Monday, May 20, 2013

Regarding "Double deduction" issue in charitable trusts




Regarding "Double deduction" issue in charitable trusts .

In other words,  Is depreciation permissible when the entire cost of the asset has been allowed as application of Income? 

by Ms.Bhavya Rangarajan, Advocate, 
and Ms.B.Mala, CA, Associate,
M/s Subbaraya Aiyar, Padmanabhan & Ramamani Advocates, Chennai


(Disclaimer: This content of the article relates to date of published and the IT Act provisions applicable at that time)
Income from property held under trust

2 The Income-tax Act grants exemption to income from property held under trust for religious or charitable purposes, subject to the fulfillment of certain conditions laid down under the Act. This exemption is provided under Sec. 11. The relevant part of Clause 1 of the said section reads as follows:

Subject to the provisions of sections 60 to 63, the following income shall not be included in the total income of the previous year of the person in respect of the income-
(a) income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied to such purposes in India; and, where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of [fifteen] per cent of the income from such property;......"

So, we see that income from property held under trust is exempt. The basic condition for claiming the exemption is that income should be derived from the property held under a trust and the said income should be applied for charitable or religious purpose in India.

Income to be determined on commercial principles

The income derived from trust property has to be determined on normal commercial manner without classification under the various heads set out in Sec. 14. The various heads of income will not come into play here. The following decisions lay out this principle

In CIT Vs Trustee of H.E.H. The Nizam's Supplemental Religious Endowment Trust 127 ITR 378 (AP), it was held that trust not being a business undertaking, its income has to be determined as per its books of account. In this case, the Court held that all outgoings, irrespective of the fact that they relate to the assessment of the previous years, constitute expenditure and are to be excluded from the income of the trust.

A similar view was held in CIT Vs. Ganga Charity Trust Fund 162 ITR 612 (GUJ) and Gonvindu Naicker Estate Vs. ADIT 248 ITR 368 (Mad).

In CIT Vs The Estate of Shri V.L. Ethiraj 136 ITR 12 (MAD), the Court held as under:
The language of s. 11(1)(a) makes it clear that the income derived from the property held under trust wholly for charitable and religious purposes, to the extent to which such income is applied to such purposes in India, is excluded. When once the income from the property as such is excluded, there is no question of computing the income from the property by applying provisions of s. 14. Therefore, it is clear that the Tribunal has committed an error in holding that as a first step the ITO has to determine the different heads of income, with reference to the statutory deductions provided for in the relevant sections and thereafter should arrive at the total income. Consequently, the Tribunal is in error in giving the directions which it did. Since there is no question of computing the income under different heads with reference to the relevant statutory deduction for the purpose of determining the income under s. 11(1), the question of allowing any other outgoing by way of expenditure in addition to the statutory deductions does not arise”

Similarly, in CIT Vs Rao Bahadur Calavala Cunnan Chetty Charities, 135 ITR 485 (Mad), the Court held that the expression "income" has to be understood in the popular or general sense and not in the sense in which the income is arrived at for the purpose of assessment to tax by the application of some artificial provisions either giving or denying deduction. Taking into account the purpose for which the conditions of Sec. 11(1)(a) are imposed, it would be clear that one has to consider the income as arrived at in the context of what is available in the hands of the assessee, subject of course to any adjustment for expenses extraneous to the trust. If the expression "income" is so understood, then one has to take the accounts of the assessee with reference to the receipts and deduct therefrom the expenses necessary for earning or looking after that income. The net amount that remains would be available for distribution or application for charitable purpose. In applying the income for charitable purposes, even capital expenditure may be incurred. Therefore, the nature of the expenditure in the hands of the entity which receives the money is not the criterion. So long as the assessee disburses the amount for charitable purposes, the assessee would have complied with that part of the requirement of Sec. 11, namely, application of the income for charitable purposes. Therefore, the income from the properties held under trust would have to be arrived at in the normal commercial manner without reference to the provisions which are attracted by Sec. 14.

