Thursday, June 18, 2009

QUESTION AND ANSWER FORUM: JUNE 2009

QUESTION: We are a Charitable Institution. We would like to seek your
valued Opinion whether a Charitable Organization registered under the Societies
Registration Act and registered with the Income-tax Department under section 80G
& 12A and has also received the Home Ministry's approval for
receipt of foreign grant be:

  • permitted to buy shares in companies?
  • Allowed to Buy shares of companies and give it to the workers who hail from our
    targeted communities?
  • Allowed to receive foreign grant within specific purpose to register a public
    limited company having share holders from general public (with their own fund) and
    workers (share amount being provided with foreign grant)?

LAKSHMIAH CHANDRIAH (TRUSTEE)
Badrachalam Ramachandraswamy shikshana Trust,
Badrachalam.

ANSWER: Section 2 (15) which identifies charitable has been amended by the Finance Act
2008, which has streamlined the definition of “charitable
purpose. An extract of the amended definition is appended below.

5. Streamlining the definition of charitable purpose

5.1 Sub-section (15) of section 2 of the Act defines charitable purpose
to include relief of the poor, education, medical relief, and the advancement of any
other object of general public utility. It has been noticed that a number of entities
operating on commercial lines are claiming exemption on their income either under
sub-section (23C) of section 10 or section 11 of the Act on the ground that they are
charitable institutions. This is based on the argument that they are engaged in the
advancement of an object of general public utility as is included in the fourth limb
of the current definition of charitable purpose. Such a claim, when made in respect
of an activity carried out on commercial lines, is contrary to the intention of the
provision.

5.2 With a view to limiting the scope of the phrase advancement of any
other object of general public utility, sub-section (15) of section 2 has been
amended to provide that the advancement of any other object of general public utility
shall not be a charitable purpose, if it involves the carrying on of any activity in
the nature of trade, commerce or business, or any activity of rendering any service
in relation to any trade, commerce or business, for a cess or fee or any other
consideration, irrespective of the nature of use or application, or retention, of the
income from such activity. Scope of this amendment has further been explained by the
CBDT vide its Circular No. 11/2008, dated 19th December, 2008.

5.3 Applicability - This amendment has been made applicable with
effect from 1st April, 2009 and shall accordingly apply for assessment year 2009-10
and subsequent assessment years.

It can be seen from the extract that the activities now intended by the
organization seeking opinion, that they are hit by the amended provisions of section
2(15) and would accordingly fall outside the scope of exemption, throwing open the
doors for the authorities to tax such gains and making all such inquiries be it
roving or normal. A very detailed circular has also been issued on 19.12.2008 by the
Central Board of Direct Taxes, which very clearly establishes that the activities of
the kind proposed would implied be hit by the amendment.

In view of this, the first two limbs of reference are directly hit. As regards the
3rd limb, it is basically very much outside the scope of charitable
purpose, as creation of a company for commercial activity cannot be regarded as an
extended activity of the already identified charitable organization, as the very
purpose envisaged clearly identifies its activity to be commercial in nature,
expressly within the clutches built by the new amendment.Â

Lastly view is also sought whether letting out of property would have any
prohibition from exemption.

It is conveyed that so long as the income derived by the charitable institution
recognized as such, is applied for the avowed purpose, it cannot forfeit exemption.
The stigma cast by virtue of the amendment is only to discourage involvement of such
charitable institutions in commercial activity, thereby circumventing their liability
to tax, which but for the exemption, is very much their burden.

The only contrast is that earning income from involvement in trade or any other
commercial activity, irrespective of their ultimate application, would forfeit
exemption. In the given case, mere letting out of space surplus or normally available
would not render such activity as commercial to forfeit exemption.

Circular No. 11/2008, dated 19-12-2008 - Definition of Charitable purpose under section 2(15) of the Income-tax Act, 1961:

Section 2(15) of the Income Tax Act, 1961 (Act) defines charitable purpose to
include the following:-

(i) Relief of the poor
(ii) Education
(iii) Medical relief, and
(iv) the advancement of any other object of general public utility.

An entity with a charitable object of the above nature was eligible for exemption
from tax under section 11 or alternatively under section 10(23C) of the Act. However,
it was seen that a number of entities who were engaged in commercial activities were
also claiming exemption on the ground that such activities were for the advancement
of objects of general public utility in terms of the fourth limb of the definition of
charitable purpose. Therefore, section 2(15) was amended vide Finance Act, 2008 by
adding a proviso which states that the advancement of any other object of general
public utility shall not be a charitable purpose if it involves the carrying on of

(a) any activity in the nature of trade, commerce or business; or
(b) any activity of rendering any service in relation to any trade, commerce or
business;

for a cess or fee or any other consideration, irrespective of the nature of use or
application, or retention of the income from such activity.

2. The following implications arise from this amendment

2.1 The newly inserted proviso to section 2(15) will not apply in respect of the
first three limbs of section 2(15), i.e., relief of the poor, education or medical
relief. Consequently, where the purpose of a trust or institution is relief of the
poor, education or medical relief, it will constitute charitable purpose even if it
incidentally involves the carrying on of commercial activities.

