Exit Tax on Accreted Income of Trusts & Institutions Under Sections 115TD to 115TF

The Exit Tax on Accreted Income for trusts and institutions, under Sections 115TD to 115TF of the Income Tax Act, 1961, is a tax levy introduced to address the conversion, merger, or dissolution of charitable or religious institutions that have previously enjoyed tax-exempt status. This exit tax mechanism serves as a crucial regulatory measure, ensuring that the financial resources and assets of charitable and religious institutions continue to serve the public good, even in cases of structural or operational transformations.

Table of Contents

1. Introduction
2. Background of the Relevant Law
3. Applicability of Chapter XII-EB

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1. Introduction

Prior to 2016, a charitable institution registered under the Income-tax Act and having obtained benefit of exemption over the years could merge with any other charitable or non-charitable institution (especially in States where there was no public trust law) or could convert into a non-charitable organisation, etc., without any express tax consequences. There was no provision in the 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, continued to be utilised for charitable purposes and was not used for any other purpose. In order to ensure that the intended purpose of exemption availed by trust is achieved, a specific provision was introduced in the form of Chapter XII-EB which imposed an “exit tax” when the organization was converted into a non-charitable organization or got merged with a non-charitable organization or did not transfer the assets to another specified charitable organisation.

2. Background of the relevant law

Chapter XII-EB (consisting of sections 115TD to 115TF) has been inserted in the Income-tax Act, 1961 (“the Act”) by Finance Act, 2016 with effect from 1st June 2016 to provide for levy of additional income-tax upon a charitable/religious institution in certain situations, namely-

(a) conversion into any non-charitable form; or

(b) merger with any other non-charitable institution; or

(c) failure to transfer its assets on its dissolution to a specified charitable institution within a specified period.

Rule 17CB has also been deemed to come into force with retrospective effect from 1st June 2016.

Subsequently, the Chapter has been amended vide –

(a) Finance Act, 2020 (which added reference to newly inserted section 12AB)

(b) Finance Act, 2022 [which extended the applicability to institutions covered under section 10(23C)(iv)/(v)/(vi)/(via)]

(c) Finance Act, 2023 [which extends the applicability to a case where the institution fails to make an application for re-approval, etc. under section 10(23C)/12A within the specified period](with effect from 1.4.2023).

This Article analyses the provisions and some issues arising out of the provisions of Chapter XII-EB and rule 17CB.

3. Applicability of Chapter XII-EB

3.1 The Chapter applies if all the following conditions are fulfilled

(ii)  A trust or institution (“institution”) is registered under section 12A/12AA/12AB/10(23C)(iv) (v)/(vi)/(via) (“specified registration”) [section 115TD(1) read with Explanation (iia) to section 115TD].

(b)(i) The institution is converted into any form which is not eligible for grant of specified registration [section 115TD(1) (a)]

or

(ii) The institution is merged with any entity; and the said entity does not have objects similar to it or is not registered/ approved under section 12AA/12AB/10(23C)(iv)/(v)/(vi)/ (via) [section 115TD(1)(b)]

or

(iii) The institution is dissolved and it has failed to transfer upon dissolution all its assets to other institution having specified registration or such transfer has not happened within a period of twelve months from the end of the month in which the dissolution takes place [section 115TD(1)I]

Implications

(a) If the aforesaid conditions in (a) and (b)(i) or (b)(ii) or (b)(iii) are fulfilled, then in addition to the income-tax chargeable on the total income of the institution), the institution shall be charged to tax on its accreted income as defined (see para 3.3);

(i) such accreted income shall be computed on the ‘specified date’;

(ii) such tax shall be levied at the maximum marginal rate on the accreted income.

(iii) such tax shall be paid within specified period.

(b) The tax on the accreted income shall be treated as the final payment of tax in respect of the said income and no further credit therefor shall be claimed by the institution or by any other person in respect of the amount of tax so paid [section 115TD(6)].

(c) No deduction under any other provision of this Act shall be allowed to the institution or any other person in respect of the income which has been charged to tax under section 115TD(1) or the tax thereon [section 115TD(7)].