A similar view has been taken in CIT Vs Sheth ManilalRanchhoddas Vishram Bhavan Trust 198 ITR 598 (Guj) wherein it was held that the income from the properties held under trust would have to be arrived at in the normal commercial manner without classification under the various heads set out in Sec. 14. It held that the expression "income" has to be understood in the popular or general sense and not in the sense in which the income is arrived at for the purpose of assessment to tax by application of some artificial provisions either giving or denying deduction.

Therefore, it is clear from the above that the income of the trust is to be calculated on commercial principles.

Analysis of the term ‘applied’

Next, we look into the term ‘applied’. The term ‘applied’ is of crucial importance. This word envisages actual application of the income for the purposes of the trust. It cannot be taken to mean ‘spent’. Rather, it is the application of income. For instance, in CIT Vs. Trustees of H. E. H. the Nizam’s Charitable Trust [1981] 131 ITR 497 AP, the sanction was communicated to the donee but disbursement in respect thereof did not take place during the year. The Court held that it is not correct to equate the word "applied" with the word "spent". If the Legislature had intended that the amounts should actually be spent, there was nothing preventing it from using that word. Therefore, as there was no doubt that the money was sanctioned for a specific purpose, it was said to be ‘applied’.

The Supreme Court in the case of Gangabai Charities Vs. CIT (1992) 197 ITR 416 held that the crux of the statutory exemption under section 11(1)(a) of the Act is not the income earned from property held under trust but the actual application of the said income for religious and charitable purposes.

Entire cost of the asset has been allowed as application of income

An issue to be considered is whether depreciation will be allowed when the entire cost of the asset has been allowed as application of income. Depreciation on assets of a trust is to be deducted for the purpose of calculating the income of a trust. This is because of the fact that the concept of commercial income necessarily envisages deduction of depreciation on assets of the trust.

Depreciation

Depreciation is a noncash expense that reduces the value of an asset as a result of wear and tear, age or obsolescence. Depreciation is allowed as a deduction under the Income Tax Act. In CIT Vs. Alps Theatre [1967] 65 ITR 377 (SC)., it was held that depreciation is allowable as a deduction both according to accountancy principles and according to the Indian IT Act. If not, one would not have a true picture of the real income of the business. In CIT Vs. Raipur Pallottine Society 180 ITR 579 (MP), it was held that a charitable trust is entitled to depreciation in respect of assets held by it.

The issue which then arises is whether allowing depreciation will lead to a double deduction.

Allowing depreciation in the computation of income to be applied will not lead to a double deduction.

Deduction of depreciation is different from application of income, as has been explained in following case laws.

In CIT Vs Raipur Pallottine Society 180 ITR 579 (MP), it was held that depreciation on assets held by assessee-trust provided in books of accounts is allowable. If depreciation is not allowed as a necessary deduction for computing the income of charitable institution, then there would be no way to preserve the corpus of the trust for deriving income. The Revenue’s contention that depreciation under Sec. 32 of the Act could be allowed only when income was computed under the head "Business" falling under Sec. 28 of the Act was not accepted and in this regard, the court relied on the observations of the Karnataka High Court in CIT Vs. Society of the Sisters of St. Anne (1984) 146 ITR 28 (Kar).

In Director of Income Tax (Exemption) Vs. Framjee Cawasjee Institute (1993) 109 CTR 463 (Bom), the Court held that depreciation on depreciable assets had to be taken into account in computing the income of the trust although the amount spent on acquiring such assets had been treated as application of income of trust in the year in which assets were acquired. The Tribunal had clarified the position by stating that: 
“When the ITO says that full expenditure has been allowed in the year of the acquisition of the assets, what he really means is that the amount spent on acquiring these assets had been treated as application of income of the trust in the year in which the income was spent in acquiring these assets. This does not mean that in computing income from those assets in subsequent years, depreciation in respect of those assets cannot be taken into account.” As the position was clear, the Court declined the reference.

