Charitable Organisations –

Taxation & Compliance (Legal Research Guide)

This guide provides an in-depth analysis of key tax and compliance issues for Indian charitable organizations. Each section is a comprehensive “article” covering the specified topic with relevant statutes, case law, procedures, examples, and recent updates. All legal provisions are cited from the Income-tax Act and other authorities in bare-act language. Emphasis is on practical implications, step-by-step compliance, benefits/limitations and common pitfalls.

Income from Property Held for Charitable Purposes

Legal Framework. Under Section 11(1)(a) of the Income-tax Act, 1961, a registered charitable trust/institution is exempt from tax on “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”. (Similarly, Section 11(1)(b) provides exemption for income from property held partly for such purposes, on a proportionate basis.) In simple terms, rent or other income from trust-owned properties used for the trust’s charitable objects is exempt, if that income is applied (spent) on those objects. Section 11(2) mandates that at least 85% of such “property income” be applied annually; any shortfall can be carried forward to the next year if the trust opts to “deem” that shortfall as applied. Section 11(4) clarifies that “property held under trust” includes any business undertaking so held, and permits the Assessing Officer to compute the undertaking’s income under normal rules. Section 11(4A) further provides that income which is profits/gains of a business carried on by the trust is not exempt unless the business is incidental to the trust’s objectives and separate books of account are maintained.

Section 11(1)(a) & (b) (Bare Act):

(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…

(b) income derived from property held under trust partly for charitable or religious purposes and partly for other purposes, to the extent to which the income so derived is applied proportionately to such purposes in India...

Application Requirement and 85% Rule.

The exemption is conditional on actual application of the income. That is, the trust must spend (or set aside) the income on its charitable objects. By proviso, non-monetary applications (like acquisition of assets) count. Section 11(2) provides relief when the trust is unable to apply the full 85% in the year earned. It allows the trust, by written option filed by the due date, to deem the unspent portion as applied in the next year – effectively carrying forward any deficit. For example, if a trust’s property income is ₹1,00,000 but it applies only ₹80,000 (short by ₹5,000 of the 15% permissible accumulation), it may opt to apply that ₹5,000 in the next year, and not lose the exemption on it. (Previously, trusts could also deposit the shortfall in notified modes to retain exemption, but Finance Act 2020 withdrew that deposit option – unspent income is now simply taxed.)

Computing Property Income.

“Property income” typically refers to rental, lease or interest from trust-held assets. The trust computes such income under normal provisions (e.g. Chapter IV computation rules for house/property income), but notes that if the income is fully exempt under Section 11, then in practice deduction provisions (like Section 24 on repairs) do not reduce it before application. The ITAT has held that if income is claimed as exempt under Section 11, that income is excluded from total income and only the applied portion (as per accounts) matters; hence deductions under heads (like 24(a)) are irrelevant for computing exempt income. In Nandlal Tolani Charitable Trust (Mumbai ITAT, 2020), the Tribunal observed that “the income of a charitable trust…is exempt… The said income does not form part of the total income… It is only the income forming part of the total income [as per Sec 2(45)] which is to be classified under the various heads of income under Chapter IV”. In other words, a trust earning rent may compute rent income commercially, but if that income is applied to charity, it is exempt and not part of “total income” for taxation.

Allowed Expenses.

While computing net property income in accounts, usual expenses (repairs, insurance, depreciation) can be charged. Importantly, administrative expenses not directly related to earning the property income are not counted as “application” of income. As per CBDT Circular No.5-P(LXX-6) of 1968 (clarified by courts), general administrative overheads reduce the net income available for charity, but cannot be double-counted as application of income. For example, if a trust rents out a building, necessary repairs may be charged against rent, but salaried trustees’ stipends (not expense of property) can only be treated as application of income (i.e. charity expense) if clearly allocable.

Case Law.

Key judicial decisions have clarified the scope: In CIT v. Harprasad & Co. (1975) 99 ITR 118 (SC), the Supreme Court held that for income to be taxed it must (1) be included in total income as per the Act, and (2) be computed in the prescribed manner. A trust’s exempt income fails the first test, so computations of deductions under heads do not apply (subject to exceptions like Sec.11(4)/(4A)). This was affirmed in Pravin Shah Trust v. Dy. CIT (Mumbai ITAT 2013), cited with approval in later cases.

A notable case, Nandlal Tolani Charitable Trust v. ADIT (2020) 118 taxmann.com 140 (Mumbai ITAT), dealt with rental income of a trust. The trust had claimed 30% standard deduction under Section 24(a) on rent, but AO disallowed it citing section 11. The Tribunal rejected the trust’s claim, holding that a trust’s exempt property income is not to be separately classified or reduced by those deductions if claimed under Sec.11.

