Tuesday, August 22, 2023

Tax Implications of Amendment to Charitable Trust Donations: An In-depth Analysis

1. Introduction and Background

  • The Finance Act 2023 introduced a significant amendment to Section 11(1) by adding clause (iii) to Explanation 4, effective from the assessment year 2024-25.
  • This amendment stipulates that only 85% of eligible donations made by one trust to another under Section 12AB or approved under Section 10(23C) will be treated as the application of income.
  • A question emerges regarding the potential tax liability on the remaining 15% of such donations.

2. Understanding the Concept of 85% Application and 15% Accumulation of Income

  • Charitable and religious trusts are exempted from tax if they apply at least 85% of their income for charitable or religious purposes and accumulate up to 15%.
  • Statutory provisions outline that 85% of income must be applied, and up to 15% can be accumulated without any conditions.
  • Accumulation of 15% is unconditional and not subject to any constraints, providing trusts with the liberty to accumulate for future use.

3. Specific Disallowances of Application

  • The Finance Acts of 2017, 2018, and 2023 introduced amendments disallowing certain applications for deductions from taxable income.
  • These disallowances include inter-charity donations towards corpus, disallowances due to TDS violations and cash payments, and disallowances of certain inter-charity donations.
  • These disallowances have led to complexities in determining the taxable amount.

4. Tax Implication on the Disallowance of 15%

  • The central question pertains to whether the 15% disallowance leads to tax liability when there's no actual available amount for accumulation.
  • The disallowed 15% can be considered as used from the statutory accumulation of up to 15%, which has no restrictions on its utilization.
  • The objective of the amendment is to ensure a minimum application of 85% at each layer of inter-charity donation, thwarting multiple-layer accumulation.

4.1. Objective of the Amendment

  • The Finance Bill 2023 amendment seeks to prevent misuse of inter-charity donation provisions by trusts forming multiple layers and accumulating 15% at each stage.
  • The amendment ensures that only 85% of eligible donations at each layer are treated as application, preserving the 15% accumulation for genuine use.

4.2. No Indirect Benefit of Statutory Accumulation

  • The amendment denies the benefit of statutory accumulation on the portion of income used for inter-charity donation.
  • Organizations must either apply more funds or pay tax on the disallowed portion of income used for such donations.

4.3. No Tax up to 15% Accumulation

  • Section 115BBI does not apply to the 15% accumulation. It is invoked only when accumulation exceeds 15%.
  • The amendment does not impose taxation on the 15% accumulation.

5. Implication of Excessive Disallowances

  • If cumulative disallowed amounts exceed 15%, the surplus beyond 15% becomes taxable under section 115BBI.
  • Organizations cannot accumulate beyond 15% in such cases, nor can they resort to Section 11(2) accumulation.

In conclusion, the amendment to Section 11(1) through the Finance Act 2023 has stirred debates about potential tax liabilities arising from disallowing 15% of donations. This analysis sheds light on the nuances of the amendment, emphasizing the objectives behind it, the complexities in application, and the impact on tax implications for charitable trusts.