In CIT Vs. Tiny Tots Education Society (2011) 330 ITR 21 (P&H), the Court held that depreciation is allowable on capital assets from the income of charitable trust for determining the quantum of funds which have to be applied for the purposes of the trust in terms of Sec. 11. 

The provision relating to compulsory application of income is altogether a different concept and would come into play only after the income is determined. In determining the income, depreciation has to be taken into account. Application of income is not computation of income of the charitable institution. Therefore, the question whether depreciation is to be allowed or not has nothing to do with the application of income. Income is always to be computed on commercial principles and as per system of accounting followed by the assessee, subject always to the statutory provisions.

A similar view has been held in CIT Vs Market Committee, PIPLI 330 ITR 16 (P&H) wherein depreciation was allowed on capital assets of the charitable trust for determining the quantum of funds to be applied for the purposes of the trust in terms of Sec. 11. The court was of the view that depreciation in case of trusts was not a double deduction as it was not an expenditure; it only reduced the percentage of funds available for charitable or religious purposes. It negatived the claim of the Revenue which relied on the decision in Escorts Ltd. Vs. Union of India (1993) 199 ITR 43 (SC)


The Escorts Ltd. case distinguished

The P&H Court in Market Committe, Pipli (supra) distinguished the case as follows:

In the Escorts case, two deductions were claimed under both Sections 32(1) (ii) and 35(1)(iv) of the Act. The assessee therein had incurred expenditure of a capital nature on scientific research relating to the business which resulted in acquisition of an asset, and had claimed depreciation on the asset under Section 32 and 100% deduction as expenditure on scientific research under Section 35(1)(iv)

The Apex Court had observed that: “…. Where a capital asset used for scientific research related to the business of the assessee is also ipso facto an asset used for the purpose of the business, it is impossible to conceive of the legislature having envisaged a double deduction in respect of the same expenditure, one by way of depreciation under Sec. 32 of the IT Act, 1961 and other by way of allowance under Secs. 35(1)(iv) of a part of the capital expenditure on scientific research, even though the two heads of deduction do not completely overlap and there is some difference in the rationale of the two deductions......"

However, in the instant case, the trust is not claiming double deduction on account of depreciation. The income of the assessee being exempt, the assessee is only claiming that depreciation should be reduced from the income for determining the percentage of funds which have to be applied for the purposes of the trust. It cannot be held that double benefit is given in allowing the claim for depreciation for computing income for the purposes of Sec. 11.

Hence, the Escorts case was distinguished and reliance was placed by the Court on CIT Vs. Society of the Sisters of St. Anne, CIT Vs. Raipur Pallottine Society, CIT Vs. Sheth Manilal Ranchhoddas Vishram Bhavan Trust etc.

Decision following Escorts Ltd. case

The Kerala High Court however followed the Escorts Ltd. (supra) decision in Lissie Medical Institutions Vs CIT (2012) 245 KLR 525  and laid down that after allowing cost of acquisition as application of income for charitable purposes and over and above if depreciation is claimed on such assets, so much of the depreciation allowed will generate income outside the books of account and unless the depreciation is simultaneously written back by the assessee as income available for application for charitable purposes in the next year, there will be violation of Sec. 11(1)(a) of the Act.

The Court held that:
a) depreciation could not be allowed when income itself was exempt as it will confer double benefit which is not permissible; and
b) in the absence of clear statutory indication to the contrary, the statute should not be read as to permit an assessee two deductions on the same expenditure.

The Court failed to note that the Escort’s case was not the case of a charitable trust/institution 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.

The Court also relied on the CBDT clarification obtained from the Central Board wherein they have stated as follows:
"The Central Board of Direct Taxes 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 expenditure account, depreciation on such asset would not be allowable to the assessee. Such notional statutory deductions like depreciation, if claimed as deduction while computing the income of the '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 expenditure account. This would imply that a correct figure of surplus from the trust property is reflected in the Income & Expenditure account of the trust to determine the income for the purpose 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.”

