This article aims to analyse the changes proposed on the taxability of non-profit organisations having regard to the draft Direct Taxes Code Bill, 2009, released on 12 August 2009 and the Revised Discussion Paper released on 15 June 2010.
Income-tax Act
Under the present scheme of the Income-tax Act ("Act"), the position on taxability of non-profit organisations ("NPO") is as follows:
Meaning of charitable purposes
“Charitable purpose” is defined to include relief of the poor, education, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest. It also includes advancement of any other object of general public utilility provided that it does not involve the carrying on any activity or services in the nature of trade, commerce or business for a cess, fee or any other consideration.
Exemption provisions
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The voluntary contribution towards corpus is exempt without there being any stipulation on application. The other income is exempt to the extent such income is actually applied for charitable purposes in India. Income from business which is incidental to the attainment of charitable objects is also covered within the ambit of exemption, provided that separate books are maintained for such business. The income on transfer of capital asset is treated as applied for charitable purpose to the extent the sale proceeds are utilised for purchase of another capital asset to be held for charitable purposes.
Unspent income
The Act recognises that it may not possible to utilise the entire income in the same year and therefore provides for accumulation to the extent of 15 per cent thereby a compulsion to utilise income only to the extent of 85 per cent of the income. Even for this 85 per cent, the Act provides a mechanism entitling the NPO to carry over the specified income for next five years subject to fulfilment of certain conditions.
Rationale for changes proposed in DTC
The government pointed out general and specific issues requiring change in the provisions governing charitable purpose. The general issues highlighted are complexity in the provisions and lack of efficiency and equity. The specific issues highlighted are litigations on the concept of accumulation which enabled deferment of utilisation, determination of whether business is incidental to the attainment of charitable objective and whether gross receipts or net income should be reckoned as income.
Salient features of the original DTC
Under the original Direct Taxes Code Bill, 2009 (“DTC”), the position on taxability of non-profit organisations (“NPO”) is as follows:
Meaning of charitable purpose
The concept of charitable purpose remained the same except that it was labelled as “permitted welfare activity” and the charitable organisation was termed as non-profit organisation.
Exemption provisions
The income was exempt only when the entire income had been spent as prescribed in the DTC. Failure to expend the entire income resulted into surplus which would be taxable.
The surplus was to be computed as difference between gross receipts from the permitted welfare activities and outgoings in relation to the activities.
The income from business or from transfer of business capital asset was to qualify for inclusion in gross receipts provided that the business was incidental to permitted activity (not being the activity for the advancement of any object of general public utility).
Unspent income
The unspent income was to be subject to tax at the rate of 15 per cent.
Other provisions
The DTC imposed the condition of mandatory registration requiring annual renewal.
The DTC also provided that the net worth of an organisation that ceases to be an NPO, converts into non-NPO or fails to transfer assets to another NPO on liquidation will be taxed at the rate of 30 per cent.
Revised Discussion Paper
It was represented before the Ministry of Finance that several of the provisions of DTC are harsh and may create undue burden on the functioning of the NPO. The Ministry has accordingly agreed to make modifications in the DTC:
1. Fresh registration will not be required for NPO’s having existing income tax registration. However, some prescribed additional information may need to be provided to the tax authorities.
2. Religious institutions, including institutions in States not having registration laws will be entitled for exemption subject to fulfillment of all the prescribed conditions. However, no income-tax deduction will be allowed in the hands of the donor.
3. Institutions engaged in charitable as well as religious activities will be exempt to the extent of income from religious activities. Income from charitable activities will be taxed in the manner of NPO’s, subject to fulfillment of all the prescribed conditions. However, no income tax deduction will be allowed in the hands of the donor.
4. Higher of 15 per cent of the surplus or 10 per cent of gross receipts may be carried forward for use within three subsequent years. However, the amount so carried forward if used for making donations to other NPO will not be regarded as application towards charitable purposes.
5. The phrase ‘permitted welfare activity’ will be replaced by the phrase ‘charitable purpose’
Additionally, it is provided that a basic exemption limit will be provided and only surplus in excess of limit will be subject to tax.
The representation that the option should be available with the NPO’s to choose between cash or mercantile basis of accounting was not accepted.
Conclusion
While the Revised Discussion Paper proposes positive changes to the earlier DTC specially by allowing carry over of unspent income and dispensing with the registration requirement, some of the concerns have still not been addressed by the Ministry of Finance. The issues such as taxing the net worth at the rate of 30 per cent on conversion, taxing income on transfer of financial assets under normal provisions are also burdensome for the NPO. Non consideration of these issues may result in the DTC provisions being more stringent as compared to the existing provisions in the Act.
The author is Leader-Business Tax at Deloitte India. Geeta Ramrakhiani, Senior Manager, Deloitte India assisted him for this article.