BUSINESS INCOME OF A CHARITABLE INSTITUTION

Section 11(4) provides that a ‘property held under trust’ includes a business undertaking held in trust and the income from such business, subject to the power of the A.O., shall not be included in the total income of the institution.

Sub-section (4A) provides for the denial of the benefit of tax exemption u/s 11(1) and prohibits the application of sub-sections (2), (3) and (3A) in relation to any income being profits and gains of business, unless the business is incidental to the attainment of the main objectives of the trust and separate books of accounts are maintained for the business.

The ‘property held under trust’ is required to be held for the charitable or religious purposes for its income to qualify for exemption from taxation. The term ‘charitable purpose’ is defined by section 2(15) and includes relief of the poor, education, yoga, medical relief, preservation of environment and of monuments or places or objects of artistic or historic interest, and the advancement of any other object of general public utility. A proviso to section 2(15) stipulates some stringent conditions in respect of an institution whose object is the advancement of general public utility, where it is carrying on any business to advance its objects. The said proviso does not apply to institutions whose objects are other than those of advancing general public utility, provided their objects otherwise qualify to be treated as charitable purposes.

The sum and substance of the aforesaid provisions, in relation to business carried out by an institution, is that a business run by it would be construed as a ‘property held under trust’ and its income, subject to the proviso to section 2(15), would be exempt from tax u/s 11. The conditions prescribed u/s (4A), where applicable, would require the business to be incidental to the attainment of the objectives of the trust and separate books of accounts would have to be maintained in respect of the business by the institution.

Some interesting controversies have arisen around the true meaning and understanding of the terms ‘property held under trust’ and ‘incidental to the attainment of the objectives of the trust’ and in relation to the applicability of sub-section (4A) to cases where provisions of sub-section (4) are applicable. The Delhi High Court has held that a business carried on with borrowed funds and unrelated to the objects of the trust could not be held to be a ‘property held under trust’. It has also held that for a business to be incidental to the attainment of the objects of the trust, its activities should be intricately related to its objects. It also held that the provisions of sub-section (4A) and sub-section (4) cannot apply simultaneously. As against the above decision, the Madras High Court has held that a business carried on by the trust is a ‘property held under trust’ and such business would be construed to be incidental to the attainment of the objectives of the trust where the profits of such business are utilised for meeting the objects of the trust and, of course, separate books of accounts are maintained by the trust.

Some of these issues have a chequered history and were the subject matter of many Supreme Court decisions, including in the cases of J.K. Trust, 32 ITR 535; Surat Art Silk Cloth Manufacturers Association, 121 ITR 1; and Thanthi Trust, 247 ITR 785. Besides the above, the Supreme Court had occasion to examine the meaning of the term ‘not involving the carrying out of any activity of profit’ and the concept of business held in trust in the cases of CIT vs. Dharmodayam Co., 109 ITR 527 (SC); Dharmaposhanam Co. vs. CIT, 114 ITR 463 (SC); and Dharmadeepti vs. CIT, 114 ITR 454 (SC).

MEHTA CHARITABLE PRAJNALAY TRUST’S CASE

The exemption u/s 11 claimed by the trust was denied by the A.O. for some of the years and such denial was confirmed by the CIT(A) on the ground that the Katha business was carried on by the trustees and not by the beneficiaries of the trust, as was required by the then applicable section 11(4A), and the exemption was not available to the trust in respect of the profits of the Katha business. In respect of some other years, the CIT(A) held that the business was held under trust and was covered by section 11(4) of the Act and on application of the said section, the provisions of sections 11(4A) were not applicable and therefore the trust was entitled for the exemption. For the years under consideration, the A.O. denied the exemption for the same reasons, besides holding that carrying on of the Katha business was not incidental to the attainment of the objects of the trust. The orders of the A.O. for those years were sustained by the CIT(A) for reasons different from those of the A.O.

On appeal, the Tribunal, following its decision for the A.Y. 1989-90, held that the Katha business carried on by the assessee was incidental to the attainment of the objects of the trust, which were for charitable purposes. Relying on the judgment of the Supreme Court in Thanthi Trust (Supra), in which the effect of the amendment was considered, the Tribunal held that the said decision squarely covered the controversy in the present case about the business being incidental to the attainment of the objects of the trust.

