Application of Income for Charitable Trusts – Understanding Section 11 Requirements

Application of income for charitable trusts refers to the expenditure of income generated by a charitable trust towards its charitable or religious objectives to qualify for tax exemptions under the Income-tax Act. According to section 11, income must be "applied" for charitable purposes within India, which includes spending on both operational and capital expenses. Generally, 85% of the income must be applied for such purposes to claim exemptions. Capital expenditures, like purchasing assets for advancing charitable activities, are also considered valid applications. Recent amendments specify that application is only allowed on a payment basis, meaning funds must be actually disbursed within the year to count as applied income.

Table of Contents

1. Summary
2. Meaning of Application
3. Application of Income of the Previous Year and Year of Application
4. Application of Income to Be Allowed on a Payment Basis
5. Term ‘Applied’ Be Equated With the Term ‘Spent’
6. Capital Expenditure is Also Treated as an Application
7. Administrative and Establishment Expenses
8. Repayment of Debt/Loan for Charitable Purposes

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1. Summary

• The application of income has to be for charitable or religious purposes in the year in which the income accrues or is received. However, such application of income is allowed on a payment basis.
• Application is not ‘charge’ against income and therefore, the income is computed after deducting all the chargeable expenditure i.e., the expenditure which is incurred on earning that income. For example, the fundraising expenditure should not be treated as applied towards charitable purposes rather, such expenditure should be deducted from the income while determining the income subject to 85% application.
• The term ‘application’ is broad enough to include capital expenditures within its ambit.
• The purchase of a capital asset, towards the advancement of objects, is an application of income, and thus, expenditure incurred on the purchase of capital asset would be deductible under section 11(1)(a).
• Set-off of past deficit against current year income is not permissible for the purpose of computing 85% application. Therefore, the charitable trusts shall not be permitted to carry forward the losses or excess application of earlier years.
• The Department Circular No. 5-P (LXX-6) of 1968, dated June 19, 1968, states that the income should be computed on the basis of normally accepted commercial principles. It implies that establishment expenses should be deducted in order to determine the net income available for application.
• Establishment expenditure can also be treated as an application for the purpose of exemption under section 11, unless certain elements of expenditure could be directly attributed to earning of income of a charitable organisation. Such expenditure should be deducted from the gross income.
• As per departmental Circular No. 100, dated 24-1-1973, payment of loan for the fulfilment of the charitable objects shall be treated as an application for the purpose of section 11(1). The application out of loans and borrowings shall not be considered an application of income for charitable or religious purposes. However, when a loan or borrowing is repaid from the previous year’s income, such repayment shall be allowed as an application in the previous year in which it is repaid to the extent of such repayment. The Finance Act, 2023 has provided that the application out of loans or borrowings will be allowed as an application of income if the conditions set out in the newly inserted second, third and fourth proviso to Explanation 4(ii) to section 11(1) are satisfied.
• Certain elements of expenditure which could be directly attributed to earning income of a charitable organisation should be deducted from the gross income to arrive at a figure of income subject to application and should not be considered as an application.
• Reasonable remuneration paid to trustees, managers, functionaries, etc., towards services rendered is considered as an application for charitable or religious purposes.
• Legal expenses incurred in defending criminal charges over the trustees or functionaries are a valid application.
• The mandatory 85% utilisation can be done by the trust or institution itself or by donating to trusts with similar objectives. However, after the amendment by the Finance Act, 2023, only 85% of the eligible donations made by a trust or institution registered under section 12AB to another trust or institution registered under section 12AB or approved under section 10(23C) shall be treated as the application.
• If tax is deductible from any payment but it is not deducted or after deduction, it is not paid within the specified time and payment has been made to a resident person, 30% of such payment will be disallowed. In other words, only 70% of that expense shall be deemed as the application of income, if tax is not deducted from such payment in accordance with Chapter XVII-B. The disallowance shall be made in accordance with section 40(a)(ia). However, such disallowances shall be considered as an application in the year in which TDS compliances are made on such amount. Also, the disallowance under section 40(a)(ia) per se does not result in tax liability.
• The provisions of sections 40A(3) and 40A(3A) are extended to charitable and religious organisations. Consequently, if payment for an expense exceeding Rs. 10,000 is made in any mode other than account payee cheque, bank draft, net banking (i.e., payment in cash or bearer cheque), that payment or expense will not be considered while computing the application of income. However, the disallowance under section 40A(3) per se does not result in tax liability.
• The application out of corpus shall not be considered as an application for charitable or religious purposes. However, when it is invested or deposited back, into one or more of the forms or modes specified in section 11(5) maintained specifically for such corpus from the income of the previous year, such amount shall be allowed as an application in the previous year in which it is deposited back to the corpus to the extent of such deposit or investment. The Finance Act, 2023 has provided that the application out of corpus will be allowed as an application of income if the conditions set out in the newly inserted second, third and fourth proviso to Explanation 4(i) to section 11(1) are satisfied.

