Analysis of Provisions related to tax on Accreted Income of Certain Trusts and Institutions

The Finance Act' 2016 has brought in a new chapter after Chapter XII-EA of the Income-tax Act, with effect from the 1st day of June, 2016, namely:-

'CHAPTER XII-EB- SPECIAL PROVISIONS RELATING TO TAX ON ACCRETED INCOME OF CERTAIN TRUSTS AND INSTITUTIONS'.

In this article we are analyzing the provisions of this newly introduced Chapter XII-EB consisting of Sections 115TD, 115TE and 115TF:

Reasons for Introducing CHAPTER XII-EB:

A society or a company or a trust or an institution carrying on charitable activity may voluntarily wind up its activities and dissolve or may also merge with any other charitable or non-charitable institution, or it may convert into a non-charitable organization.

There was no provision in the Income-tax Act which ensured that the corpus and asset base of the trust accreted over period of time, with promise of it being used for charitable purpose, continues to be utilized for charitable purposes and is not used for any other purpose.

This chapter is introduced to ensure that the benefit conferred over the years by way of exemption claimed by charitable trusts is not misused by converting it into non-charitable organization. It is a levy in the nature of an exit tax.

Circumstances where Exit Tax is levied:

Section 115TD prescribes circumstances under which exit tax is leviable. This tax is in addition to income-tax chargeable in hands of entity and leviable at the maximum marginal rate on the accreted income.

1) Trust is converted into any form which is not eligible for grant of registration under section 12AA.Trust or an institution shall be deemed to have been converted into any form not eligible for registration under section 12AA:

1. The registration granted to it under section 12AA has been cancelled or
2. Trust has adopted or undertaken modification of its objects which do not conform to the conditions of registration and it:

• has not applied for fresh registration under section 12AA in the said previous year.
• has filed application for fresh registration under section 12AA but the said application has been rejected.

2) Trust is merged with an entity which is not having similar objectives and not registered u/s 12AA.

3) Trust failed to transfer upon dissolution all its assets to any other trust or institution registered under section 12AA or approved u/s 10(23C) within a period of twelve months from the end of the month in which the dissolution takes place.

The accreted income of the trust or institution is taxable in the above circumstances.

Extract of CBDT CIRCULAR NO - 21/2016, Dated: May 27, 2016 -

Clarification regarding cancellation of registration u/s 12AA of the Income-tax Act, 1961 in certain circumstances - regarding

With the introduction of Chapter XII-EB in the Act vide Finance Act, 2016, prescribing special provisions relating to tax on accreted income of certain trusts and institutions, cancellation of registration granted u/s 12AA may lead to a charitable institution getting hit by sub-section (3) of section 115TD and becoming liable to tax on accreted income. The cancellation of registration without justifiable reasons may, therefore, cause additional hardship to an assesses institution due to attraction of tax-liability on accreted income. The field authorities are, therefore, advised not to cancel the registration of a charitable institution granted u/s 12AA just because the proviso to section 2(15) comes into play. The process for cancellation of registration is to be initiated strictly in accordance with section 12AA(3) and 12AA(4) after carefully examining the applicability of these provisions.

Method of Calculation of Accreted Tax:

This levy is in addition income-tax chargeable in hands of entity and is calculated as below:
Accreted Tax = Accreted Income * Maximum Marginal Rate

Meaning of Accreted Income:

Aggregate FMV of the total assets as on the specified date

Less:

Total liability of such trust computed as per the prescribed method of valuation (Rule 17CB inserted by the Income-tax (Eighth Amendment) Rules, 2017, w.r.e.f. 1-6-2016 prescribing method of valuation.)

Below are to be excluded while calculating accreted income:

1. Accreted income related to any asset which is established to have been directly acquired by the trust or institution out of its agricultural income of the nature referred to in clause (1) of section 10. Liability in relation to such asset has also to be excluded.

2. Accreted income related to any asset acquired by the trust or institution during the period beginning from the date of its creation or establishment and ending on the date from which the registration under section 12AA became effective, if the trust or institution has not been allowed any benefit of sections 11 and 12 during the said period. Liability in relation to such asset has also to be excluded.

3. The assets and liabilities, if any, related to such asset, which have been transferred to any other trust or institution registered u/s 12AA or 10(23C) within the specified period to be excluded while calculating accreted income.

Let's take an example showing calculation of accreted tax:

XYZ Trust was dissolved and not transferred its assets to any other trust or institution registered under section 12AA or approved u/s 10(23C) within a period of twelve months.

The aggregate FMV of assets computed in terms of method prescribed in Rule 17CB is Rs. 6 Crore and liability is Rs. 2 Crore. Calculate tax liability.

Solution:

Accreted Income= Aggregate FMV of total assets Less Total Liability
i.e. 6 Crore - 2 Crore= 4 Crore

Accreted Tax = Accreted Income * Maximum Marginal Rate
i.e. 4 Crore * 35.535% = Rs. 1,42,14,000/-

Important Points related to Accreted Tax:

• The accreted Tax shall be at the Maximum Marginal Rate.
• The accreted tax shall be in addition to any income chargeable to tax in the hands of the entity.
• This tax shall be final tax for which no credit can be taken by the trust or institution or any other person.
• This shall be leviable even if the trust or institution does not have any other income chargeable to tax in the relevant previous year.
• The trust or institution shall be liable to pay the tax on accreted income to the credit of the Central Government within fourteen days from the date specified in section 115TD(5)
• No deduction under any other provision of this Act shall be allowed to the trust or the institution or any other person in respect of the income which has been charged to tax or the tax thereon.

Interest payable for non-payment of tax by trust or institution:

Section 115TE:  If the trust fails to pay the tax on the accreted income referred in section 115TD (1), within the time allowed u/s 115TD (5), simple interest at the rate of one per cent for every month or part thereof on the amount of such tax will be payable.

Period of Interest: The period beginning on the date immediately after the last date on which such tax was payable and ending with the date on which the tax is actually paid.

When trust or institution is deemed to be assessee in default:

Section 115TF:

1. The principal officer or the trustee of the trust or the institution and the trust or the institution shall be deemed to be an assessee in default for non-payment of tax.

2. In the case of transfer of assets upon dissolution of the trust or institution to a recipient, which is not a charitable organization, the recipient of the asset of trust shall also be liable to be held as assessee in default. The liability of the recipient shall be limited to the extent to which the asset received by him is capable of meeting the liability.