CHAPTER VI - TAXATION OF NON-PROFIT ORGANISATIONS - Revised Discussion Paper – Direct Tax Code (DTC)

1. Chapter XV of the Discussion Paper on the Direct Taxes Code (DTC) deals with taxation of non-profit organizations. The Code uses the phrase „permitted welfare activities‟ instead of the phrase "charitable purpose" used in the current legislation to define the activities to be pursued by these organisations. Permitted welfare activities has been defined to mean any activity involving relief of the poor, advancement of education, provision of medical relief, preservation of environment, preservation of monuments or places or objects of artistic or historic interest and the advancement of any other object of general public utility. Advancement of any other object of general public utility will not include any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or business, for a fee or for any other consideration, irrespective of the nature of use, application or retention of the income from such activity.

1.1 The Discussion Paper mentions thatwhiletrusts and institutions established for charitable purposes have generally enjoyed tax exemptions, the following shortcomings have been observed in the exemption regime:-
(a) The exemption regime is complex, overlapping and dissimilar since it varies across institutions based on their activities.
(b) The provisions fail to meet the test of efficiency as they provide different conditions for institutions carrying on similar activities.
(c) The provisions also do not meet the test of equity as the compliance cost for an institution varies depending upon the provision of law under which the exemption is granted.
(d) The concept of income of such an institution has been the subject matter of litigation. Should gross receipts of the institution or the net income of the institution be reckoned as the income? This question has been the subject matter of extensive debate.
(e) A vexed issue is whether the institution should be allowed to accumulate income not applied or utilized for charitable purposes and how the accumulation should be treated.
(f) There is unending dispute whether a business is incidental to attainment of the objectives of the institution or not, since the income from incidental business is exempt from tax.

1.2 The DTC proposes a new tax regime for all trusts and institutions carrying on charitable activities. The salient features of the new regime are as under:-

(a) An organization shall be treated as a non-profit organization if,-
(i) it is established for the benefit of the general public;
(ii) it is established for carrying on permitted welfare activities;
(iii) it is not established for the benefit of any particular caste;
(iv) it is not established for the benefit of any of its members;
(v) it actually carries on the permitted welfare activities during the financial year and the beneficiaries of the activities are the general public;
(vi) it does not intend to apply its surplus or other income or use its assets or incur expenditure, directly or indirectly, for the benefit of any interested person;
(vii) any expenditure by the organisation does not enure, directly or indirectly, for the benefit of any interested person;
(viii) the funds or assets of the organisation are not used or applied, or deemed to have been used or applied, directly or indirectly, for the benefit of any interested person;
(ix) the surplus, if any, accruing from its permitted activities does not enure, directly or indirectly, for the benefit of any interested person;
(x) the funds or the assets of the non-profit organisation are not invested or held in any associate concern or in any prescribed form or mode;
(xi) it maintains such books of account and in such manner, as may be prescribed;
(xii) it obtains a report of audit in the prescribed form from an accountant before the due date of filing of the return in respect of the accounts of the business, if any, carried on by it; and the accounts relating to the permitted welfare activities and
(xiii) it is registered with the Income-tax Department under the Code.

(b) The tax liability of a non-profit organisation shall be 15 per cent.of the aggregate of the following:-
(I) the amount of surplus generated from the permitted welfare activities; and
(II) the amount of capital gains arising on transfer of an investment asset, being a financial asset;

Surplus generated from permitted welfare activities;

The amount of surplus generated from the permitted welfare activities shall be the gross receipts as reduced by the outgoings.
The gross receipts shall be the aggregate of the following:-
(i) The amount of voluntary contributions received during the financial year;
(ii) Any rent received in respect of a property consisting of any buildings or lands appurtenant thereto;
(iii) The amount of any income derived from a business which is incidental to any of the permitted welfare activities;
(iv) Full value of the consideration received from the transfer of any investment asset, not being a financial asset;
(v) Full value of the consideration received from the transfer of any business capital asset of a business incidental to its permitted welfare activities;
(vi) The amount of any income received from any investment of its funds or assets; and
(vii) All other incomings, realizations, proceeds, donations or subscriptions received from any source.

