberally so as to construe education as being the ‘predominant or main object’ of the institution. The taxpayer relied on earlier rulings1 of the Supreme Court that favoured such an interpretation. On the other hand, the tax authorities contended that the predominant object test applied in various rulings was erroneous, since the provision expressly stipulates that the institution must exist ‘solely’ (and not ‘predominantly’) for educational purposes.
In its ruling, the Supreme Court held that the plain and grammatical meaning of the term ‘solely’ is ‘only’, or ‘exclusively’. The court observed that earlier rulings had erroneously extended the ‘predominant object’ test laid down in the case of Surat Art Silk to institutions seeking to avail exemption under Section 10(23)(vi). The Surat Art Silk2 ruling was rendered in the context of a charitable institution that was engaged in the advancement of objects of general public utility. The ruling was clearly inapplicable in the context of educational institutions seeking exemption under Section 10(23)(vi) of the ITA. Given the unambiguous manner in which Section 10(23)(vi) is worded, the objects of charitable institutions engaged in imparting education must necessarily be aimed only at facilitating education. Accordingly, the Supreme Court overruled its earlier rulings on this subject, insofar as they pertain to the interpretation of the term ‘solely’.
Additionally, the taxpayer sought to place reliance on the seventh proviso to Section 10(23)(vi), which provides that business income of a charitable educational institution will not be exempt from taxation, unless the business is ‘incidental’ to the attainment of its objectives and separate books of account are maintained by it in respect of such business. According to the taxpayer, the proviso alluded to the ‘predominant object’ test, i.e., a charitable educational institution can carry out business activities, so long as its predominant objective is to facilitate education. In this context, the Supreme Court held that the proviso cannot be used to interpret the meaning of the word ‘solely’ employed in Section 10(23)(vi), which must be given its ordinary and grammatical meaning. Section 10(23)(vi) must be interpreted to mean that the charitable educational institution must solely exist for the object it professes (i.e., education), and not for profit. The seventh proviso carves out a limited exception to this rule, and permits the trust or institution to earn profits, provided the ‘business’ is incidental to education, or educational activities.
Since the Supreme Court departed from its previous rulings, it held that this ruling shall apply prospectively, to avoid hardship and to give time to institutions likely to be affected by the ruling to make appropriate changes and adjustments. Further, new applications for approval and periodic renewal of the tax-exempt status would have to be considered afresh in light of the ruling.
The prospective application of the ruling is welcome, as it would give time to institutions to take steps to align their activities and incorporation documents to comply with the ruling.
-
Supreme Court expounds on the scope of ‘general public utility’ for charitable institutions, discards ‘predominant object’ test laid down in the Surat Art Silk ruling
On the same day that it pronounced the ruling in M/s New Noble Educational Society v CCIT, the Supreme Court, in another batch of appeals led by ACIT v Ahmedabad Urban Development Authority, held that charitable institutions advancing objectives of general public utility (GPU) cannot engage in any business or commercial activities except when such activities are carried out in the course of achieving the GPU objectives and receipts therefrom do not exceed 20% of the total receipts of the institution (Quantitative Threshold).
As a brief background, the income of not-for-profit institutions from property held for, or applied for, ‘charitable purposes’, is exempt from income tax under the ITA, subject to the satisfaction of certain conditions. Section 2(15) defines ‘charitable purpose’ to mean relief of the poor, education, yoga, medical relief, preservation of environment (including watersheds, forests and wildlife), preservation of monuments or places or objects of artistic or historic interest, and the advancement of any other object of GPU.
Further, the proviso to Section 2(15) provides that the advancement of any other object of GPU shall not be construed as a ‘charitable purpose’, if it involves the carrying on of any business or commercial activity (irrespective of the nature of use of income, or application or retention of income, from such activity). The restriction imposed by the proviso does not apply when business/commercial activities are undertaken during the course of achieving the GPU objectives and receipts therefrom do not exceed the Quantitative Threshold of 20% as mentioned above.
In the present case, the primary question before the Supreme Court was whether carrying on business and commercial activities would disqualify charities engaged in the advancement of GPU from availing income tax exemption under the provisions of the ITA.
The Supreme Court interpreted the current definition of ‘charitable purpose’ in Section 2(15) of the ITA (post amendments in 2008, 2012 and 2015) and observed that there is an express bar on GPU charities from carrying on business/commercial activities under the proviso to the section. Specifically, GPU charities are barred from engaging in any trade, commerce or business, and from providing any service in relation to trade, commerce or business, if such activities are undertaken for a fee, cess or any other consideration. The bar operates irrespective of the application or retention of income from such activities, with the implication being that such activities are necessarily motivated by profit and hence not charitable.
Given the express restriction in the proviso on engaging in business or commercial activities, the Supreme Court discarded the ‘predominant object’ test laid down in the ruling of Surat Art Silk.
The Supreme Court noted that the Quantitative Threshold in the proviso to Section 2(15) carves out a limited exception to the restriction on business and commercial activities. That is, tax exemption is allowed where activities in the nature of trade, commerce or business are undertaken in the course of advancement of the objective of GPU, and receipts from such activities do not breach the Quantitative Threshold as prescribed in the ITA.
Therefore, the Supreme Court clarified that so long as the objectives of a GPU charity involve carrying on of any profit-generating trade, commerce or business, the charity can be granted an income tax exemption provided the Quantitative Threshold is not exceeded. Further, as stipulated in the ITA, separate books of accounts in relation to such business or commercial activities must be maintained, to demonstrate that receipts therefrom do not exceed the Quantitative Threshold.