2. Meaning of Application

The income of charitable trusts is computed under sections 11 to 13, therefore the other provisions of the Income-tax Act do not apply to them. It’s worth noting that under the current scheme of the Income-tax Act, the charitable trusts are not subject to assessment under the five heads of income, and section 14, which deals with computation under five heads of income does not apply to them. In the case of charitable or religious institutions, their taxable income is not computed. Instead, the income that qualifies for exemptions under section 11 or 10(23C) is computed. This is the key distinction between a normal taxpayer and an exempt institution. Section 11(1)(a) makes it clear that the income derived from property held under trust wholly for charitable and religious purposes, to the extent to which such income is applied to such purposes in India, is excluded. According to section 11(1) of the Income-tax Act, in order to claim exemption of income derived from property held under trust or on receipts from voluntary contributions, the trust must apply the income for charitable purposes. It is important to understand the meaning and implications of the term ‘application’ under the Act.

According to Third New International Dictionary, Vol. 1, the word ‘applied’ means:

“to put to practical use; engaged in for a utilitarian or contributory purpose; employed in the decoration, design or execution of useful objects”

In the context of charitable trusts, the term ‘application’ implies the utilisation of income on activities of the trust for the advancement of its objects. The emphasis on ‘application’ can be related to the intent of the statute, which seems to ensure that such income/funds are not needlessly accumulated and are properly utilized for their avowed purpose. For the purposes of section 11, in order to be treated as ‘application’, funds must be spent/applied for charitable or religious purposes out of the income of the trust. It may be noted that for charitable or religious trust, the scope of ‘income’ includes capital income and the scope of ‘application’ includes applications of capital nature.

Additionally, it’s worth noting that corpus donations are considered part of income under section 2(24)(iia), but they are exempt under section 11(1)(d) subject to certain conditions. Notably, section 11(1)(a) doesn’t use the term “expenditure,” but instead uses the word “applied”. However, whether corpus donation could be treated as income under section 2(24)(iia) itself is under question.

3. Application of Income of the Previous Year and Year of Application

In order to claim exemption, 85 per cent of the income derived from property held under trust, including the amount received as voluntary contributions (other than voluntary contributions towards the corpus of the trust) in the previous year, has to be applied for such purposes. Section 11(1) provides that subject to the provisions of sections 60 to 63, the
following income shall not be included in the total income of the previous year of the person in receipt of the income—

(a) income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied to such purposes in India; and, where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of fifteen per cent of the income from such property;

It can be noted the term b is succeeded with the term ‘of the previous year’ but while allowing exemption, the term ‘application’ is not linked with any year and is kept open. Therefore, it can be argued that application amount of previous year (if not claimed as an application) can be set-off and claimed as an application against the income of subsequent year.

The Finance Act, 2021 has inserted Explanation 5 to section 11(1) to provide that for the computation of income required to be applied or accumulated during the previous year, no set-off or deduction or allowance of any excess application, of any of the year preceding the previous year, shall be allowed.

4. Application of Income to Be Allowed on a Payment Basis

A trust deriving income from a property held under trust for charitable or religious purposes is not included in its total income if such income is applied for charitable purposes in India. The application of income includes all payments and expenditures for the purpose of charitable and religious purposes in India.

