Under the provisions of the Income-tax Act, 1961 (‘IT Act’), any income of an institution from property held for or applied for a ‘charitable purpose’, subject to satisfaction of certain conditions, is exempt from income tax.^[1] Section 2(15) of the IT Act defines ‘charitable purpose’ to mean relief to the poor, education, yoga, medical relief and includes advancement of any other object of general public utility (‘AGU’).^[2]

Initially, AGU included activities lacking the element of profit.^[3] A five-judge bench of the Hon’ble Supreme Court of India (‘SC’) in ACIT v. Surat Art Silks Cloth Manufacturers’ Association,^[4] whilst dealing with the issue of AGU had held that if the primary / predominant activity of the institution is related to AGU, the mere fact that certain ancillary objects / activities of the institution are in the nature of trade, commerce or business would not render the institution ineligible for exemption from tax under the Act.

The Indian Parliament has time and again amended the definition of the term ‘charitable purpose’. The law as on date prohibits any institution involved in AGU activities to engage in any activity which is in the nature of trade, commerce or business unless such activity is undertaken during the course of the main AGU activity and receipts thereof are not exceeding 20% of the total receipts of the institution received from charitable activities.^[5]

In a paradigm shift from the earlier position of law, recently a three-judge bench of the SC in ACIT v. Ahmedabad Urban Development Authority,^[6] has clarified the scope of income from AGU activities and observed that any institution in the course of achieving the object of AGU, can carry on trade, commerce or business but it must be connected and incidental to AGU activities. Further, the fee charged / earned from such incidental trade, commerce or business should be on a ‘cost-to-cost basis’ or ‘nominally above the cost’ and should not be ‘significantly higher’ from the cost incurred by the institution.

The effect of the judgement would be the enormous amount of subjectivity likely to be introduced into the field of exemptions of such institutions. With huge potential for discretion with tax authorities while interpreting the terms like ‘cost-to-cost basis’, ‘nominal markup’, ‘significant amount / significantly higher’ etc., it is likely to lead to further litigation as opposed to settling it.

This may also have wide ramifications on the exemption status of the institutions providing yeoman services such as Chambers of Tax Consultant, Chambers of Commerce and Trade Association etc., wherein fee charged by them from the members may also come under the radar of scrutiny by the tax authorities. Further, institutions involved in AGU activities enjoying tax exemption status would be required to align their memorandum of incorporation to include only those business activities which are incidental and connected to their AGU activities.

Thus, the ruling rendered by the SC has settled the interpretation of the phrase ‘advancement of any other object of general public utility’ whereby bogus entities misusing the exemption from tax under the disguise of its predominant activity of AGU would not be able to enjoy such benefit.^[7] However, terms such as ‘cost-to-cost basis’; ‘nominal markup’ and ‘significant amount / significant higher’ used in the judgement invites subjective opinion of the tax authority into the arena of exemption of institutions involved in AGU activities resulting in opening of yet another can of worms.

[1]  Sections 11-13 of the IT Act.

[2]  Section 2(15) of the IT Act.

[3]  Section 2(15) of the IT Act as on April 01, 1973.

[4]  ACIT v. Surat Art Silks Cloth Manufacturers’ Association, [1979] 2 Taxman 501 (SC).

[5]  Section 3 of the Finance Act, 2015.

[6]  ACIT v. Ahmedabad Urban Development Authority, [2022] 144 taxmann.com 78 (SC).

[7]  CIT v. Batanagar Education and Research Trust, [2021] 129 taxmann.com 30 (SC).