The High Court noted that the Tribunal did not specifically address itself to the question which arose out of the order of the CIT(A), whether the business itself can be said to be property held under trust within the meaning of section 11(4). There was no discussion in the order of the Tribunal as to the impact of the various clauses of the trust deed which were referred to by the CIT(A) while making a distinction between the objects of the trust and the powers of the trustees. In respect of all the other assessment years, namely, 1993-94, 1994-95, 2001-02 and 2005-06 to 2007-08, the Tribunal followed the order passed by it for the A.Y. 1992-93.

On an appeal by Revenue, the Delhi High Court in appreciation of the contentions of the parties, held as under:
• There was no exhaustive definition of the words ‘property held under trust’ in the Act; however, sub-section (4) provided that for the purposes of section 11 the words ‘property held under trust’ include a business undertaking so held.

• The question whether sub-section (4A) would apply even to a case where a business was held under trust was answered in the negative in several authoritative pronouncements. Thus, if a property was held under trust, and such property was a business, the case would fall u/s 11(4) and not u/s 11(4A). Section 11(4A) would apply only to a case where the business was not held under trust. In view of the settled legal position, the contention of the Revenue, that the provisions of section 11(4A) were sweeping and would also take in a case of business held under trust, was not acceptable.

• In the facts of the present case, and having regard to the terms of the trust deed and the conduct of the trustees, it could not be said that the Katha business was itself held under trust. There was a difference between a property or business held under trust and a business carried on by or on behalf of the trust, a distinction that was recognised in Surat Art Silk Cloth Manufacturers Association (Supra), a decision of five Judges of the Supreme Court. It was observed that if a business undertaking was held under trust for a charitable purpose, the income therefrom would be entitled to the exemption u/s 11(1).

• In the case before the Court, the finding of the CIT(A), in his order for the A.Y. 1992-93, was that the Katha business was not held under trust but it was a business commenced by the trustees with the aid and assistance of borrowings from the sister concerns in which the settlors and the trustees or their close relatives had substantial interest, as well as from banks. It was thus with the help of borrowed funds, or in other words, the funds not belonging to the assessee trust, that the Katha business was commenced and profits started to be earned.

• There was a distinction between the objects of a trust and the powers given to the trustees to effectuate the purposes of the trust. The Katha business was not even in the contemplation of the settlors and, therefore, could not have been settled upon trust, even where they were empowered to start any business.

• There was thus no nexus or integration between the amount originally settled upon the trust and the later setting up and conduct of the Katha business. Moreover, the distinction between the original trust fund and the later commencement of the business with the help of borrowed funds should be kept in mind in the context of ascertaining whether the particular Katha business was even in the contemplation of the settlors of the trust.

• There was no connection between the carrying on of the Katha business and the attainment of the objects of the trust, which were basically for the advancement of education, inculcation of patriotism, Indian culture, running of dispensaries, hospitals, etc. The mere fact that the whole or some part of the income from the Katha business was earmarked for application to the charitable objects would not render the business itself being considered as incidental to the attainment of the objects. The Delhi High Court was in agreement with the view taken by the CIT(A) in his order for A.Y. 1992-93 that the application of the income generated by the business was not the relevant consideration and what was relevant was whether the activity was so inextricably connected to or linked with the objects of the trust that it could be considered as incidental to those objectives.

• Prima facie, the observations in the case of Thanthi Trust (Supra) would appear to support the assessee’s case in the sense that even if the Katha business was held not to constitute a business held under trust, but only as a business carried on by or on behalf of the trust, so long as the profits generated by it were applied for the charitable objects of the trust, the condition imposed u/s 11(4A) should be held to be satisfied, entitling the trust to the tax exemption.

