By TIOL News Service

NEW DELHI, APRIL 11, 2018: THE ISSUE IS - Whether when the dominant objective of the society is charitable, exemption u/s 10(23C)(vi) cannot be denied even if it makes profit by collecting franchisee fees which are ploughed back into funds for charitable purpose. YES IS THE VERDICT.

Facts of the case:

The Assessee-society, engaged in providing educational facilities. The Assessee had filed an application u/s 10(23C)(vi) for grant of exemption for AYs 2008-09 onwards, as a charitable organization. The Assessee was enjoying exemption, in respect of its income u/s 10(22) since AY 1977-78 till AY 2007-08. The Assessee had established 11 schools and had also permitted societies/organizations/trusts with similar objects to open schools under the name of 'Delhi Public School', in and outside India. The arrangement for opening schools by other societies were executed through an 'education joint venture agreement'. In terms of the said agreement, the parties jointly agree to manage the school where the Assessee had a significant say and control in the management of these schools. Nevertheless, sec. 10(22) was substituted by sec. 10(23C)(vi) w.e.f. April 1, 1999. Accordingly, the Assessee had applied in Form 56D requesting for approval of exemption, u/s 10(23C)(vi) for AY 2008-09 onwards. However, the Additional DIT(E) issued SCN to the Assessee directing it to file relevant material in support of the claim for exemption u/s 10(23C)(vi). In reply, the Assessee that it entered into an agreement with the satellite schools, for providing services to such schools and accordingly, received maintenance charges from the 120 functional schools. The Assessee also stated that the said maintenance charges were received towards a number of obligations discharged by it and not in lieu of a franchise of its name and logo.

However, the Additional DIT(E) rejected the Assessee's application by stating that the franchisee fee received by it from the satellite schools in lieu of its name, logo and motto amounted to a 'business activity' with a profit motive and certain clauses of the Assessee's MoA were not in conformity with its objectives.

On appeal, the High Court held that,

++ the prescribed authority has examined the Assessee's application for exemption u/s 10(23C)(vi) in light of the recent audits of the Assessee's accounts. Although DPS Society, in the earlier years had been granted exemption u/s 10(23C)(vi), that itself does not cause for a res judicata principle, as examination of the Assessee's audited accounts may be done afresh by the prescribed authority, corresponding to the specific AY, as prescribed in the second proviso to sec. 10(23C)(vi). Despite this stipulation, the prescribed authority will still have to apply the determinative test of assessing whether the business is incidental to the attainment of the objectives of the entity and whether separate books of account are being maintained in respect of such business, even if the profits received by the Assessee as such increase exponentially, if the Assessee qualifies this test, they will still be eligible for exemption u/s 10(23C)(vi);

++ in light of the decisive test for determining eligibility for exemption u/s 10(23C)(vi), it is apparent that the assertion of the DGIT that the Assessee's activities including charging a franchisee fee could not be regarded as a charitable activity within the meaning of sec. 2(15), and thus, inapplicable for exemption u/s 10(23C)(vi), has not been adequately substantiated, despite examination of the Assessee's audited accounts. The DGIT asserted that the Assessee is carrying out a business activity for profit motives by entering into franchise agreements, whereby, it has opened and is running around 120 schools, and that these charges were received by the Assessee for using the name of Delhi Public School by the satellite schools in and outside India and no separate books of accounts were maintained by the Assessee for the business activity as required u/s 11(4A). This is prima facie not correct, because the Assessee has maintained, accounts audited in detail for FYs 2000-2001, 2003-04, 3004-05 and 2005-06. That aspect has been found by the ITAT for those AYs. Such accounts have been maintained in compliance to what is required under the seventh proviso to Ss 10(23C)(vi) and 11(4A);

++ the memorandum of association of DPS Society, as well as the joint venture agreements entered into by DPS Society with the satellite schools validate the motive of an educational purpose that the Assessee aims through its business activities and substantiate its contentions in that regard. On review of the Assessee's audited accounts, it can be observed that the surpluses accrued by DPS Society are being fed back into the maintenance and management of the DPS schools themselves. This, reaffirms the Assessee's argument that the usage of the gains arising out of its agreements are incidental to its educational purpose outlined by its objective of the Assessee. The interpretation of sec. 10(23C)(vi) is one that requires fulfillment of a two pronged test: firstly, that any business activity if carried out by the educational institution applying for exemption should be incidental to their educational purpose, and secondly, that proper accounts of such business activity ought to be maintained, as highlighted in the case of Queen's Educational Society.

++ a mere incurrence of (surplus) profit does not automatically presuppose a business activity that invalidates the exemption u/s 10(23C)(vi); the same has to be tested on whether such profits are being utilized within the meaning of the larger charitable purpose as defined in sec. 2(15) or not. On scrutiny, it can be observed that the accounts marked the heading 'Secretary's Account', detail the heads of income and expenditure that cater to the various requirements of running and maintaining the satellite schools. Thus, arguendo if it were held that the objected activity were indeed commercial in nature, nevertheless, the realization of profit by the Assessee is through an activity incidental to the dominant educational purpose that its memorandum of association sets out, and is in turn being channeled back into the maintenance and management of the same schools, thus, fulfilling the objectives the Assessee has set out in its memorandum of objectives;

++ after the Assessee filed an application for grant of exemption u/s 10(23C)(vi) for AY 2008-09 onwards, that was rejected; in a notification, the DGIT u/s 10(23C)(vi) issued certain conditions which were also duly fulfilled by the Assessee. The Assessee has fulfilled the requirements u/s 10(23C)(vi) to qualify for exemption; DPS Society is maintaining its eleven schools and the 120 satellite schools in furtherance of the education joint venture agreements with an educational purpose that also qualifies as a 'charitable purpose' within the meaning of sec. 2(15) and is not in contravention of sec. 11(4A);

++ section 10(23C)(vi) ought to be interpreted meticulously, on a case-to-case basis. This is because, the larger objective of an educational/charitable purpose of the institution and its manifestation can only be subjectively adjudged; for instance, in the present situation, the Assessee's balance sheets demonstrate how the profits are utilized for the growth and maintenance of the very schools they are accrued from, thus, subscribing to a charitable motive. However, the educational institutions may take more creative steps to qualify their objectives as an 'educational purpose' that is more universal than the individual objectives set out in the memoranda of objectives of such institutions. For instance, a percentage of profits earned from a business activity indulged in by such an educational institution may be mandated towards fructifying the implementation the provisions of the Right to Education Act, 2009, particularly, to create a more sensitive learning environment for children with disabilities in implementation of the provisions in the Persons with Disabilities (Equal Opportunities, Protection of Rights and Full Participation) Act, 1995, or have a system to analyze the ratio of inflow of money over progressive AYs as opposed to how much of this money is channeled back into the growth and maintenance of such educational purpose, in order to put in place a visible system of accountability. This is an observation, to ensure that the purpose for which sec. 10(23C)(vi) was introduced, is adequately fulfilled and not disadvantageously circumvented by vested parties.

(See 2018-TIOL-661-HC-DEL-IT)