The Finance Act, 2022 inserted the following Explanation after section 11(7)

“Explanation.—For the purposes of this section, any sum payable by any trust or institution shall be considered as application of income in the previous year in which such sum is actually paid by it (irrespective of the previous year in which the liability to pay such sum was incurred by the trust or institution according to the method of accounting regularly employed by it):

Provided that where during any previous year, any sum has been claimed to have been applied by the trust or institution, such sum shall not be allowed as application in any subsequent previous year.”

This Explanation explicitly provides that any sum payable by any trust shall be considered an application of income in the previous year in which such sum is actually paid. Thus, the application of income shall be allowed only on a payment basis. This is irrespective of the previous year in which the liability to pay such sum was incurred by such trust according to the method of accounting regularly employed.

A proviso to the Explanation further provides that where any sum has been claimed to have been applied by such trust during any previous year, such sum shall not be allowed as an application in any subsequent previous year.

These amendments will take effect from 1st April, 2022 and will, accordingly, apply in relation to the assessment year 2022-23 and subsequent assessment years.

5. Term ‘Applied’ Be Equated With the Term ‘Spent’

The Karnataka High Court in the case of CIT (Exemptions) v. Ohio University Christ College [2018] 99 taxmann.com 377 held that payments made to the professors of Ohio University, USA for which the requisite provision was made in the books of account of the previous year, the actual payment was made in the next assessment year and was permissible as application.

In CIT v. Trustees of H.E.H. the Nizam’s Charitable Trust [1981] 7 Taxman 178/131 ITR 497 (AP), it was held that it was not necessary that the money should have been actually ‘spent’ for being treated as ‘application’. It would not be correct to equate the word ‘applied’ with the word ‘spent’, and therefore, even the funds, which have been allocated for the purposes, will be deemed to have been applied. The amounts that are actually disbursed are debited to the income and expenditure account but which are not actually disbursed are shown as liabilities in the balance sheet. These facts and circumstances would constitute application of the funds for charitable purposes within the meaning of section 11(1)(a) of the Act. If the Legislature intended that the amounts should actually be spent, there was nothing preventing it from using that word.

In the above case, reference was made to the case of CIT v. Radhaswami Satsang Sabha [1954] 25 ITR 472 (All.) where it was categorically held that word ‘applied’ does not necessarily mean spent. But this decision was in context of section 4(3)(i) of the Act. It may be noted that in the old Act, the income was exempted irrespective of application or accumulation. In other words, even 100 per cent accumulation was permissible and therefore, application or non-application did not have any tax implications. The implication of the term ‘application’ is different under the new Act. On the basis of recent case laws, currently the term ‘applied’ is more or less close to the term ‘spent’ unless there is no doubt about the authenticity of application. The accounting standards and the guiding principles of ‘accrual accounting’ are also relevant.

In Nachimuthu Industrial Association v. CIT [1999] 235 ITR 190, the Supreme Court upheld the decision of Madras High Court where it was held that sums transferred to a donation reserve fund could not be treated as application of funds.

The Finance Act, 2022 inserted an explanation after section 11(7) which provides that all applications shall be allowed on a payment basis only. Therefore, all the above case laws shall not be applicable from the assessment year 2022-23 and subsequent assessment years.

5.1 Mere earmarking of funds will not always suffice

It’s important to note that the aforementioned case should not be interpreted as allowing the claiming of applications by simply earmarking funds for various purposes. In the case of CIT v. Thanthi Trust [1982] 137 ITR 735, the Madras High Court held that the term “application” must be interpreted as “actually expended.” However, the court also noted that if there is no doubt regarding the authenticity of the application, it cannot be disallowed even if physical funds have not been disbursed.