• The observations of the Apex Court, however, have to be understood in the light of the facts before it. The assessee in that case carried on the business of a newspaper and that business itself was held under trust. The charitable object of the trust was the imparting of education which fell u/s 2(15). The newspaper business was certainly incidental to the attainment of the object of the trust, namely, that of imparting education. The observations were thus made having regard to the fact that the profits of the newspaper business were utilised by the trust for achieving the object, namely, education. The type of nexus or connection which existed between the imparting of education and the carrying on of the business of a newspaper did not exist in the present case. There was no such nexus between the Katha business and the objects of the assessee trust that can constitute the carrying on of the Katha business, an activity incidental to the attainment of the objects, namely, advancing of education, patriotism, Indian culture, running of hospitals and dispensaries, etc.

• It would be disastrous to extend the sweep of the observations made by the Supreme Court in the case of the Thanthi Trust (Supra), on the facts of that case, to all cases where the trust carried on business which was not held under trust and whose income was utilised to feed the charitable objects of the trust. The observations of the Supreme Court must be understood and appreciated in the background of the facts in that case and should not be extended indiscriminately to all cases.

The Delhi High Court held that a business carried on with borrowed funds and unrelated to the objects of the trust could not be held to be a ‘property held under trust’. It has also held that for a business to be incidental to the attainment of the objects of the trust, its activity should be intricately related to its objects. It also held that where a property was held under trust and such property was a business, the case would fall u/s 11(4) and not u/s 11(4A). Section 11(4A) would apply only to a case where the business was not held under trust. It therefore held that the Katha business was not a property held under trust, the provisions of section 11(4) did not apply, and the provisions of section 11(4A) would have to be applied. Since the business was not incidental to the attainment of the objects of the trust as required by section 11(4A), the trust was not entitled to exemption in respect of the business income.

The Special Leave Petition filed by the assessee against this decision has been admitted by the Supreme Court as reported in Mehta Charitable Prajnalay Trust vs. CIT, 248 Taxman 145 (SC).

BHARATHAKSHEMAM’S CASE

In this case, the facts gathered from the order of the High Court reveal that the claim for exemption of the trust in respect of its profit from its Chitty / Kuri business was denied by the A.O. on the grounds that such a business was not incidental or ancillary to the attainment of the objects of the trust. The A.O. had also evoked the proviso to section 2(15) which was held by the Court to be irrelevant in view of the finding that the said proviso had a restricted application to the cases where a business was being carried on for pursuing its object of carrying on an activity of general public utility. In the case before the Court, the main object was providing medical relief and the profits of the business were utilised for medical relief which was the main object of the trust.

The first appellant authority held that the business was carried out by the trust for the mutual benefit of the subscribers to the Chitty / Kuri and the substantial profit of the business was passed on to such subscribers and therefore such business, which retained minor profits, could not have been treated as incidental to the objects of the trust. It also held that the profit, even where applied fully to the objects of the trust, could not have deemed the business to be incidental to the main objects of the trust. On appeal by the assessee to the Tribunal, it agreed with the findings of the first appellate authority and also referred to the first proviso to section 2(15) to hold that the business of the trust was not incidental to the attainment of the objects of the trust.

On further appeal to the High Court, relying on a few decisions of the courts, the Kerala High Court held that the proviso to section 2(15) had no relation to the case of the trust which had as its object providing medical relief. This part is not relevant to the issues under consideration here and is mentioned only for completeness.

The Court also observed, though not relevant to the issue before it, that in the aftermath of the deletion of section 13(1)(bb) and insertion of sub-section (4), the distinction between a business held in trust and one run by the trust was not very relevant and the observations in the minority judgment in the case of Thanthi Trust (Supra) should not be applied in preference to the observations of the majority, more so when the court later on delivered a unanimous judgment of the five judges.