Irrelevant factor

The tax on the accreted income shall be payable by such institution even if no income-tax is payable by it on its total income computed in accordance with the provisions of this Act.

3.2 ‘Conversion into a form which is not eligible for grant of registration’ – Meaning

An institution shall be deemed to have been converted into any form not eligible for registration under section 12AA in a previous year, if,—

(a) the specified registration granted to it has been cancelled; or

(b) it has adopted or undertaken modification of its objects which do not conform to the conditions of registration and it,—

(i) has not applied for fresh registration to obtain specified registration in the said previous year; or

(ii) has filed application for fresh registration to obtain specified registration but the said application has been rejected; or

(c) It fails to make an application for approval in accordance with clause (i)/(ii)/(iii) of first proviso to section 10(23C) or for registration under section 12A(1)(ac)(i)/(ii)/(iii), within the period specified therein, which expires in the said previous year.
[Section 115TD(3)]

3.3 ‘Accreted income’ – Meaning

3.3.1 Tax is payable on accreted income. For this purpose,

(a) accreted income means the amount by which the aggregate fair market value of the total assets of the charitable institution exceeds the total liability of such institution;

(b) such value shall be as on ‘specified date’;

(c) the value shall be computed in accordance with the method of valuation as may be prescribed [Rule 17CB].

3.3.2 Exceptions

There are two exceptions:

(a) General

Accreted income shall exclude following assets and liability, if any, related to such asset-

(i) Any asset which is established to have been directly acquired by the charitable institution out of its income of the nature referred to in section 10(1) (that is, agricultural income)

(ii) Any asset acquired by the charitable institution during the period beginning from the date of its creation or establishment and ending on the date from which the registration under section 12A/12AA became effective, if the trust or institution has not been allowed any benefit of sections 11 and 12 during the said period:

[First and second proviso to section 115TD(2)]

For this purpose, where due to the first proviso to section 12AA(2), the benefit of sections 11 and 12/10(23C) has been allowed to the institution in respect of any previous year beginning prior to the date from which the registration under section 12AA/12AB/10(23C) is effective, then, the registration shall be deemed to have become effective from the first day of the earliest previous year.

Illustration:

Suppose a charitable institution was formed on 1st May 2001 and had made application for registration on 31st May 2003. Upon registration, it got exemption from 1st April 2003. In this situation, the assets acquired by the institution from 1st May 2001 to 31st March 2003 will not be liable to accreted tax. Further, suppose the institution acquired a building out of its agricultural income. In this case, the building will also not be liable to tax. However, there is no express exemption for agricultural land itself.

(b) For institutions which are dissolved [section 115TD(1)(c)]

For the purpose of section 115TD(1)(c) (regarding failure to transfer upon dissolution, assets and liabilities, if any, related to such asset), the assets which have been transferred to any of the following within the period of 12 months from the end of the month in which the dissolution takes place shall be ignored:

(i) other trust or institution registered under section 12A/12AA/12AB; or

(ii) any institution referred to in section 10(23C)(iv) or (v) or (vi) or (via).

[Third proviso to section 115TD(2)]

3.4 Summarising

(a) in case of conversion or merger, the computation formula is as follows:

(i) Aggregate fair market value of assets (computed as per prescribed method under rule 17CB)

(ii) Less: total liabilities

(iii) Less: assets acquired out of agricultural income

(iv) Less: income during the initial period before registration

(v) Add: liability related to asset/income referred to in (iii) and (iv) above

(vi) Accreted income = [(i) – (ii) – (iii) – (iv) + (v)]

(b) in case of dissolution, the computation formula is

(vii) Accreted income as per (vi) above

(viii) Less: assets transferred to specified institution within the specified period [see para 3.3.2(b) above]

(ix) Accreted income = [(vii) – (viii)]

For the above purpose, ‘specified date’ means,—

(a) the date of conversion in a case falling under section 115TD(1) (a);

(b) the date of merger in a case falling under section 115TD(1) (b); and

(c) the date of dissolution in a case falling under section 115TD(1)(c).