5.2 Application means ‘actually expended’ even without the physical transfer

In the case of the same assessee, the Supreme Court, vide CIT v. Thanthi Trust [1999] 239 ITR 502 held that the word application has to be understood as actually expended. But at the same time, it was observed that, when there is no doubt about the authenticity of the application, then it cannot be disallowed even if physical funds have not been parted. The Apex Court observed that the High Court was right in the conclusion which it arrived at by holding that the credit entries made in the assessee’s books of account were genuine and there was no evidence to prove that they were mere make-believe or bogus. In this case a sum of Rs. 10,41,689.47 had been credited by the assessee trust in favour of the educational institution out of which Rs. 3,04,035 had been drawn by the said institution, and for the accounting year 1967-68 corresponding to the assessment year 1969-70, a sum of Rs. 8,99,535 had been credited in favour of the educational institution and the educational institution had drawn Rs. 16,71,500 during that year. The revenue held that unless the educational institution expended the amount donated by the assessee trust within the assessment year, the assessee could not claim benefit of exemption under section 11. The Supreme Court did not agree to the contention of the revenue as there was no reason to treat the entries as bogus.

The Finance Act, 2022 inserted an explanation after section 11(7) which provides that all applications shall be allowed on a payment basis only. Therefore, all the above case laws shall not be applicable from the assessment year 2022-23 and subsequent assessment years.

5.3 Every spent may not be treated as application

In certain circumstances, even money advanced or disbursed may not be treated as application of funds. It has to be satisfied that the money was applied for charitable purposes. In other words, not only the money should be disbursed but it should have been applied for charitable purposes. In CIT v. V.G.P. Foundation [2004] 134 Taxman 663/[2003] 262 ITR 187 (Mad.) the trust disbursed funds as advance for construction of a hospital to a contractor but no construction was made. It was held that the money instead of lying with the assessee was laid with another organisation which could not be regarded as application of income for charitable purposes. In this case, the assessee-trust had advanced certain amount to its sister concern, a private limited company, of which trustees of assessee were also directors. It claimed that monies so given were meant to be used to meet cost of construction of hospital and, therefore, should be regarded as having
been applied for charitable purpose. The Assessing Officer rejected claim of the assessee because the money instead of lying with assessee had been laid with sister company, therefore such amount could not be regarded as application of funds for a charitable purpose.

6. Capital Expenditure is Also Treated as an Application

The term ‘application’ has a relatively wider connotation for the purposes of section 11. For instance, even capital expenditure which is otherwise not considered as an allowable expense is also treated as application. It may be noted that the scope of ‘income’ includes capital income and the scope of application includes applications of capital nature. Further, even corpus donations are considered as a part of income under section 2(24)(iia) and subsequently exempted under section 11(1)(d) and similarly the word ‘expenditure’ is not used under section 11(1)(a) instead, the word ‘applied’ has been used. It may also be appreciated that unlike commercial or business organisations, in case of charitable trusts, capital gains are also considered as a part of income under section 11(1) and are not computed under the head ‘Capital Gains’ under sections 45 to 55. In other words, the scheme of computing income, as well as application, is totally different as far as charitable or religious organisations are concerned.

In a ruling of the Allahabad High Court applied the legal ratio the above Supreme Court ruling in CIT v. Mool Chand Sharbati Devi Hospital Trust [2010] 190 Taxman 338 (All.) where it was held that Capital Expenditure on building and infrastructure were basic necessity and therefore should be treated as expenditure u/s 11(1). It may be mentioned here that the assessee has its prime object of running educational institutions. For running an educational institution building and physical infrastructure is a basic necessity. It has not been doubted that the construction of a suitable building and other infrastructure was necessary for the assessee-trust to be able to carry out its objects of providing education. Thus, the expenditure in question was incurred by the assessee in constructing a building and physical infrastructure for carrying out its purposes and such expenditure would necessarily be an expenditure incurred for carrying out the objects of the assessee-trust. It is settled law that even capital expenditure incurred by an assessee in acquiring assets which are necessary for carrying out its objects amounts to the application of income of the trust for charitable objects.

In Satya Vijay Patel Hindu Dharamshala Trust v. CIT [1972] 86 ITR 683 (Guj.) also it was held that expenditure incurred in acquiring a capital asset for carrying out the dominant purpose of the trust was an expenditure within the meaning of section 11(1)(a) of the Income-tax Act, 1961.

