Tuesday, December 26, 2023

Taxation on Sale of Capital Assets by Charitable Institutions

Charitable institutions, integral to social causes, rely on diverse funding sources, including the sale of capital assets. The taxation dynamics for these entities differ significantly from non-charitable entities. In this discussion, we delve into the various aspects of the taxation on the sale of capital assets by charitable institutions.

1. Nature of Charitable Institutions

Charitable institutions are typically set up as trusts, societies, or companies under Section 8 of the Companies Act, 2013, to engage in charitable or religious activities. Notable examples include Anubhuti and Care India.

2. Income Tax Exemptions and Compliance Requirements

Entities seeking exemption under Section 10(23C) or Sections 11 to 13 must file timely income tax returns under ITR-7. The requirement for auditing and bookkeeping varies based on gross receipts, as outlined below:

  • Gross Receipts Up to Rs. 2.5 Lakhs: Books not mandatory, no audit required.
  • Gross Receipts Rs. 2.5 Lakhs - 5 Crore: Books mandatory, Form 10BB audit, ITR mandatory.
  • Gross Receipts more than Rs. 5 Crore: Books mandatory, Form 10B audit, ITR mandatory.

Useful Table:

Gross ReceiptsBooks MandatoryAudit Form RequiredITR Mandatory
Up to Rs. 2.5 LakhsNoNot requiredNo
Rs. 2.5 Lakhs - 5 CrYesForm 10BBYes
More than Rs. 5 CrYesForm 10BYes

3. General Treatment of Trust Income

Trust income is subject to the 85% and 15% rule. While 15% receives complete exemption, the remaining 85% qualifies for exemption only if applied for the trust's intended purposes. Options for cases where the full 85% cannot be applied include deemed application via Form 9A, accumulation through Form 10, or paying tax on the shortfall.

4. Tax Implications on Sale of Capital Assets

When charitable institutions sell capital assets held wholly for charitable or religious purposes, Section 11(1A) applies. Three primary options for treating capital gains are:

  1. Reinvest the entire sale proceeds for full exemption under Section 11(1A).
  2. If part of the proceeds is invested, compute capital gain based on the indexed cost, and the excess is deemed applied for charitable purposes.
  3. Use the sale proceeds for the trust's object (excluding acquiring a new asset) as an application of income. If 85% is applied, the income is exempt under Section 11(1)(a).

Useful Table:

Options for Capital Gain TreatmentDescription
Reinvest entire sale proceedsFull exemption under Section 11(1A), deemed applied for charitable object.
Invest part of proceeds, compute gain based on indexed costExcess amount deemed applied for charitable purpose. Cost of transferred asset is the indexed cost.
Use proceeds for trust's object (excluding new asset acquisition)If 85% applied, income falls under "Income derived from property held under trust," exempt under Section 11(1)(a).

5. Understanding Section 11(1A)(a)

Section 11(1A)(a) outlines the treatment for the transfer of a capital asset held wholly for charitable purposes. The amount deemed to be applied is based on the net consideration utilized.

6. Case Studies for Better Understanding

Case 1:

  • Trust transfers an asset for Rs. 50 Lakhs, incurs transfer expenses of Rs. 1 Lakh, and invests Rs. 49 Lakhs in a new asset. Result: Nil capital gain.

Case 2:

  • Trust transfers land for Rs. 45 Lakhs, indexed cost Rs. 25 Lakhs, acquires new land for Rs. 30 Lakhs. Result: Exemption available for Rs. 5 Lakhs.

7. Frequently Asked Questions (FAQs)

Useful FAQs:

  1. Is capital gain from the sale of assets included in gross receipts? (Answer: Yes, as per CBDT Circular No. 72)
  2. Is the cost of improvement considered in computing capital gain? (Answer: Yes, but improvements before April 1, 2001, are ignored)
  3. Does the charitable trust benefit from indexation? (Answer: Yes, as per Section 11(1A))
  4. Are assets like National Savings Certificates considered capital assets? (Answer: Yes, as per relevant court cases)
  5. What are the reporting responsibilities of an auditor? (Answer: Detailed reporting in Form 10B)

8. Conclusion

In conclusion, the taxation of capital assets by charitable institutions involves unique considerations. Understanding the distinct self-code for calculating capital gains, along with exemptions and reporting requirements, is crucial for these entities. Sections 45 to 55 of the Income Tax Act do not apply, making the taxation landscape distinctive for charitable institutions