Activities of a Trust cannot be Deemed as ‘Non-Charitable’ on Mere Ground That it Earned Certain Revenue or Generated Surplus: High Court

A Trust, which loses its ‘charitable purpose’ on account of commercial receipt, then it would not get the benefit of tax exemption under the Income Tax Act irrespective of whether or not the registration or approval granted is cancelled, withdrawn or rescinded.

Section 12AA of the Income-tax Act, 1961 (ITA), introduced by the Finance Act, lays down the procedure to be followed for grant of registration to a trust or institution. Income derived from property held under trust or such institution wholly for charitable/religious purpose is exempt, if 85% of the income is spent on the objects of the trust, during the year. If the amount spent is less than 85% of the income, the shortfall is taxable, unless the trust has complied with the conditions mentioned in the table below.

The Finance Act, 2012 ensures that if the purpose of a trust or institution does not remain charitable due to the application of the amended definition of the term "charitable purpose" on account of commercial receipt, then such organisation should not get benefit of tax exemption under Section 10(23) of ITA irrespective of whether or not the registration or approval granted or notification issued is cancelled, withdrawn or rescinded.

Pursuant to an amendment under section 12AA, the Principal Commissioner or Commissioner as the case may be, is empowered to cancel the registration granted to a trust or an institution if it is noticed that the activities of such a trust or institution is carried out in such a manner that it is denied the exemption under Section 12.

The High Court of Madras in the case of ‘Investor Financial Education Academy v. Income Tax Officer’ had held that on the mere ground that an assessee earned certain revenue after being engaged in imparting 'financial education/awareness' to investors, then the activities of the assessee cannot be deemed as non-charitable so as to cancel its registration under section 12AA of ITA.

Background to the case:

  1. The assesse was a company engaged in imparting 'financial education/awareness' to investors in field of investments and was registered under Section 25 of the Companies Act, 2013.
  2. They filed an application for grant of registration under section 12AA of the ITA before the Director of Income-tax (Exemptions). But this application was rejected on the ground that the assessee was imparting services on commercial basis for earning profits and there was no element of charity.
  3. The assessee filed an appeal under Section 260A of the ITA against this order delivered by the Income-tax Appellate Tribunal (ITAT).
Findings of the Madras High Court on the Issues raised:

If a company is registered under Section 25 of the Companies Act, then does this entitle the company for automatic registration under Section 12AA of the ITA?

The high Court observed that the Income-tax Department in India has been consistently granting registration under section 12AA of ITA to several companies registered under Section 25 of the Companies Act, which have been established for the purpose of education or for advancement of any other project of general public utility.

The Court stated that a company registered under section 25 of the Companies Act upon examination of its Memorandum and Articles of Association and a licence being granted mentioning the objects and activities permitted to be carried on by the company, cannot be ignored when the company applies under the Income-tax Act for registration under section 12AA of ITA.

The Court clarified that it is not compulsory that every company registered under section 25 of the Companies Act would be automatically entitled for registration under section 12AA of ITA, but this registration is nonetheless a very relevant factor to be noted by relevant authorities while considering the application for registration under section 12AA of ITA, as the registration under Section 25 of the Companies Act recognises the main objective of the company, which is a non-profit organisation.

Whether the activities of the assessee can be deemed as educational activities or not?

The High Court relied on Supreme Court’s decision in the case of Lok Shikshana Trust v CIT. The case discussed the use of the word 'education' under Section 2(15) of the ITA. The word 'education' in the section was not used in a wide and extended sense, according to which every acquisition of further knowledge constitutes education. What 'education' connotes in that clause is the process of training and developing the knowledge, skill, mind and character of students by normal schooling. It also connotes the whole course of scholastic instruction which a person has received.

Can the activities of a trust be held non-charitable on mere fact that trust has earned certain revenue or generated surplus? Can it lead to cancelation of its registration under Section 12AA?

The Supreme Court in Queen's Educational Society v. CIT had held that where an educational institution carries on the activity of education primarily for educating people, the fact that it makes a surplus does not lead to the conclusion that it ceases to exist solely for educational purposes and becomes an institution for the purpose of making profit.

In the present case, the surplus generated by the Company was retained by them and not distributed. The purpose of education should not be submerged by a profit making motive. A distinction must be drawn between the making of a surplus and an institution being carried on "for profit". Merely because imparting education results in making a profit, it does not become an activity for making profits. If after meeting expenditure, a surplus arises incidentally from the activity carried on by the educational institution, it will not be cease to be one existing solely for educational purposes.

The Memorandum of Association of the company clearly stated that whatever income and profit is derived by the company, it would be applied solely for the promotion of its objects as set forth in the memorandum. It was clearly mentioned that no portion of the income or property would be paid or transferred, directly or indirectly, by way of dividend, bonus, otherwise by way of profit to persons who, at any time are, or have been member of the company or to any one or more of them or to any person claiming through any one or more of them.

The Court finally held that the rejection of the application filed by the assessee for registration under section 12AA was erroneous in nature and went against the precedent set forth by Supreme Court in the case of Lok Shikshana Trust v CIT.