In the case of CIT v. Queens Educational Society [2009] 177 Taxman 326 (Uttaranchal) the Assessing Officer had refused exemption to the assessee u/s 10(23C)(iiiad) relying on the judgment of the Hon’ble Supreme Court in Aditanar Educational Institution v. Addl. CIT [1997] 90 Taxman 528/224 ITR 310. However, the above Queens Educational Society (supra) was in context of exemption under section 10(23C)(iiiad) and was not applicable to organisation eligible under section 10(23C)(iv) or section 11. It may be noted that the Supreme Court in Queen’s Educational Society v. CIT [2015] 55 taxmann.com 255/8 SCC 47 quashed the Uttarakhand High Court ruling in the Queens case (supra).

In a case Pinegrove International Charitable Trust v. Union of India [2010] 188 Taxman 402 the Punjab & Haryana High Court has pointed out that the above Queens case (supra) was not applicable to organisation eligible under section 10(23C)(iv) or section 11 as it was in context of section 10(23C)(iiiad). The other relevant cases in this regard are ST. Lawrence Educational Society (Regd.) v. CIT [2011] 9 taxmann.com 233/197 Taxman 504 (Delhi), Vanita Vishram Trust v. Chief CIT [2010] 192 Taxman 389/327 ITR 121,(Bom.), Himachal Pradesh High Court in Maa Saraswati Educational Trust v. Union of India [2010] 194 Taxman 84, Sunbeam English School Society v. CIT, Varanasi [2011] 9 taxmann.com 228/129 ITD 299 (All. – Trib.), Kashatriya Sabha Maharana Partap Bhawan v. Union of India [2010] 194 Taxman 442 (Punj. & Har.).

In the case of Hans Raj Samarak Society v. Asstt. DIT (Exemptions), Trust Circle-II, Delhi [2011] 16 taxmann.com 103/133 ITD 530 (Delhi – Trib.) it was held that purchase of capital asset is an application of income, thus expenditure incurred on purchase of capital asset would be deductible under section 11(1)(a).

In the case of CIT v. Kannika Parameswari Devastham & Charities [1982] 133 ITR 779 (Mad.), it was held that if the expenditure is on capital account on object(s) contained in the object clause, the expenditure will amount to application of income.

In the case of CIT v. Janmabhumi Press Trust [2000] 242 ITR 457 (Kar.), the assessee constructed a building out of accumulated and borrowed funds. The building was later rented out. A part of the rent was used for repayment of loan. Such repayment of loan was treated as application of income.

6.1 Purchase of Building

The Supreme Court in S. RM. M. CT. M. Tiruppani Trust v. CIT [1998] 96 Taxman 635/230 ITR 636, observed that the assessee was entitled to claim the benefit of section 11(1)(a). In the case, the assessee applied ` 8 lakhs for charitable purposes in India by purchasing a building which was to be utilised as a hospital. This income, therefore, was entitled to an exemption under section 11(1).

6.2 Construction of Dharamshala, Hospital etc.

Expenditure on land and building including dharamshalas, hospitals have been considered as application [Satya Vijay Patel Hindu Dharamshala Trust v. CIT [1972] 86 ITR 683 (Guj.), CIT v. St. George Forana Church [1988] 36 Taxman 42/170 ITR 62 (Ker.)]. In the aforesaid two cases, this issue was debated and held in favour of the assessee. These two cases slightly differ from each other, in Satya Vijay Patel Hindu Dharamshala Trust’s case, the Court held that capital expenditure was allowable provided it was towards the objects of the organisation. But in the St. George Forana Church’s case, the Court held that the scope of the term ‘application’ was wider than the term ‘expenditure’, therefore, expenditures on properties, the income from which was applied for charitable purposes, was also a part of application for the purposes of section 11. It has to be understood that the Court held that if the construction of the building is for the purpose of getting some
income by way of rent and such income would be applied to the charitable or religious purposes. The building in itself may not be for charitable purposes but since the income derived from it is used solely for charitable purposes, therefore, the construction cost of the building was also entitled to be treated as application of income for charitable purposes.