2.2. Relief of the poor encompasses a wide range of objects for the welfare of the
economically and socially disadvantaged or needy. It will, therefore, include within
its ambit purposes such as relief to destitute, orphans or the handicapped,
disadvantaged women or children, small and marginal farmers, indigent artisans or
senior citizens in need of aid. Entities who have these objects will continue to be
eligible for exemption even if they incidentally carry on a commercial activity,
subject, however, to the conditions stipulated under section 11(4A) or the seventh
proviso to section 10(23C) which are that

(i) the business should be incidental to the attainment of the objectives of the
entity,and
(ii) separate books of account should be maintained in respect of such
business.

Similarly, entities whose object is education or medical relief would also
continue to be eligible for exemption as charitable institutions even if they
incidentally carry on a commercial activity subject to the conditions mentioned
above.

3. The newly inserted proviso to section 2(15) will apply only to entities whose
purpose is advancement of any other object of general public utility i.e. the fourth
limb of the definition of charitable purpose contained in section 2(15). Hence, such
entities will not be eligible for exemption under section 11 or under section 10(23C)
of the Act if they carry on commercial activities. Whether such an entity is carrying
on an activity in the nature of trade, commerce or business is a question of fact
which will be decided based on the nature, scope, extent and frequency of the
activity.

3.1. There are industry and trade associations who claim exemption from tax u/s 11
on the ground that their objects are for charitable purpose as these are covered
under any other object of general public utility. Under the principle of mutuality,
if trading takes place between persons who are associated together and contribute to
a common fund for the financing of some venture or object and in this respect have no
dealings or relations with any outside body, then any surplus returned to the persons
forming such association is not chargeable to tax. In such cases, there must be
complete identity between the contributors and the participants.

Therefore, where industry or trade associations claim both to be charitable
institutions as well as mutual organizations and their activities are restricted to
contributions from and participation of only their members, these would not fall
under the purview of the proviso to section 2(15) owing to the principle of
mutuality. However, if such organizations have dealings with non-members, their claim
to be charitable organizations would now be governed by the additional conditions
stipulated in the proviso to section 2 (15).

3.2. In the final analysis, however, whether the assessee has for its object the
advancement of any other object of general public utility is a question of fact. If
such assessee is engaged in any activity in the nature of trade, commerce or business
or renders any service in relation to trade, commerce or business, it would not be
entitled to claim that its object is charitable purpose. In such a case, the object
of general public utility will be only a mask or a device to hide the true purpose
which is trade, commerce or business or the rendering of any service in relation to
trade, commerce or business. Each case would, therefore, be decided on its own facts
and no generalization is possible. Assessees, who claim that their object
is for charitable purpose within the meaning of Section 2(15), would be
well advised to eschew any activity which is in the nature of trade, commerce or
business or the rendering of any service in relation to any trade, commerce or
business.

QUESTION: We own extensive vacant lands around the far outskirts of
Vijayawada. The lands are being owned by us as a joint hereditary property over a
period of decades. They are within the local Municipal limits, though we are not
paying any land tax thereon. We had not done any cultivation, as there is limited
scope for irrigation. Most of our children got employed at different far off places
and visit our place only during their vacation or for any family function. We are
three brothers and I am he eldest. The extent of land we own is about 12 acres, all
barren.

Our children suggest that we can develop he land, for industrial purpose partly
and of the remaining, sell out housing layouts after obtaining the approval of the
concerned authorities.

Now, we understand that notices are being issued to similar holders of land by the
Income-tax department, suggesting that they are urban land and all vacant lands are
liable to Wealth-tax. However, on consulting with consultants, we are
advised that once we undertake the development of land for industrial purpose and
convert them into lay outs for housing plots, the department cannot tax them as urban
land. We are told that we would become liable to wealth-tax for a number of years and
valued at the market rate, we would be liable to pay sizable amount as wealth-tax. In
this situation, we solicit your learned counsel to advise us on

  • What is an urban land, as defined for wealth-tax purposes and
  • what are the circumstances, it cannot be subjected to tax.

GEDDHA RAMASUBBU, VIJAYAWADA.

ANSWER: The reader has brought out a very lengthy question. However as it
emerges, the issue is simple. The lands which though remain barren are vacant lands
which can be classified as urban lands. Urban lands have been defined under the
Wealth-tax as under:
  • Any area which is comprised within the jurisdiction of a Municipality (whether
    known as municipality, Municipal Corporation, notified area committee, town area
    committee, or any other name, or a cantonment board and which has a population of
    not less than 10,000 according to the last preceding census of which relevant
    figures have been published before the valuation date or
  • In any area within such distance (no being more than 8 kilometers) from the
    local limits of Municipality or cantonment board referred to earlier, as the
    Central Government may having regard to the extent and scope for urbanization of
    that area and other relevant considerations specify.(Notification So 87(E) dt:
    November 9,1993).
It can be deduced from the above definition that all lands which remain vacant and
which are situated in municipal limits or other limits where the population exceeds
10,000 or that area is specifically notified by the government, will be regarded as
“Urban landâ€. Given this under standing, the lands
owned by the family of the reader which is within the Municipal limits can be
identified as urban land liable to Wealth-tax and the reader can be charged to
wealth-tax on the market value of the said lands atr the appropriate rates.