On the issue of satisfaction of the condition of sub-section (4A), relating to the business being incidental to the attainment of the objects of the trust, the Kerala High Court exclusively relied on paragraph 25 of the decision of the Supreme Court in the case of the Thanthi Trust (Supra) for holding that the business of Chitty / Kuri was incidental to the attainment of the objects of the trust. The said paragraph 25 is reproduced hereunder:

‘The substituted sub-section (4A) states that the income derived from a business held under trust wholly for charitable or religious purposes shall not be included in the total income of the previous year of the trust or institution if “the business is incidental to the attainment of the objective of the trust or, as the case may be, institution” and separate books of accounts are maintained in respect of such business. Clearly, the scope of sub-section (4A) is more beneficial to a trust or institution than was the scope of sub-section (4A) as originally enacted. In fact, it seems to us that the substituted sub-section (4A) gives a trust or institution a greater benefit than was given by section 13(1)(bb). If the object of Parliament was to give trusts and institutions no more benefit than that given by section 13(1)(bb), the language of section 13(1)(bb) would have been employed in the substituted sub-section (4A). As it stands, all that it requires for the business income of a trust or institution to be exempt is that the business should be incidental to the attainment of the objectives of the trust or institution. A business whose income is utilised by the trust or the institution for the purposes of achieving the objectives of the trust or the institution is, surely, a business which is incidental to the attainment of the objectives of the trust. In any event, if there be any ambiguity in the language employed, the provision must be construed in a manner that benefits the assessee. The trust, therefore, is entitled to the benefit of section 11 for A.Y. 1992-93 and thereafter. It is, we should add, not in dispute that the income of its newspaper business has been employed to achieve its objectives of education and relief to the poor and that it has maintained separate books of accounts in respect thereof.’

The Kerala High Court, in paragraph 13, examined the facts and the decision of the Delhi High Court in the case of Mehta Charitable Prajnalay Trust (Supra) relied upon by the Revenue. In paragraph 14 it reiterated the above-referred paragraph 25 of the decision in the case of the Thanthi Trust (Supra) to disagree, in paragraph 15, with the ratio of the decision of the Delhi High Court in the case of Mehta Charitable Prajnalay Trust (Supra). The Court also held that the Chitty / Kuri business did not require any initial investment and therefore the facts in the case before it were found to be different from the facts in the case before the Delhi High Court. The Kerala High Court also noted that the example cited by the Delhi High Court was relevant only in the context of section 13(1)(bb), which became irrelevant on its deletion; on simultaneous insertion of sub-section (4A), the case was to be adjudicated by reading the substituted provision that did not stipulate any condition that business carried on by the trust should be connected or should have nexus with the charitable purpose for such business to be treated as being carried on as incidental to the attainment of the objects of the trust. It held that the Chitty / Kuri business was incidental to the main object as long as its profits were applied for medical relief, which was the object of the trust. The trust was accordingly granted the exemption in respect of its profits of the Chitty / Kuri business.

OBSERVATIONS
The issue that moves in a narrow compass, is about the eligibility of a trust for exemption u/s 11 where it carries on a business, the corpus whereof is supplied by the borrowings from the sister concerns of the settlor / trustees and the profit thereof is used for the purpose of meeting the objects of the trust; should such business be treated as one ‘held in trust’ and if yes, whether the business can be said to be incidental to the attainment of the objects of the trust.

A business run by a charitable institution, whether out of borrowed funds or from the funds settled on it, is surely a ‘property held under trust’ as is confirmed by the express provisions of sub-section (4) of section 11 and this understanding is confirmed by the decision of the Supreme Court in the case of Thanthi Trust (Supra). In this case, the Supreme Court observed ‘A public charitable trust may hold a business as part of its corpus. It may carry on a business which it does not hold as a part of its corpus. But it seems that the distinction has no consequence insofar as section 13(1)(bb) is concerned.’ The doubt, if any, was eliminated by the deletion of section 13(1)(bb) w.e.f. 1st April, 1983. Section 13(1)(bb) provided that nothing contained in section 11 or section 12 shall operate so as to exclude from the total income of the previous year of the person in receipt thereof, in the case of a charitable trust or institution for the relief of the poor, education or medical relief, which carries on any business, any income derived from such business, unless the business is carried on in the course of the actual carrying out of a primary purpose of the trust or institution.

