TAXABILITY OF TRUST LOOSING EXEMPTION DUE TO MORE THAN 20% BUSINESS ACTIVITIES

Hi Madhavi, here’s a detailed explanation addressing your concerns about a charitable trust losing exemption due to excess business income (>20%) and the related tax filing implications:

Background

• Trust X paid Trust Y for orphanage maintenance (ancillary object).

• Trust X deducted TDS under Section 194C treating it as business income for Trust Y.

• This amount is 25% of total receipts of Trust Y, exceeding the 20% limit of business income allowed under the Income Tax Act for exemption under Section 11.

• So, Trust Y risks losing exemption under Section 11.

Your questions:

1. Should the trust file ITR-7?

Yes.

• When a charitable trust loses exemption under Section 11 or other related sections, it must file ITR-7 (which is meant for trusts, institutions, NGOs, etc.).

• ITR-7 allows disclosure of income from business, capital gains, etc., and helps in computing tax liability properly.

• Filing ITR-7 will also require disclosure of reasons for loss of exemption and details of income under various heads.

2. Will the trust not get deduction for expenses like salary for the remaining 75% donations?

• No, the trust can claim expenses related to the charitable activities (including salary, maintenance, etc.) to the extent of income derived from charitable activities (75% donations).

• The deduction of expenses will be proportionate to the income heads.

• Expenses specifically related to the business income portion (25%) may not be allowed as deduction if the trust loses exemption on business income.

• However, expenses related to the charitable part can be claimed and set off against that income.

3. Will the trust have to pay tax @ 30% on the total gross receipts without any claim of expenses?

• No, the trust is not taxed on gross receipts without expenses.

• Once exemption under Section 11 is lost (fully or partially), the trust is taxed as a regular entity.

• The business income portion (25%) will be taxed at normal corporate tax rates applicable to trusts (usually 30% plus applicable surcharge and cess).

• The trust can claim expenses related to business income to arrive at net taxable business income.

• Income from charitable activities (75%) will continue to be exempt if conditions are met, but the overall exemption could be affected depending on the nature of income and compliance.

Important points:

• If business income exceeds 20%, exemption under Section 11 is lost only on the business income portion, not the entire income.

• Trust should maintain proper segregation of accounts — charitable receipts and business receipts separately.

• Proper documentation to show ancillary nature and related expenses is critical.

• TDS deducted under 194C indicates the payer treated the payment as business income; this may attract scrutiny.

• The trust may also explore if the amount qualifies as income under Section 2(15) (whether the business is incidental to charitable purpose).

Summary: