Review on taxation of Non-Profit Organisations under certain provisions of the Direct Tax Code

Through the years, Institutions and Trusts have received special privileges by the Indian Government in the form of deductions and exemptions. However with the advent of the Direct Tax Code, the Government seeks to decrease its leniency towards these Non-Profit Organisations. The first proposal under the Direct tax Code has been examined and revised to accommodate some of the concerns arising under them.
On the reading of the DTC, the clarity of the inclusive definition under ' charitable purposes' is hard to miss as they substantially alter the wider definitions under the existing Income Tax Act, 1961. The IT Act 1961, allowed a wider import to the terms used under the definition of charitable purpose. However the DTC on one hand seeks to restrict 'charitable purposes' to include relief to the poor, advancement of education, provisions for medical relief and on the other hand enhances the definition by including preservation of the environment, monuments; or places or objects of artistic or historical interest and advancement of any other object of general public utility. The implication of such a provision is that it will restrict the nature of NPO’s for specific purposes. In consonance with the wider definition under the prevailing law several NPO’s have been established for the general activities within the ambit of charitable purposes. Since the DTC specifies the scope of activities within the ambit of charitable purposes, several NGO’s will have to alter their nature. Such a specific inclusive definition will result in unnecessary hardship for several NPO’s and may result in confusion and trivial litigation on the interpretation of such restrictive terms. It is pertinent to note that unlike the Direct Tax Code, under the present Act, 'general public utility' includes any institution set up for promoting trade and commerce which is encompassed within the ambit of 'charitable purposes' as it is believed that such an activity promotes common good through enhancement of business. Such a restriction under the DTC will jeopardise the position of several such trusts and institutions as it seeks to completely prohibit “any activity in nature of trade, commerce or business or any activity of rendering any service in relation to any trade, commerce or business…irrespective of the nature of use, application or retention of the income from such activity”. In consonance with the strict application of the taxing structure, the DTC has laid the burden on these institutions to prove that all such charitable purposes are‘actually’carried out and that the beneficiaries are the general public. One of the effects of such an exacting liability will prevent any such trust or institution from avoiding tax and carrying out activities for its own profits and interests. However the other possible effect could be that under the existing law the NPO’s which are allowed to carry on incidental business will be liable to be taxed as gross receipts under the DTC even though the entire income may be used for charitable purposes. This proposition by the code would clearly invalidate the judgment of the Apex Court in CIT v. Thanthi Trust which recognises income from incidental business under section 11.

Under s.11 of the existing Act, NPO’s are allowed to maintain their surplus income and carry it forward to the succeeding years without limitations. The law also allows them to accumulate or set aside an income for a specific purpose. With a view of restraining such an accumulation over a determined period of time, the DTC proposes to allow either 15% of the surplus or 10% or gross receipts, whichever is higher, to be utilised within three years from the end of the relevant financial year. Such a provision can be viewed in two ways. Firstly it can be presumed that such a provision would enhance the functioning of the NPO’s so that they make use of the funds so received within a definite period of time thereby preventing the mischief under the existing law. On the flipside such a provision may prohibit certain NPO’s on utilising their funds for specific savings. Illustrating further, if an NPO which accumulates or sets aside a part of their surplus for future benefits would have to pay a tax of 15% on the same if such is not utilised within the period prescribed by the code. This would in effect limit the capability of the NPO in the advancement of its chosen sphere of charitable purpose. Certain savings made by NPO’s would also be in jeopardy as it would become liable to tax after a period of three years. The DTC has also clearly demarcated a prohibited form of investment for NPO’s, however without specifying the nature of such assets. For instance the code fails to specify the nature and scope of financial assets. Further it becomes pertinent to analyse whether the segregation of deductions available to donors under section 72 benefits the NPO’s more than the existing provision under s.35AC which provides for a 100% deduction. Segregation in deductions would create a difference in the capabilities of different NPO’s to provide deductions thereby preventing the capitalisation of funds at an equal footing.

It is necessary to understand that NPO's play a significant role in the aiding the society. Therefore it creates an even higher burden on the Government to implement changes which would create incentives for NPO's.Pursuant to the above observations it is necessary to determine which provisions would benefit the NPO’s and to what extent they would provide a better structure over the existing Act. In my opinion it is necessary to review the applicability of the proposed provisions by consulting existing NGO's so that it creates a balance between the tax code and its subsequent effect on these institutions and trusts.
For the benefit of comparative review, both the first proposal of the Direct Tax Code and the subsequent revised code has been attached.