The Court failed to note that the CBDT was dealing with the larger issue of checking generation of black money and the CBDT has not categorically held that charitable trusts are not entitled for the claim for depreciation.

Further CBDT circulars are not binding on the assessee. Moreover, the statute does not expressly state that depreciation is not allowable in computing the income of charitable trusts.

Subsequent decisions

However, subsequently, in the same year, the High Court of Delhi dealt with a similar issue in DIT Vs. Vishwa Jagriti Mission and once again distinguished the Escorts Ltd. case (supra)

In DIT Vs. Vishwa Jagriti Mission (2012) 73 DTR (Del) 195, the Court held that in computing the income of a charitable institution/trust, depreciation of assets owned by the trust/institution is a necessary deduction on commercial principles. The amount of depreciation debited to the accounts of the charitable institution has to be deducted to arrive at the income available for application to charitable and religious purposes. It also distinguished the Escorts Ltd. case and held that:
“…. In the Escorts case, the Supreme Court was not concerned with the case of a charitable trust/institution 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. It was a case where the assessee was carrying on business and the statutory computation provisions of Chapter IV-D of the Act were applicable. In the present case, we are not concerned with the applicability of these provisions. We are concerned only with the concept of commercial income as understood from the accounting point of view. Even under normal commercial accounting principles, there is authority for the proposition that depreciation is a necessary charge in computing the net income. Secondly, the Supreme Court was concerned with the case where the assessee had claimed deduction of the cost of the asset under Section 35 (1) of the Act, which allowed deduction for capital expenditure incurred on scientific research. The question was whether after claiming deduction in respect of the cost of the asset under Section 35 (1), can the assessee again claim deduction on account of depreciation in respect of the same asset. The Supreme Court ruled that, under general principles of taxation, double deduction in regard to the same business outgoing is not intended unless clearly expressed. The present case is not one of this type, as rightly distinguished by the CIT(Appeals).”

In CIT Vs. Institute of Banking Personnel 264 ITR 110, the Court followed the principle laid down in CIT vs. Munisuvrat Jain (1994) Tax LR 1084 (Bom) and held that depreciation is allowable on the assets the cost of which has been fully allowed as application of income under Sec. 11 in past years. The Court rejected the argument of the Revenue that that depreciation can be allowed as deduction only under Sec. 32 of the IT Act and not under general principles; and held that normal depreciation can be considered as a legitimate deduction in computing the real income of the assessee on general principles or under Sec. 11(1)(a) of the IT Act. It held that income of a charitable trust derived from building, plant and machinery and furniture was liable to be computed in normal commercial manner although the trust may not be carrying on any business and the assets in respect whereof depreciation is claimed may not be business assets. In all such cases, Sec.32 of the IT Act providing for depreciation for computation of income derived from business or profession is not applicable. However, the income of the trust is required to be computed under Sec. 11 on commercial principles after providing for allowance for normal depreciation and deduction thereof from gross income of the trust.

Following these judgments, the Income tax Appellate Tribunals have also decided the issue in favour of the assessee and allowed depreciation in the following cases:
  • Coimbatore Stock Exchange Ltd. Vs Department Of Income Tax on 8 February
  • ITO(OSD) Vs. M/s. The Educational Trust of the Seventh Day Adventists in ITA No. 640/Mds/2009
  • DDIT (Exemptions) Vs. M/s. St. John's Educational Trust in ITA Nos. 987 to 990/Mds/2010 dated 18.10.2010 etc. 
     
Conclusion

Therefore, in our view, the plethora of above decisions amply endorse the concept that :
  1. Depreciation is allowable even when the entire cost of asset has been allowed as application of income as the trust’s income should be computed on commercial principles, and
  2. Application of income is different from computation of income



1 comment:

  1. Very well and informative content given about Regarding "Double deduction" issue in charitable trusts. Thanks for given this information here about this blog.
    2bhk Flats for Sale in Kelambakkam

    ReplyDelete