Issue for Consideration
U/s. 11 of the Income Tax Act, 1961, a charitable or religious trust, subject to certain conditions,is entitled to exemption in respect of income from property held under trust for charitable or religious purposes, to the extent that such income is applied for charitable or religious purposes, or accumulated for charitable or religious purposes.
The CBDT has clarified vide its circular number 5 – P(LXX-6) dated 19th June 1968 that for the purposes of such exemption u/s. 11, the income of a trust is to be taken in the commercial sense, and not as computed under the provisions of the Income Tax Act. In other words, the income, that is eligible for exemption, is the one that has been determined as per the books of account. This position clarified by the CBDT is also confirmed by the decisions of the various high courts .
Taking this into account, various high courts have also held that that depreciation had necessarily to be deducted in computing the commercial income, as depreciation was a necessary accounting adjustment to income. Further, various courts, including the Supreme Court in the case of M. Ct. M. Tiruppani Trust vs. CIT 230 ITR 636, have held that all capital expenditure laid out in furtherance of the objects and purposes of the trust would be treated as an application of the income.
The question that has arisen before the courts as to whether, when a trust has claimed the capital expenditure on acquisition of an asset as an application of income for the purposes of claiming exemption u/s. 11, whether depreciation on such asset was also allowable as a deduction in computing the income of the trust. While the Bombay, Punjab and Haryana and Delhi High Courts have taken the view that depreciation would be allowable as a deduction even in such cases where the capital expenditure had been allowed as an application of income for charitable purposes, the Kerala High Court has taken a contrary view, holding that such depreciation should be added back to the income of the trust as disclosed in its books of account.
Institute of Banking Personnel Selection’s case:
The issue came up before the Bombay High Court in the case of CIT vs. Institute of Banking Personnel Selection 264 ITR 110. In that case, the assessee was a charitable trust registered under the Bombay Public Trusts Act, 1950, as well as u/s. 12A of the Income Tax Act. It claimed depreciation on buildings, the cost of which had been allowed as a deduction in earlier years. It also claimed depreciation on furniture and fixtures which had been received by transfer from another trust, whose income was also exempt u/s. 11, and which had claimed the cost of such furniture and fixtures as an application of income in earlier years. The Assessing Officer disallowed the depreciation on buildings as well as on furniture and fixtures, on the grounds that capital expenditure incurred was allowed as a deduction from the income of the assessee, and that if depreciation was allowed, it would result in double deduction as full capital cost of furniture and fixtures had been allowed.
The Bombay High Court referred to its earlier decisions in the cases of CIT vs. Munisuvrat Jain Temple Trust (1994) Tax LR 1084 and DIT(E) v Framjee Cawasjee Institute 109 CTR 463. In the first case, it had been held that the income of a charitable trust was liable to be computed in normal commercial manner, although the trust might not be carrying on any business and the assets in respect whereof depreciation was claimed might not be business assets. It was also held that section 32 of the Income Tax Act would not apply to such depreciation, and that income was to be computed after providing for allowance for normal depreciation, and deducting such depreciation from gross income of the trust.
In Framjee Cawasjee Institute’s case, it was held that though the amount spent on acquiring the assets had been treated as application of income of the trust in the year in which the income was spent on acquiring those assets, that did not mean that in computing income from those assets in subsequent years, depreciation in respect of those assets could not be taken into account.
The Bombay High Court followed its earlier decisions and took the view that depreciation was allowable even on those assets whose actual cost had been allowed as a deduction in computing the income of the earlier years. A view similar to that of the Bombay High Court has been taken by the Punjab and Haryana High Court in the case of CIT vs. Market Committee, Pipli 330 ITR 16 and by the Delhi High Court in the case of DIT vs. Vishwa Jagriti Mission 73 DTR (Del) 195.
Lissie Medical Institutions’ case:
The issue also came up before the Kerala High Court in the case of Lissie Medical Institutions vs. CIT 76 DTR (Ker) 372.