In CIT v. Divine Light Mission [2005] 146 Taxman 653 (Delhi), it was held that the amount spent on acquiring/constructing capital asset is well settled, it is no more required to be discussed as the same is covered by the decision of the Apex Court in S.RM. M. CT. M Tiruppani Trust v. CIT [1998] 96 Taxman 635/230 ITR 636.

6.3 Capital expenditure out of funds accumulated under section 11(2)

In the case of DIT (Exemption) v. Guru Nanak Foundation [2008] 170 Taxman 547 (Delhi), it was held that capital expenditure out of accumulated funds under section 11(2) were permissible. It was observed that the issue raised was squarely covered in favour of the assessee by the decision of the Supreme Court in S. RM. M. CT. M. Tiruppani Trust v. CIT [1998] 96 Taxman 635/230 ITR 636 and of this Court in CIT v. Divine Light Mission [2005] 146 Taxman 653 (Delhi).

6.4 Summing Up

To sum up, it can be said that capital expenditures are not required to be distinguished from revenue expenditures as far as application of income for charitable purposes is concerned. The Supreme Court in S. RM. M. CT. M. Tiruppani Trust v. CIT [1998] 96 Taxman 635/230 ITR 636, has held that capital expenditure should be considered as application provided they are towards the objects of the organisation. The Kerala High Court, has held that if the construction of the building is for the purpose of getting some income by way of rent and such income would be applied to the charitable or religious purposes, then such application should also be considered as application though the building by itself may not be for charitable or religious purposes.

Various case laws have established that the application of income need not be limited to revenue expenditure only. The crucial factor is that the application should serve the organization’s objectives. For example, solely adding or enhancing trust corpus property may not entitle an organization to exemptions. The section requires a consideration of the trust’s objectives as well as the income derived from the property held in trust. The income from trust properties must be applied to the trust’s objectives. In terms of the trust’s objectives, the amount can be applied for revenue or capital purposes. There is no reason why capital expenditures cannot be considered as applications if they serve the trust’s objectives.

7. Administrative and Establishment Expenses

Administrative and establishment expenses have always remained an issue of judicial and legislative debate. The prime issue in this regard is whether the income available for charitable or religious purposes should be considered after deducting administrative and establishment expenses or should they be considered as an application for charitable or religious purposes or to what extent establishment expenditure would be permitted because there might be a circumstance where the activities are dormant but establishment expenditure still continues.

7.1 View of the department on administrative and establishment expenses

The view of the department seems to be towards deducting administrative and establishment expenses from the total income to determine the income available for application. Establishment or administrative expenses are considered as a charge to the income of the organisation and, therefore, only the net income after such expenses is available for charitable purposes. Circular No. 5-P (LXX-6) of 1968, dated June 19, 1968, states that the income should be computed on the basis of normally accepted commercial principles. Therefore, it implies that establishment expenses should be deducted in order to determine the net income available for application. The relevant extracts of the said circular are as under:

“Where the trust derives income from house property, interest on securities, capital gains, or other sources, the word ‘income’ should be understood in its commercial sense, i.e., book income, after adding back any appropriations or applications thereof towards the purposes of the trust or otherwise, and also after adding back any debits made for capital expenditure incurred for the purposes of the trust or otherwise. It should be noted, in this connection, that the amounts so added back will become chargeable to tax under section 11(3) to the extent that they represent outgoings for purposes other than those of the trust. The amounts spent or applied for the purposes of the trust from out of the income, computed in the aforesaid manner, should be not less than 75 per cent of the latter, if the trust is to get the full benefit of the exemption under section 11(1).”

7.2 Whether such expenses amount to the application of income

There seems to be a generic treatment to the establishment expenses and they are considered as application along with other items of expenses, though in strict commercial/accounting sense, such treatment is debatable. The establishment expenses are a charge on the income and ‘application’ is analogous to ‘appropriation’ of the income available for charitable purposes. Administrative and establishment expenses could be of various categories some part of which could be directly attributed to the generation of income and some part could be towards charitable or religious purposes. This issue has been debated in various cases as to whether establishment expenses can be considered as application for the objects of the organisation.