More importantly, the Supreme Court held that where the consideration received by the charity for such activities is significantly or markedly above cost, the receipts shall be construed to be business or commercial receipts. Such business/commercial receipts would qualify for income tax exemption only if these receipts are within the Quantitative Threshold.
The ratio laid down in the present ruling will have far-reaching ramifications for various GPU charities such as statutory corporations, authorities or bodies, statutory regulators, trade promotion bodies/councils, non-statutory bodies, sports associations, etc. The claim for tax exemption by these charitable institutions would be subject to the rigours of Section 2(15), as interpreted by the Supreme Court.
This ruling is a departure from the earlier position of law for charitable institutions involved in advancement of objects of GPU. With respect to the application of the law declared in the ruling, the Supreme Court issued an order clarifying that for the assessment years under consideration in the appeals, its adjudication is to be treated as final. For the assessment years that were not before the Supreme Court, the tax authorities are required to apply the law declared in the judgement, having regard to the facts of each such assessment year.
Given this, the ruling is likely to result in a significant amount of litigation, with the tax authorities seeking to examine the facts of each year separately. The ruling has also made the issue of consideration charged by GPU charities (i.e., whether such consideration is significantly or markedly above cost) subjective and prone to litigation.
-
Supreme Court settles judicial conflict on the due date for payment of employees’ contributions to statutory funds
On 12 October 2022, the Supreme Court, in a batch of appeals led by Checkmate Services P. Ltd. v CIT, held that employees’ contributions towards employees’ provident fund (EPF), state insurance (ESI) and other similar funds must be deposited by the employer on or before the due dates specified under the statutes governing such funds (Statutory Due Dates). Otherwise, such employee contributions would constitute taxable income for the employer for the subject year.
Under the scheme of the ITA, employees’ contributions towards statutory funds received by an employer-taxpayer are treated as its business income, if such sums are not deposited with the concerned authorities before the Statutory Due Dates prescribed under the applicable labour welfare laws. On the other hand, under Section 43B of the ITA, employer’s contributions towards these funds for a particular financial year may be claimed as tax deductible expenditure for such year even if such contributions by the employer are paid beyond the Statutory Due Dates, so long as the deposits are made before the due date for filing the annual tax return of the employer-taxpayer.
The ITA does not explicitly provide this extended timeline (i.e., up to the due date for filing the annual tax return) in respect of employees’ contributions towards such funds. However, in several cases, many High Courts (namely the High Courts of Bombay, Himachal Pradesh, Calcutta, Guwahati and Delhi) have held that employees’ contributions paid beyond the Statutory Due Dates prescribed under the applicable labour welfare laws but before the due date for filing the annual tax return should not be considered as the taxable income of the employer-taxpayer. However, other High Courts (i.e., the High Courts of Gujarat and Kerala) took the opposite view.
The Supreme Court, while observing the division of opinion between various High Courts on this issue, finally ruled in favour of the tax authorities and upheld the minority view.
In its ruling, the Supreme Court held that there is a marked distinction between the nature of employees’ contributions towards statutory funds, and employer’s contributions. There is a specific provision (Section 36(1)(va)) dealing with employees’ contributions that are deducted from the employees’ salary and deposited with the relevant authority by the employer. These contributions are the employees’ funds that are held in trust by the employer till they are deposited with the relevant authority. Such contributions are not per se a part of the employer-taxpayer’s income but are only deemed to be so, to ensure that they are paid within the Statutory Due Dates prescribed in the relevant labour enactments. On the other hand, there is a separate provision (Section 36(1)(iv)) dealing with the employer’s contributions towards statutory funds. Employer’s contributions are over and above the employees’ contributions and are deposited directly by the employer.
Owing to this difference and the manner in which Section 43B is phrased, the Court held that the extended timeline (i.e., up to the due date for filing the annual tax return) provided under this section applies only to employer’s contributions towards such funds, and not to employee contributions (which must be deposited by the Statutory Due Dates prescribed in the relevant labour enactments, so as to not constitute taxable income of the employer).
An amendment was also brought in the ITA by the Finance Act, 2021 which clarified that employees’ contributions towards statutory funds must be deposited with the authorities concerned before the Statutory Due Dates so as not to constitute taxable income of the employers. However, the way the amendment was worded led to some ambiguity about its retrospective applicability.
Given the disputes on this issue, the Supreme Court’s ruling is welcome and finally settles the position on the meaning of ‘due date’ for the deposit of employees’ contributions by the employer for the pre-amendment period.
To summarise, there have been significant developments in relation to the taxation of charitable institutions in this quarter. While several issues have been settled, some questions remain. For instance, while the ruling in the case of Ahmedabad Urban Development Authority comprehensively discusses legislative changes, judicial precedents and developments in provisions of law relating to charitable institutions over a period of time, it fails to provide any guidance on the manner in which the cost of providing services may be determined or what constitutes nominal or significant mark-up. Additionally, the yardstick against which the mark-up charged by various charitable institutions may be measured is also undefined, and prone to further litigation. It will be interesting to see the manner in which the courts and tax authorities interpret and apply these concepts in the future.
[1] American Hotel and Lodging Association v CBDT (2008) and Queen’s Education Society v CIT (2015)
[2] Additional Commissioner of Income Tax v Surat Art Silk Cloth Manufacturers’ Association (1980)