However, under the following circumstances, the lands would fall outside the tax
net:
  • If it is a land on which construction is not permissible under any law for the
    time being in force, governing the area in which the land is situated.
  • Land occupied by any building which has been constructed with the approval of
    the appropriate authority
  • Un-used land held for industrial purposes. And
  • Any land held by any assessee as stock in trade for a period of 10 years from
    the date of acquisition.
It can be seen from the exceptional situations discussed above, that the lands of
the querist family do not subscribe to any of the conditions. However, if they
convert the land for any industrial purpose and treat it as a business asset and for
this purpose developing the lands as industrial site or house site and hold it as a
stock in trade or business asset, which is actually commenced or run, then they could
be covered by the exceptional clauses. If the asset is held as a stock in
trade then it would get the benefit of exemption. At the same time, I is cautioned,
the reader is liable to Capital gains tax on the conversion of personal asset into
stock in trade by virtue of the definition of transfer under section 2(47) of the
Act. On the date of transfer into business books, the value of the lands would be
regarded as transferred at market value and once they are sold, the liability to
capital gains would arise.


QUESTION: I am one of the directors of a medium scale Iron and Steel
Industry based at Vizagapatnam. We have been having lucrative business,
though there have been ups and downs in between. Our Income-tax assessments are
almost up to date. It is under stood that in one of the major
customers’ case there was a search from the Income-tax department
and they had reportedly laid their hands on certain documents, they regard as
incriminating. As a consequence, the assessing officer of our company has issued a
notice, suggesting re-opening of our assessments for the last 6 years. When asked for
the basis for the re-opening of the assessments, it is merely stated that certain
particulars of income have been understated besides commission paid to certain
constituents exaggerated. We have consciously furnished all the particulars of income
correctly and have neither overstated our commission payments nor understated our
income in any manner. We are accountable to the Excise department where everything is
put to strict proof and only when they are cleared, that the stock can be lifted. All
our sales are accounted for and tallied, systematically. Under the circumstances, we
are not agreeable to the department’s stand and strongly resist
the move to re-open the assessment. We would be thankful, if we are enlightened on
this issue.

GOPALARATHNAM NAIDU, VIZAGAPATNAM

ANSWER: Under the Income-tax Act, an assessment can be re-opened upto a
maximum period of 6 years, where the income is considered to have escaped assessment.
There are specific parameters laid down. The deeming fiction are:
  • Where no return of income has been furnished although the total income in which
    he is assessable exceeded the taxable minimum.
  • Where a return has been filed, but the assessee has understated the income or
    claimed excessive loss, deduction, allowance or relief in the return
  • Where an assessment has been made but
    1. the income chargeable to tax has been under assessed or
    2. such income has been assessed at too low a rate or
    3. such income has been subjected to excessive relief or
    4. excessive loss or depreciation allowance or any other allowance under the Act
      is computed.

    Again the re-opening of assessment beyond 4 years in a case where the original
    assessment was completed under section 143(3) is permissible, if only the probable
    tax that is considered to have escaped assessment is to the tune of Rs.1 lakh or
    more.

    It is thus seen from the facts furnished by the reader, that they are being
    assessed over a period of time. He has not, however stated whether the assessments
    have been completed under section 143(3) or 143(1). However, from the facts
    furnished, it is reasonably presumed, that being a large entrepreneur, the assessment
    could have been put to scrutiny and completed applying the norms laid down therefore.
    However coming to the issue of re-opening, the assessing Officer has to specifically
    state as to the manner the income is understated. In his connection, it is relevant
    to extract the observation of their lordship of the Delhi High Court in the case of
    JSRS UdyogLtd., Vs. CIT 313 ITR 328

    "In the reasons supplied to the petitioner, there is no
    whisper, what to speak of any allegation, that the petitioner had failed to disclose
    fully and truly all material facts necessary for assessment and that because of his
    failure there has been escapement of income chargeable to tax. Merely having reason
    to believe that income had escaped assessment, is not sufficient to re-open
    assessment beyond the four years period indicated in the section. The escapement of
    income must also be occasioned by the failure on the part of the assessee to disclose
    material facts, fully and truly. This is a necessary condition for overcoming the bar
    set up by the proviso to section 147. If this condition is not satisfied, the bar
    would operation and no action under section 147 can be
    taken"

    Relying on its own earlier decision, in the case of Wel Intertrade Private Ltd.,
    Vs. ITO (2000) 308 ITR 22(DEL), the Hon’ble court has quashed the
    notice issued under section 148.

    In the light of the decision discussed supra, it is for the department to prove
    that the income in question has escaped assessment by virtue of failure on the part
    of the assessee to disclose truly all particulars of income. If the
    reader's company conforms to this requisite, they can resist the
    issue of notice on the above lines.