[Explanation (ii) to section 115TD]

Date of conversion

For the aforesaid purposes, ‘date of conversion’ means,—

(a) the date of the order cancelling the specified registration in a case referred to in section 115TD(3)(i); or

(b) the date of adoption or modification of any object, in a case referred to in section 115TD(3)(ii); or

(c) the last date for making an application for registration under section 12A(1)(ac)(i)/(ii)/(iii) or for approval under clause (i)/(ii)/(iii) of first proviso to section 10(23C), in a case referred to in section 115TD(3)(iii).

[Explanation (i) to section 115TD]

3.5 Tax shall be levied at Maximum Marginal Rate (MMR)

The tax on accreted income will be levied at the “maximum marginal rate”, which term has been defined in section 2(29C) as follows:

‘“maximum marginal rate” means the rate of income-tax (including surcharge on income-tax, if any) applicable in relation to the highest slab of income in the case of an individual, association of persons or, as the case may be, body of individuals as specified in the Finance Act of the relevant year”’.

Tax on accreted income is to be increased further by sur- charge @ 12% of such tax [section 2(4) of the Finance Act, 2023].

3.6 Period within which payment is required to be made

The tax on accreted income has to be paid to the credit of the Central Government within 14 days from the time frame tabulated below:

Notes:

1. “Specified date” means the date of valuation of assets and liabilities.

2. The tax has to be paid within 14 days of the date on which,—

(a) the period for filing appeal under section 253 against the order cancelling the registration expires and no appeal has been filed by the trust or the institution; or

(b) the order in any appeal, confirming the cancellation of the registration, is received by the trust or institution

3. The tax has to be paid within 14 days of the date on which,—

(a) the period for filing appeal under section 253 against the order rejecting the application expires and no appeal has been filed by the trust or the institution; or

(b) the order in any appeal, confirming the cancellation of the application, is received by the trust or institution

Thus, in case of cancellation of registration, tax is not payable until the Tribunal order is received or the time for filing Tribunal appeal has expired. To illustrate, suppose the cancellation order is received on 17-8-2023. In this case, the Tribunal appeal has to be filed within sixty days from the date of receipt of order, that is, by 16-10-2023. If no appeal is filed, then, the payment has to be made within 14 days of 16-10-2023, that is, by 30-10-2023. If appeal is filed and the Tribunal order confirming the cancellation is received on 15-7-2024, then the payment has to be made within 14 days of 15-7-2024, that is, by 29-7-2024. However, if the Tribunal quashes the cancellation, then the payment is not required to be made at all.

3.7 Consequences of failure to pay

(a) Where the principal officer or the trustee of the institution and the institution fail to pay the whole or any part of the tax on the accreted income referred to in section 115TD(1) within the time allowed under section 115TD(5), he or it shall be-

(i) deemed to be an assessee in default in respect of the amount of tax payable by him or it and all the provisions of this Act for the collection and recovery of income-tax shall apply; and

(ii) liable to pay simple interest @ 1%, such interest shall be payable for every month or part thereof on the amount of such tax for 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.

[section 115TE/section 115TF(1)]

(b) Further, in a case where the tax on accreted income is pay- able under the circumstances referred to in section 115TD (1)(c), the person to whom any asset forming part of the computation of accreted income under section 115TD(2) has been transferred, shall be deemed to be an assessee in default in respect of such tax and interest thereon and all the provisions of this Act for the collection and recovery of income-tax shall apply. In such a case, the liability of the person shall be limited to the extent to which the asset received by him is capable of meeting the liability. To illustrate, suppose the institution under dissolution (say ‘A’) transfers 30% of its assets to another institution B. If the institution A fails to transfer upon dissolution all its assets in the manner specified in section 115AD(10)(c), the institution B shall also be deemed to be an assessee in default.

3.8 Prescribed method for computation of accreted income (rule 17CB)

The CBDT has notified, through Income-tax (8th Amendment) Rules, 2017 dated 21st April 2017, Rule 17CB [“Rule”] containing the prescribed rules for calculation of accreted income.
Section 115TD(1) providing for valuation as per prescribed rules has been substituted vide Finance Act, 2022 and hence, the rule will have to be re-prescribed. For the purpose of this Article, it is assumed that the re-prescribed rule will be same as the existing rule 17CB.