In this case, the assessee was a charitable institution registered u/s.12A, and running a hospital. It acquired medical equipment, such as x-ray units, scanning machines, etc., the expenditure for acquisition of which was treated as application of income for charitable purposes u/s. 11. In computing the income from the hospital, the assessee also claimed depreciation on such equipments, on assets acquired during the year as well as on assets acquired during earlier years.
The Assessing Officer was of the view that the assessee’s case was that of a double deduction of capital expenditure, since acquisition of assets was treated as acquisition of income for charitable purposes, and the value of the assets stood fully written off. On appeal, the tribunal, following the judgment of the Supreme Court in the case of Escorts Ltd vs. Union of India 199 ITR 43, confirmed such disallowance.
On a further appeal by the assesee, the Kerala High Court observed that if the assessee treated an expenditure on acquisition of assets as application of income for charitable purposes u/s. 11, and the assessee also claimed depreciation on the value of such assets, then in order to reflect the true income that was available for application for charitable purposes, the assessee should write back the depreciation amount in the accounts to form part of the income to be accounted for application for charitable purposes. If this was not done, according to the Kerala High Court, the income which would be available for application for charitable purposes got reduced by the depreciation amount, which in the court’s view was not permissible u/s. 11. The net effect in a case where an assessee claimed depreciation in respect of an asset the full value of which was claimed as an application of income for charitable purposes, such notional claim of depreciation became cash surplus available with the assessee, which remained outside the books of account of the trust, unless it was written back, which was not done by the trust.
The Kerala High Court observed that it did not think it was permissible for a charitable institution to generate income outside the books in this fashion. The Kerala High Court noted that in all the other decisions cited before it of the other high courts, none of the courts had examined the aspect of availability of income to the trust on write back of the depreciation, in cases where depreciation was claimed as a notional cost after the assessee claimed 100% of the cost incurred for it as application of income for charitable purposes, the depreciation so claimed was to be added back as income available.
Interestingly, the Kerala High Court, on a consideration of the clarification of the CBDT filed before it, observed that based on the decisions of other high courts, all the charitable institutions were generating unaccounted income equal to the depreciation amount claimed on a year-to-year basis, which was nothing but black money, and that this aspect had not been considered in any of these decisions.
The Kerala High Court also was of the view that the issue was covered by the decision of the Supreme Court in Escorts’ case (supra), where the Supreme Court had observed that “the mere fact that a baseless claim was raised by some overenthusiastic assessees who sought a double allowance or that such claim may perhaps have been accepted by some authorities is not sufficient to attribute any ambiguity or doubt as to the true scope of the provisions as they stood earlier”.
However, considering the fact that depreciation had been allowed for several years to the assessee, the Kerala High Court observed that the assessee could not be taken by surprise by disallowing depreciation, which was being allowed for several years. It therefore allowed the assessee to write back the depreciation for the year before it, and even for previous years, and carry forward such income for application for subsequent years.
Observations
The CBDT, in spite of its clarification vide its circular number 5 – P(LXX-6) dated 19th June 1968 that for the purposes of such exemption u/s. 11, the income of a trust is to be taken in the commercial sense, and not as computed under the provisions of the Income Tax Act put forward following the interesting contention before the Kerala High Court that seem to have appealed to the court to a great extent :
“The CBDT is of the considered view that where an assessee has acquired an asset, through application of income and has also claimed this amount as expenditure in its income and expenditure account, depreciation on such assets would not be allowable to the assessee. Such notional statutory deductions like depreciation, if claimed as deduction while computing the income of the property held under trust under the relevant head of income, is required to be added back while computing the income for the purpose of application in the income and expenditure account. This would imply that the correct figure of surplus from the trust property is reflected in the income and expenditure account of the trust to determine the income for the purposes of application under section 11 of the Income Tax Act. This would reduce the possibility of revenue leakage which may be a cause for generation of black money.”
One fails to understand as to why depreciation should be written back in the books of account of the assessee, when it is otherwise a charge on the profits of the year and is required to be provided for as per the accounting standards and practices. The accounts will represent a fallacious view where on one side it provides for the depreciation and on the other side it credits a write back of the same depreciation. Again, it is impossible to fathom as to how black money could ever be generated by not writing back depreciation, because there is no outflow of funds from the trust, depreciation is merely a notional entry in accordance with accounting standards and practices. At best, there is a reduction in the commercial profit of the trust.