The Supreme Court also stated in the Thanthi case:
 ‘Sub-section (4) of section 11 remains on the statute book and it defines property held under trust for the purposes of that section to include a business so held. It then states how such income is to be determined. In other words, if such income is not to be included in the income of the trust, its quantum is to be determined in the manner set out in sub-section (4).
Sub-section (1)(a) of section 11 says that income derived from property held under trust only for charitable or religious purposes, to the extent it is used in the manner indicated therein, shall not be included in the total income of the previous year of the trust. Sub-section (4) defines the words “property held under trust” for the purposes of section 11 to include a business held under trust. Sub-section (4A) restricts the benefit under section 11 so that it is not available for income derived from business unless ……’

The Supreme Court therefore clearly indicated that both sub-sections (4) and (4A) of section 11 have to be read together.

The position now should be accepted as settled unless the A.O. finds that the business is not owned and run by the institution. It is difficult to concur with a view that a business owned and run by a trust or on its behalf may still not be held to be ‘a property held under trust’. Sub-section (4) should help in concluding the debate. Yes, where the business itself is not owned or run by the trust, there can be a possibility to hold that it is not ‘a property held in trust’, but only in such cases based on conclusive findings that the business belongs to a person other than the trust.

The fact that the business is a ‘property held in trust’ by itself shall not be sufficient to exempt its income u/s 11 unless the business is found to be incidental to attainment of the objects of the trust and further the institution maintains separate books of accounts for such business. These conditions are mandated by the Legislature on insertion of sub-section (4A) into section 11 w.e.f. 1st April, 1992. In our considered opinion, the compliance of the conditions of sub-section (4A) is essential even for a business held as a ‘property held under a trust’. A co-joint reading of sub-sections (4) and (4A) is advised in the interest of the harmonious construction of the provisions that enables an institution to claim the exemption from tax.

The term ‘property held under trust’ is not defined in the Act; however, vide sub-section (4), for the purposes of section 11, the words ‘property held under trust’ include a business undertaking held by the trust. This by itself shall not qualify the trust to claim an exemption from tax. In our opinion, it is not correct to hold that once the case falls under section 11(4), the conditions of section 11(4A) will not have to be satisfied. For a valid claim of exemption, it is necessary to satisfy the twin conditions: that the business is a property held in the trust and the same is incidental to the attainment of the objects of the trust and that separate books of accounts are maintained of such business. It is also incorrect to hold that the provisions of sub-section (4A) would apply only to a business which is not a property held in trust; taking such a view would disentitle a trust altogether from claiming exemption for non-compliance of conditions of sections 11(1)(a) to (c) of the Act; the whole objective of insertion of sub-section(4A) would be lost inasmuch as it cannot be read in isolation of section 11(1)(a) to (c).

As regards the meaning of the term ‘incidental to the objects of the trust’, the better view is to treat the conditions as satisfied once the profits of the business are spent on the objects of the trust. There is nothing in section 11(4A) to indicate that there is a business nexus to the objects of the trust, for example, a business of running a laboratory or a school or a hospital w.r.t. the object of medical relief. The profit of the business of running a newspaper or printing press shall satisfy the conditions of section 11(4A) once it is utilised for the charitable purposes, i.e., the objects of the trust, even where there is no business nexus with the objects of the trust.

Attention is invited to the decision of the Madras High Court in the case of Wellington Charitable Trust, 330 ITR 24. In that case, the Court held that when a business income was used towards the achievement of the objects of the trust, it would amount of carrying on of a business ‘incidental to the attainment of the objects of the trust’. Importance is given to the application of the business income and not its source, its use and not its origin. Nothing would be gained by exempting an income which has a nexus with the objects of the trust but is not utilised for meeting the objects of the trust. The provisions of section 11(4) and section 11(4A) will have to be read together for a harmonious construction; it would not be correct to hold that section 11(4A) would override section 11(4) as doing so would make the very provision of section 11(4) otiose and redundant. The Court should avoid an interpretation that would defeat the provision of the law where there is no express bar in section 11(4A) that prohibits the application of section 11(4). The provisions should be construed to be complementary to each other.

Having said that, it would help the case of the trust, for an exemption, where the settlor of the trust has settled the business in the trust and the objects of the trust include the carrying on of such business for the attainment of the charitable objects of the trust.