A person sitting in front of chess board

Union Budget 2023: strict clauses continue to challenge charitable institutions

Availing tax exemption will now be subject to intense scrutiny by tax authorities.


In brief

  • Charitable institutions have faced many complexities due to amendments in the Income Tax Act in the past many years.
  • A recent amendment is likely to restrict their ability to incur large capital expenditure.
  • While the income of charitable institutions registered under the Income Tax Act continue to remain exempt from taxes, the process for availing such exemption is now subject to review and intense scrutiny by tax authorities.

The past few years witnessed a complete overhaul in the tax regime for charitable institutions be it under the income-tax laws or foreign contribution regulation law. Charitable institutions registered under the Income Tax Act still enjoy tax exemption on their income. However, the process of obtaining this exemption is now under increased scrutiny by tax authorities. While the intention is said to ensure allowance of exemption to deserving institutions and avoiding misuse of beneficial provisions, increased complexity in administration and compliances of charitable institutions severely impacted small charities.

Two recent Supreme Court rulings in the case of New Noble and AUDA further unsettled the well-established interpretation of tax laws adding to the agony of charitable institutions by impacting their ability of fundraising, self-sustainability and tax exemption. 

Charitable institutions were eagerly awaiting Union Budget 2023 in anticipation of some clarification to soften the effects of these Supreme Court rulings. The Union Budget 2023, however, stopped short of providing any relief to charitable institutions, both from a tax exemption and compliance perspective. 

Currently, when a charitable institution receives grant and donates 85% of such grant to another charity, it is entitled to claim 100% of the grant as tax exempt. However, the law would now require charitable institutions to donate 100% of the grant amount to other charities in order to avail full tax exemption. This amendment is said to be made to plug a so-called loophole arising from chain donations where each donating charitable institution can claim 15% of deemed tax exemption. Misuse of provision by a few, has led to increased obligation for all charities.

The Income-tax Act provides that when an amount is spent out of corpus, the same would be allowed as application only upon recoupment of corpus. Also, in case of loans, repayment of loans would be allowed as application in the year of repayment. Currently, the law does not provide for any time-limit for such recoupment / repayment. Now, a new amendment is proposed allowing application only where recoupment of corpus or repayment of loans is completed within a period of 5 years. This may restrict the ability of charitable institutions to incur large capital expenditure, where the returns would flow in after a few years.

 

Charitable institutions that have already initiated their activities are now allowed to apply for final tax exemption registration directly instead of a provisional one. While this is a welcome amendment, Principal Commissioner / Commissioner of Income-tax are now empowered to examine the objects, genuineness of activities and past compliances of the institutions before granting registrations. 

 

Charities are exposed to the provisions of ’exit tax’ and are liable to pay tax at 34.94%  on the accreted income (FMV of assets less FMV of liabilities) upon violation of certain conditions (viz. conversion into non-charity form, transferring assets to any non-charitable entity, merger with entity not having similar objects etc). Now, in addition to these conditions, if there is a delay in filing of application for registration / re-registration for tax exemption, it would be deemed that the charitable institutions have been converted into non-charitable form, thereby triggering exit tax implications. This is an unrelenting amendment and would put additional pressure on charitable institutions from an administration and compliance standpoint. 

Charitable institutions are required to apply 85% of their income every year to claim tax exemption. In a year where they fall short of 85% application, they are allowed to carry forward the balance to subsequent years for application. The law requires institutions to intimate tax authorities (in prescribed form) about such accumulation before the due date of filing of tax return. The timeline of filing this form has been preponed by two months (i.e. one month ahead of due date of audit). This amendment would be difficult to execute since in the absence of completion of audit, charities would struggle to finalize their numbers and determine the amount for which intimation is required to be made to the tax authorities in a time-bound manner.

 

If there is a single day of delay in filing of tax returns beyond statutory due dates, charitable institutions will lose their tax exemption. Many may consider this amendment to be very rigid and strict, and would expect institutions to tightly follow compliance timelines to miss out on tax exemption. 

 

With constant changes in the tax laws and ever evolving jurisprudence, charitable institutions are expected to be more vigilant about their activities, compliances and governance than ever before. While the government is aiming to bring parity between different schemes of exemption for charitable institutions under the income tax Act, it is only adding complexity in charity administration and taxation. The need of the hour is clearly having a uniform tax regime which should not only be easy to follow but also help avoid misinterpretation and reduce litigation.

 

This article is written by Sheetal Shah, Associate Partner, EY India 

Download the full pdf

Summary

While the recent amendments are aimed at tightening of controls which may make the existence of charitable institutions further challenging.

About this article

Related articles

Budget 2023 widens the scope of Tax Deducted at Source (TDS)

EY highlights how Budget 2023 widens the scope of Tax Deducted at Source (TDS). Learn more about TDS rates.

Is the simplified new tax regime the right step to provide a better tax planning and tax payer experience?

EY highlights how Budget 2023 attempts to make the new concessional tax regime more attractive. Learn more about the new and old tax regimes.

How amendments in angel tax will impact companies

In Budget 2023, the scope of angel tax expanded, to cover foreign funding. Learn more about the amendments in angel tax.

KT Chandy + 1