Perhaps, what the CBDT desired was that in computing the commercial income for the purposes of grant of exemption, the amount of such depreciation should be added back and treated as income available for application for charitable purposes, since the cost of the assets had been treated as an application of income for charitable purposes. This desire however, is not set out in the provisions of the Act and in any case is contrary to its own circular clarifying that the profit of the trust is the one that is understood in the commercial sense and as a consequence thereof has to be computed in the manner as is computed by a commercial man, i.e after providing for depreciation on the assets used by it, irrespective of the fact that the cost of it is treated as an application of income and as a consequence of such treatment is allowed, as a deduction in computing the income of the trust.
Can such depreciation ever be regarded as an income of the trust in commercial terms? In the context of repayment of loan scholarships by scholars who had taken loans by way of scholarships for their studies from a trust, the CBDT had clarified, vide Circular No. 100 dated 24-01-1973 that when such loans were given, they should be treated as an application of income for charitable purposes, but that the re-payment of the loans should then be regarded as income of the trust. No such clarification is issued in the context of application of income qua the capital assets and incidental claim if depreciation thereon. The said circular in fact, supports the view of the assessee, where it goes on to state that the repayment of loan by a trust originally taken is an application of income in the hands of the trust. The Bombay High Court, in the case of CIT vs. Trustees of Kasturbhai Scindia Commission Trust 189 ITR 5, had held that return of a loan by a debtor to a creditor could never constitute an income, even though the trust might have got a deduction as an application for charitable purposes for the amount of loans given, in the year of grant of such loans. By the same logic, depreciation provided by a trust can never be added back as its income, as it is never commercially considered to be income.
The Punjab and Haryana High Court in the Market Committee’s case (supra) has rightly observed, in relation to the argument that allowance of such depreciation amounted to a double deduction and therefore was covered by the decision in the Escorts’ case (supra), that it was not a double deduction. The court observed that the income of the assessee being exempt, it was only claiming that depreciation that was required to be reduced from the income for determining the percentage of funds that were to be applied for the charitable purposes. According to the Punjab and Haryana High Court, it was therefore not a case of a double benefit, and that the decision in the Escorts’ case (supra) was distinguishable.
Similarly, the Delhi High Court in the Vishwa Jagriti Mission’s case (supra), while noting the various High Court decisions holding that depreciation was a necessary deduction in computing the commercial income, observed that the allowance of depreciation was necessary on commercial principles. It distinguished the Escorts’ case on the grounds that the Supreme Court, in that case, was not concerned with the case of a charitable trust involving the question as to whether its income should be computed on commercial principles in order to determine the amount of income available for application to charitable purposes, but was dealing with a case where a deduction was allowed in computing business profits and depreciation was also being claimed while computing business profits. In case of charitable trusts, what was relevant was only the concept of commercial income as understood from the accounting point of view, and there was an authority for the proposition that depreciation was a necessary charge in computing the net income. The Delhi high court also noted that the Supreme Court was concerned with a case where the assessee had claimed deduction of the cost of an asset u/s. 35, which allowed deduction for capital expenditure incurred on scientific research, and the question was whether, after claiming deduction in respect of the cost of the asset u/s. 35, whether the assessee could again claim deduction on account of depreciation in respect of the same asset. The Supreme Court in that case had observed that under general principles of taxation, double deduction was not intended unless clearly expressed and , the case before it was not one of that type.
A capital expenditure is treated as an application of income for charitable purposes, under the Act, while depreciation is a deduction in computing the income itself, which is available for application for charitable purposes. These are two different things. Claiming the cost of an asset as an application for charitable purposes is not the same thing as providing depreciation in computing the profit available for spending for charitable purposes. This is therefore not a case of a double deduction.
The better view of the matter therefore seems to be that of the Bombay, Punjab and Haryana and Delhi High Courts which holds that reduction of depreciation from the income is not a double deduction. The view taken by the Kerala High Court requires reconsideration.