In CIT v. Birla Janahit Trust [1994] 73 Taxman 465/208 ITR 372 (Cal.), the Court opined that expenses incurred for running a trust should be considered to have been applied for the objects of the trust. In this case, reference to various other cases was also made. The following extracts are very relevant in this regard:

“It appears from the order of the Appellate Assistant Commissioner that the assessee has incurred the expenditure on salaries and miscellaneous expenses for the purpose of carrying out the objects and purposes of the trust and not only to earn the income from dividend. It is now well-settled that in determining the portion of income applied or accumulated for charitable or religious purposes, regard should be had to the trust income in a commercial sense or according to the accounts of the trust and not the total income as computed under the provisions of the Income-tax Act. Our attention has been drawn to  several decisions in this connection. In Deo Radha Madhava Lalji Genda Trust v. Property Tax Officer [1980] 125 ITR 531 (MP), it has been observed that tax liability and other outgoings in respect of the trust property are all incidental expenses relating to and connected with the main objects of the trust, which are exclusively religious and charitable. If the trust property is not properly maintained and proper accounts are not kept, the very existence of the trust would be in jeopardy and its object and purpose would be lost. In this view of the matter, simply because a part of the rental income is spent in the maintenance, repairs, payment of salaries to employees, taxes and legal expenses, etc., it could not be said that the income derived from the trust property was not applied exclusively to religious or charitable purposes.”

In Gem & Jewellery Export Promotion Council v. ITO [1999] 68 ITD 95 (Mum. – Trib.), the Tribunal held that the entire non-code expenditure could not be said to have been incurred towards earning of the income and, therefore, only that portion of the expenditure – which could be attributed to the earning of income should be deducted from the gross income for computing the income on which application and accumulation under section 11(1)(a) was allowed. In other words, the expenditure which can be precisely or reasonably be
attributed to earning an income should be deducted first to determine the income available for charitable purposes, and the remaining portion of expenditure shall be treated as applied towards charitable purposes.

7.3 15% of income to be computed before admin and establishment expenses

The ITAT Kolkata Bench C in the case of Kanehialall Lohia Trust v. Income-tax Officer (Exemption) [2020] 120 taxmann.com 208 (Kolkata – Trib.) held that 15 per cent accumulation for application in future has to be calculated on gross receipt and not on net receipt after deduction of revenue expenditure. In this case the AO argued that the administrative and establishment expense should be deducted first to determine the income available for charitable purposes and 15% of such income to be allowed for indefinite accumulation. The ITAT held that 15% should be calculated based on the total income before administrative and establishment expense.

8. Repayment of Debt/Loan for Charitable Purposes

Repayment of any debt or loan has been considered as application. [CIT v. Maharana of Mewar Charitable Foundation [1987] 164 ITR 439 (Raj.)]. The Court referred with approval to the departmental Circular No. 100, dated 24-1-1973 which has expressed the view that the repayment of the loan if taken for fulfilment of the charitable objects shall be treated as application for the purpose of section 11(1).

The Finance Act, 2021 has inserted Explanation 4(ii) to section 11(1) to provide that the application out of loans and borrowings shall not be considered an application of income for charitable or religious purposes. However, when a loan or borrowing is repaid from the previous year’s income, such repayment shall be allowed as an application in the previous year in which it is repaid to the extent of such repayment.

The Finance Act, 2023 has further inserted an amendment to provide that the application out of loans or borrowings will be allowed as an application of income if the conditions set out in the newly inserted second, third and fourth proviso to Explanation 4(ii) to section 11(1) are satisfied.

8.1 Text of department circular

Circular No. 100, dated 24-1-1973, is reproduced as under:

“Repayment of a debt incurred for charitable purposes by a charitable trust and loans advanced by educational trusts – Application of income.

