Generation of surplus is not fatal for granting exemption if such surplus is utilized for charitable purposes

In the case of CIT vs. Gulab Devi Memorial Hospital Trust (P&H High Court), the CIT (Commissioner of Income Tax) overruled the claim made by the assessee for renewing the exemption which was granted to the assessee under Section 80G of the Income Tax Act, 1961. The basis for the withdrawal of the same was that while in the course of assessment proceedings for AY 2006-07, the A.O noticed that the assessee was indulging in profiteering. The surplus of 18.59 percent to 28.66 percent for the last 5 years was found to be generated that was considered to be substantial. Tribunal then reversed decision granted by the CIT on the grounds that the generation of surplus could not be considered fatal for granting exemption of income under Section 80G of the Income Tax Act, 1961 as the surplus was considered to be used by the assessee for its expansion on large scale of its facilities that in turn was utilized for the purpose of charitable activities. Tribunal also noted that the assessee’s hospital charges on comparison with other commercial institutions, was of nominal nature, further throwing light over its charitable nature.

Can Exemption of Income for Charitable Purposes be denied if assessee has made surplus?

Before the Honourable High Court, the department trusted the judgements as prevailed in case of Visvesvaraya Technological University vs. Assistant Commissioner of Income Tax (2014) 362 ITR 279 (Karnataka) and Visvesvaraya Technological University vs. Assistant Commissioner of Income Tax (2016) 384 ITR 37 (SC) and it was considered that the allowable extent of surplus which can be generated by the assessee for retaining the charitable character was around 6 percent to 15 percent. As the generated surplus, If in hand, was more than the above prescribed percentage, the assessee will be deemed to deviate from the charitable objects and hence the assesse disentitled itself with respect the grant of the exemption under Section 80G of the Income Tax Act, 1961.

Even if Substantial Surplus is generated, exemption of income cannot be denied: High Court

It was considered that a smaller percentage of the total amount of the donations which were received by assessee was expended on free treatment the years ending March 31st, 2006, March 31st, 2007 and March 31st, 2008, only 3.38 percent, 5.56 percent and 4.57 percent respectively of the donations received were expended on charitable activities by the assessee, and hence, it was obvious that the assessee was not utilizing the donations fully for its charitable purposes which resulted in the accumulation of the surplus. It was contended that the huge amount of accumulated surplus by the assessee cannot be considered as “incidental surplus” that alone was permitted. The High Court held dismissing the appeal:

(i) The exemption under Section 10(23C)(vi) and (via) and the registration under Section 12A and of the Income Tax Act, 1961 by itself does qualify the assessee for granting of the exemption under Section 80G of the Income Tax Act, 1961 though the granting of exemption under Section 10(23C) and the registration under Section 12A of the Income Tax Act, 1961 in support of the institution are persuasive and essential factors for granting exemption under Section 80G of the Income Tax Act, 1961.

(ii) In case of Visvesvaraya Technological University vs. Assistant Commissioner of Income Tax (2016) 384 ITR 37 (SC), over the first issue, the Supreme Court held that in case the accumulated surplus over a period of years are reinvested back for educational activities, the institution will continue to exist for purposes of educational activities solely and not for profit purposes. Though, with respect to the second issue, on facts, the Supreme Court concluded that the assessee was financed by the Government directly or substantially and hence, was not falling under the expression “substantially or wholly financed by the Government”, as present in Section 10(23C)(iiiab) of the Income Tax Act, 1961. Not agreeing with the assessee over the second issue, the appeal was then dismissed (Islamic Academy of Education v. the State of Karnataka – (2003) 6 SCC 697 and Queen’s Educational Society vs. Commissioner of Income Tax – (2015) 8 SCC 47 referred).

(iii) With reference to the findings of the Supreme Court in the paragraphs 8 and 9 of its judgment in Visvesvaraya’s case (supra), as provided earlier, it could be concluded that even in case substantial surplus could be generated, but is discovered to reinvested for assets or building infrastructure that are used for charitable or educational purposes, the institution cannot be devoid of its charitable character. In the present case, there has been no dispute over assessee’s registration under Section 12A of the Income Tax Act, 1961 and that it has been held eligible for granting exemption under Section 10 (23C)(vi) of the Income Tax Act, 1961 according to the orders of this Court passed in C.W.P. No. 6031 of 2009, upheld by the Apex Court in Civil Appeal No. 9606 of 2013.

It has also come over the record that the exemption was granted to the assessee under Section 80G of the Income Tax Act, 1961 from1997 until impugned order was passed. Furthermore, findings of the Tribunal, that assessee never utilized its funds wrongly, has not been assailed before us. The surplus so generated which being reinvested for the purposes of expansion also stays undisputed by Revenue since no challenge is made. In fact, utilization of the surplus for huge expansion at the directive of the assessee was also recognized by the Commissioner.

The Tribunal further detailed in the order the capital expenditure, receipts, income/surplus of receipts over expenditure, income utilized for the charitable purposes and the percentage of the income utilized in a tabulated form that represented clearly the application of the surplus by the assessee for charitable purposes only.

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