FEBRUARY 21, 2017

By Yogesh Shah, Aparna Parelkar & Shweta Changlani

A charitable and religious organization enjoys various benefits under the Income Tax Act, 1961 ("the Act") on fulfillment of certain conditions as specified under the provisions governing the taxation of trusts.

Section 11 of the Act specifies that the incomes of a trust is not taxable to the extent it is applied towards its objects. Further a donation received by a trust as a corpus donation is not considered as income of the trust and not subjected to tax.The term corpus donation has not been defined under the the Act. However, in general parlance, ‘Corpus Donation' refers to the donation given with the specific direction of the donor i.e. the contributions given by the donor intending to form the corpus of the receiver trust or institution (trust here means a trust registered u/s 12AA of the Act).

Tax treatment for Corpus Donation:

- Judicial precedence shows that donation given by one Trust to another Trust as a corpus donation is considered as application of income in the hands of the Donor Trust. The Hon'ble Gujarat HC has taken such a view in case of Sarladevi Sarabhai Trust No.2 (40 taxman 388).

- Accordingly in this situation, Corpus donation was considered as an application of fund in the hands of the Donor Trust and for the recipient trust, corpus donation is not considered as income as per section 11(1)(d) of the Act

Proposed Amendment:

The Finance Bill, 2017 has proposed that a corpus donation given by a Fund or Trust of institution or any university or other educational institution whose income is exempt under section 10 or a Trust registered under section 12AA to another trust or institution which is registered under section 12AA, for this purpose, would not be considered as application of income in the hands of the donor trust.

Reason of the Proposed Amendment:

Earlier many trusts, as a tax evasion practice, were accumulating its income taking the benefit of section 11(2) of the Act for the period of ten years (now amended to five years). On expiry of the said period of ten years the trusts used to give the voluntary donations to other trusts. These recipient trusts used to consider such donations as its income and similarly without applying the same, used to accumulate it u/s 11(2) of the Act. Continuing the cycle, on expiry of said ten years, the recipient trust again gives back the amount in form of voluntary donations to the former trusts.This resulted in huge tax evasion and main purpose of section 11(2) of the Act was defeated. This loophole was sealed vide Finance Act, 2002 inserting an explanation to section 11(2) of the Act, barring the trusts to give donations to other trusts out of accumulated funds.

However, the aforesaid amendment does not restrict the trust to give corpus donation to other trust which helps the donor trust to treat donation as application of income but it would not be treated as income in the hands of recipient trust and thus it provided unintended benefit. Therefore to plug this loophole, Finance Bill 2017 has brought amendments restricting corpus donation as an application by donor trust.

Below Illustration explains the purpose of the above amendment:

A trust receives voluntary donations for Rs.100 Lakhs. Application done by the said trust towards the objects of the trust is for Rs.50 lakhs and Rs.35 Lakhs is given towards corpus donation to other trust. Following shall be pre and post amendment implication for the said scenario:

In the pre-amendment position, the corpus donation of Rs.35 lakhs given by the trust is considered as application of income in the hands of the donor trust. On the other hand, the recipient trust's income in form of corpus donation would be exempt from tax. Therefore, there is double tax benefit whenever the donation is given/received in form of corpus fund.

Post the proposed amendment there would not be such double benefit since the corpus donation would not be considered as application of funds to the donor trust. Therefore, donor trust will have to apply its income towards its objects itself in order to get the exemption, thereby restricting the double deduction. However, the recipient trust shall continue having the exemption of funds received by way of corpus donation.

Accordingly, the amendment proposed by the Hon'ble Finance minister would now require the trust to carry out the activities towards its object to enjoy exemption under the Act and would not have an easy way out of giving donation to another trust to continue with exemption without actual application of income.

(Mr. Yogesh Shah is Partner; Ms. Aparna Parelkar is Senior Manager; and Ms. Shweta Changlani is Deputy Manager with Deloitte Haskins & Sells LLP. The views expressed are strictly personal.)