The amount of outgoings shall be the aggregate of-
(i) voluntary contributions received during the financial year by the non- profit organisation made with a specific direction that they shall form part of the corpus of the non-profit organisation;
(ii) the amount actually paid during the financial year for any expenditure, excluding capital expenditure, incurred wholly and exclusively for earning or obtaining any "gross receipts";
(iii) the amount actually paid during the financial year for any expenditure, excluding capital expenditure, on the permitted welfare activities;
(iv) the amount of capital expenditure actually paid during the financial year in relation to-
(A) any business capital asset of a business incidental to any of the permitted welfare activities; or
(B) any investment asset, not being a financial asset.
(v) any amount actually paid during the financial year to any other non- profit organisation engaged in a similar permitted welfare activity;
(vi) any amount applied outside India during the financial year if the amount is applied for an activity which tends to promote international welfare in which India is interested and the non-profit organisation is notified by the Central Government in this behalf.
(c) The surplus generated from permitted welfare activities will be determined on the basis of cash system of accounting.
(d) Capital gains arising on the transfer of an investment asset, being a financial asset, will be computed in accordance with the provisions under the head "Capital gains".
(e) A non-profit organisation will be prohibited from investing any of its funds or holding any of its asset in any associate concern or in any prescribed form or mode.
(f) It will be mandatory for every non-profit organisation to register with the Income-tax Department by making an application to the Chief Commissioner or Commissioner concerned. The registration, once granted, shall be valid from the financial year in which the application is made till it is withdrawn.
(g) The donations made to a non-profit organisation will be eligible for deduction in the hands of the donor at the appropriate rates.
(h)The income of any trust or institution recognised/registered under the religious endowment Acts of the Central Government or the State Governments shall be fully exempt from income-tax. However, donations to such trusts or institutions will not enjoy any deduction in the hands of the donor.
2. A number of inputs have been received regarding the proposed regime -


(i) The Code provides for fresh registration of NPOs after introduction of DTC. This will lead to increase in the compliance cost for NPOs and also substantially increase the workload of the income-tax department.

(ii) The status of public religious institutions in the DTC is not clear as the DTC exempts the income of only such religious trusts which are registered under a religious endowments legislation of the Central or a State Government. However, there are many states where such legislation does not exist or even if it exists, it does not cover all religious institutions.

(iii) The status of partly religious and partly charitable institutions is not clear under the Code.

(iv) Instances have been cited where NPOs receive grants at the end of the financial year or are unable to spend due to reasons beyond their control. In the absence of any window for carry forward of surplus for use in the subsequent years, taxation of the surplus of income over expenditure will be harsh.

(v) The phrase „charitable purpose‟ should be used instead of „permitted welfare activity‟ in order to emphasize the charitable intent of the activities rather than permitting of certain specified welfare activities. This will ensure greater clarity and will minimize litigation as the phrase has been in use for long.

(vi) Only cash system of accounting is stipulated for NPOs, whereas under the existing provisions of the Income-tax Act, 1961 NPOs can follow either cash or mercantile system of accounting. The option of choosing one of the systems should be allowed.

3. The issues have been examined and having considered the concerns, the tax regime for NPOs is proposed to be modified to provide that-

(a) NPOs already registered under the Income-tax Act, 1961 and holding valid registration on the date on which DTC comes into effect, would not be required to apply for fresh registration under the DTC. However, they would be required to provide additional information to facilitate the administration of the new provisions.
(b) The income of a public religious institutions will be exempt subject to fulfillment of all the following conditions:

(A) it shall be registered under the Code.
(B) the trust/institution shall apply its income wholly for public religious purposes;
(C) it shall be registered under the state law, if any;
(D) it is established for the benefit of the general public;
(E) the trust / institution shall file the return of tax bases before the due date;
(F) it shall maintain books of account and obtain an audit report from a qualified accountant in case its gross receipts exceed a prescribed limit;
(G) the funds or the assets of the trust / institution shall be invested or held, at any time during the financial year, in specified permitted forms or modes; and
(H) the funds or the assets of the trust / institution shall not be used or applied or deemed to have been used or applied, directly or indirectly, for the benefit of interested person.

Donations to these institutions will not be eligible for any deduction in the hands of the donor.

(c) Partly religious and partly charitable institutions will also be treated as NPOs if they are registered under the Code. Their income from public religious activity will be exempt subject to the fulfillment of the following conditions-
(i)the trust deed / memorandum of the institution shall contain a clause specifying the application of its gross receipts in a pre-determined ratio between charitable and religious activities;
(ii) it shall maintain separate books of account and separate financial statements in respect of religious and charitable activities;
(iii) it shall fulfil the conditions stipulated in clause (b) above.

In respect of income from charitable activities, the income of the trust / institution will be liable to tax in the manner provided for NPOs if they fulfill the conditions prescribed in the Code. Donations to such trust / institution will not be eligible for deduction in the hands of the donor.

(d) To address the concern that an NPO would not be able to spend the entire receipts during the financial year itself, it is proposed that upto 15% of the surplus or 10% of gross receipts, whichever is higher, will be allowed to be carried forward to be used within three years from the end of the relevant financial year.
(e) Donations by an NPO out of its accumulated surplus to another NPO will not be considered as application for the charitable purpose.
(f) The definition of the phrase „permitted welfare activity‟ is on the same lines as what is currently used for the phrase „charitable purpose‟. Accordingly, to maintain continuity and minimise litigation, the phrase „charitable purpose‟ will be retained in place of „permitted welfare activity‟.
(g) A basic exemption limit will be provided and the surplus in excess of such limit will be subject to tax.
(h) It is proposed to retain the cash system of accounting since it is simple to follow and easy to administer.
(i) It is also proposed that the Central Government shall be empowered to notify any non-profit organization of public importance as an exempt entity.