Another ITAT decision, Dy. CIT v. Gyanganaga Education Society (Rajkot ITAT, 2022), addressed rent paid by a trust to related persons. The trust let its school premises to its own trustees at rates lower than market; AO disallowed exemption under Sec.11 on this ground (arguing it violated Sec.13(3) by giving undue benefit to specified persons). The Tribunal upheld the trust, noting the rent was below market/municipal values and not an “excessive” benefit. In Gyanganaga the ITAT held that paying fair rent to trustees or relatives does not automatically attract Sec.13(3) disallowance, so the income remained exempt under Section 11.

Practical Implications & Compliance. To claim Section 11 exemption on property income, the trust should:

• Maintain Books Separately: Record rental or interest income and related expenses in trust accounts. Avoid mixing with donations or business receipts.
• Apply Income Timely: Track actual spending on charitable activities. Ensure at least 85% of property income is applied to the trust’s objects each year (failure means tax on the shortfall).
• File Form 10: If opting under Section 11(2) to carry forward an unspent amount, do so in Form 10 (filed before the normal return due date) as per law.
• Claim on ITR: Report property income in ITR-7, showing exempt portion under Sec.11 in Schedule B and the applied amount in Part B. Attach audit report Form 10B (if audit applicable).
• Safe Investments (Historical): (Pre-2020) If unable to spend 85%, deposit the shortfall in prescribed modes (Sec.11(5)). (Post-2020) This route is abolished; shortfall is taxable.
• Avoid Distribution: Never distribute any income or asset to members; violation of Sec.13(1) can revoke Section 11 benefits entirely.

Example: A school trust owns a building and rents out two floors commercially (rent ₹10 Lakh/year). It must apply ₹8.5 Lakh (85%) to charity activities (scholarships, maintenance, etc). Suppose it spends ₹8 Lakh in FY; ₹0.5 Lakh shortfall can be “carried forward” to the next year by Form 10. The ₹8.5 Lakh applied amount is exempt; if ₹1.5 Lakh remains unspent and not carried forward, it would be taxable. The trust should compute net rent after allowable expenses and then show the exempt/applied portion in its return.

Benefits & Disadvantages: The main benefit is full exemption of such income if rules are met – effectively funding the charity from own assets without tax. However, the disadvantage is the stringent 85% spending requirement and record-keeping: 15% of income (or shortfalls) cannot be deposited as before (post-2020), so any under-spend is taxed. Also, trusts cannot claim standard deductions or depreciation on these incomes if exempt. Care must be taken to comply strictly with the provisions and maintain documentation (rental agreements, bank records of application of funds, etc.) to support the exemption.

Mistakes to Avoid: Common pitfalls include (a) failing to apply 85% of property income to charitable purposes (leading to tax on the balance); (b) neglecting to file Form 10 for any carry-forward of unspent income; (c) using Section 11 funds to benefit trustees or outsiders improperly (Sec.13(1)(c)/(3) issues); (d) inconsistent accounting of rent/lease income and expenses; (e) forgetting to register under Section 12A/12AA – registration under 12AA is a precondition for Sec.11 exemption. Recent case law underscores that fair market transactions with related parties (e.g. trustees as tenants) are permissible, but trusts should document valuations to avoid disputes.

Recent Updates (Post-2020): Finance Acts 2020–2024 brought several changes. Notably, Finance Act 2023 amended Section 11(1) so that when a trust donates funds to another charitable entity, only 85% of that donation will be treated as application of income. This means if Trust A gives a grant of ₹100 to Trust B (or a university/hospital), only ₹85 is counted as “applied” by Trust A; the balance ₹15 is not considered used for its own charity (in effect disallowing that portion of exemption). Also, Finance Act 2020 inserted Explanation to Sec.11(1) clarifying that a donation by Trust A to the corpus of Trust B cannot be claimed as application by Trust A. These rules tighten the scope of application. There have been no changes specific to “property income” computation aside from these general rules, but trustees should keep abreast of Budget proposals and court decisions (e.g. SC decisions interpreting what counts as ‘incidental’ business affecting Sec.11(4A), which may indirectly impact property usage).

Sources: Key statutory provisions (Section 11, etc.) are cited in the guide above. Relevant case law is discussed with citations. The content above also incorporates CBDT clarifications (e.g. Circular No.5-P/1968) and recent tax updates (Finance Acts 2020–2024).