A number of high-net-worth charities and trusts are at risk of losing their tax-exempt status due to two recent Supreme Court (SC) rulings if they don’t undertake a proper internal restructuring, tax experts said. However, since the judgments are applied prospectively, these companies do not have to pay higher amounts of taxes for previous periods for this reason.
In an October 19 decision, the SC ruled that educational institutions or foundations can only claim the benefits of tax exemptions if they are dedicated “only” to education and not to another lucrative activity. In exchange, they cannot even have non-educational purposes, the Supreme Court ruled, adding that if an entity’s purpose appears to be for profit, those entities would not be able to obtain a permit under Section 10 (23C) of the Income Tax. . Act.
In a separate ruling on Oct. 20, the SC said a “general public service (GPU)” cannot engage in any business or commercial activity if it wishes to take advantage of income tax exemptions available to organizations that perform community service.
The first ruling reversed two of the previous Supreme Court rulings that ancillary business activities are not excluded from tax exemption as long as their primary purpose is education, said Sheetal Shah, associate partner at EY India. “By recognizing that the decision will have a disruptive effect on policies established by previous decisions, the SC has made the decision prospectively effective, meaning that ongoing proceedings and previous orders will not be affected,” Shah said.
According to Maneesh Bawa, CEO of Nangia Andersen LLP, “Many private institutions are at risk of losing their tax-exempt status if they do not make the appropriate changes to their purpose, fee structure, and operating style to align with the CS saying.
While the ruling is aimed at reducing the tax exemption for institutions involved in profitable educational ventures, it is expected to affect bonafide non-profit educational institutions as well, said S. Sriram, a partner at Lakshmikumaran and Sridharan Attorneys. In practice, many schools subsidize the fees charged to students, thus increasing income from parallel activities, such as renting infrastructure (classrooms, playgrounds, etc.) to private companies (for organizing courses, training sessions, private sporting events, etc.) due to schedules or vacations. “Such activities would result in the institution as a whole being denied tax exemption in the future,” Sriram said.
Referring to the GPU’s Oct. 20 ruling, CS said that if a high surcharge were imposed on the cost of these services, they would lose their character as “charitable purposes” and the institution would lose tax exemption and pay taxes accordingly. The Supreme Court ruled that the amounts charged by these institutions must be calculated either on a cost-to-cost basis or with a nominal margin.
In the absence of any guidance on what would qualify as a ‘theoretical margin’, this is again a subjective exercise and subject to the whims and fancies of the tax officer, Vishwas Panjiar, Partner, Nangia Andersen LLP, offered his opinion.
“The ruling has the potential to push the NPO (non-profit organization) sector in India towards the donation model instead of an independent model. The legal framework must be designed to deal more effectively with the real threat posed by promoters who profit fraudulently by operating under the guise of a non-profit organization, instead of imposing an onerous obligation on all non-profit organizations. for-profits to be held accountable for their reason to justify and provoke each year with the tax official,” Panjiar said.
“This would require institutions to review their service and pricing models and make any necessary changes as directed by the court,” Shah said.
With this GPU ruling, the SC has put an end to hundreds of high-value tax disputes across the country, Sriram said. “The clarity and guidance the court offers in the 150-page ruling will guide taxpayers and taxpayers for a long time to come,” Sriram added.