(1) Section 11 of the Income-tax Act requires 100 per cent of the income of a charitable and religious trust to be applied for religious and charitable purposes to be entitled to the exemption under the said section. Two questions have been considered regarding the application of income:

(i) Where a trust incurs a debt for the purposes of the trust, whether the repayment of the debt would amount to an application of the income for the purposes of the trust; and

(ii) Whether loans advanced by an educational trust to students for higher studies would be treated as application of income for charitable purposes.

(2) Board has decided that repayment of the loan originally taken to fulfil one of the objects of the trust will amount to an application of the income for charitable and religious purposes. As regards the loans advanced for higher studies, if the only object of the trust is to give interest bearing loans for higher studies, it will amount to carrying on of money lending business. If, however, the object of the trust is advancement of education and granting of scholarship loans as only one of the activities carried on for the fulfilment of the objectives of the trust, granting of loans, even interest-bearing, will amount to the application of income for charitable purposes. As and when the loan is returned to the trust, it will be treated as income of that year.”

8.2 Application out of loans & borrowings

As per section 11(1), the exemption is available for the income derived from property held under trust or for the voluntary contributions, provided the organisation applies the income for charitable purposes. As long as the expenditure is incurred out of the income of the trust on the objects of the trust, it would be considered as a valid application of income, even if such expenditure is for capital purposes. Thus, all expenditures, whether revenue or capital, for charitable purposes shall be considered as an application of income.

8.3 Application to be considered in the year of repayment of loans

The Finance Act, 2021 inserted Explanation 4(ii) to section 11(1) with effect from the assessment year 2022-23 to provide that application from loans and borrowings shall not be considered as an application for charitable or religious purposes for the purposes of section 11(1)(a).

When the borrowing is repaid by utilising the income of the previous year, then the amount repaid out of income shall be allowed as an application in the previous year in which it is repaid [Proviso to Explanation 4(i) to section 11(1)]

“Text of Amendment by Finance Act, 2021

(ii) application for charitable or religious purposes, from any loan or borrowing, shall not be treated as application of income for charitable or religious purposes:

Provided that the amount not so treated as application, or part thereof, shall
be treated as application for charitable or religious purposes in the previous
year in which the loan or borrowing, or part thereof, is repaid from the income of that year and to the extent of such repayment.”

Therefore, the application out of loans and borrowings shall not be considered an application of income for charitable or religious purposes. However, when a loan or borrowing is repaid from the previous year’s income, such repayment shall be allowed as an application in the previous year in which it is repaid to the extent of such repayment.

8.4 Restriction on application out of loans or borrowings

The Finance Act, 2023 inserted the second, third and fourth proviso to Explanation 4(ii) to  section 11(1) with effect from 1-4-2023 and will accordingly apply to the assessment year 2023-24 and subsequent assessment years.

(i) Conditions to be satisfied while making an application out of loans or borrowings

The second proviso provides that the first proviso (i.e. application of income out of repayment of loan or borrowings ) shall apply subject to the following specified conditions.

(a) Such application should not be in the form of a corpus donation to another trust [Explanation 2 to section 11(1)];

(b) TDS, if applicable, should be deducted on such application [Explanation 3 to section 11(1)];

(c) Where payment or aggregate of payments made to a person in a day exceeds Rs. 10,000 in other than specified modes (such as cash) is not allowed [Explanation 3 to section 11(1)];

(d) Carry forward and set off of excess application is not allowed [Explanation 5 to section 11(1)];

(e) Application is allowed in the year in which it is actually paid [Explanation to section 11];

(f) The application should not directly or indirectly benefit any person referred to in section 13(1) and the income of the trust or institution should not enure any benefit to such person [Section 13(1)(c)]; and

(g) The application should be in India except with the approval of the Board in accordance with the provisions of section 11(1) (c).

(ii) Cap of 5 years to repay the loan or borrowings

The third proviso provides that any application out of a loan can be set off against future years’ income for a period of five years from the end of the year in which such a loan was applied for charitable purposes.

(iii) Application out of loans before 1-4-2021 should not be allowed as an application

The fourth proviso states that in cases where application from any loan or borrowing is made on or before 31-3-2021, the repayment of such a loan shall not be allowed as an application of income.