Lissie Medical Institutions vs Commissioner of Income Tax

C.N. Ramachandran Nair, J.—The appellant is a charitable institution registered u/s 12A of the income tax Act, 1961 (hereinafter referred to as "the Act" for short), and is running a hospital. In the course of running the hospital, the appellant acquires medical equipment such as x-ray units, scanning machines, etc., which were purchased with the surplus funds available. The entire expenditure incurred for acquisition of capital assets is treated as application of income for charitable purposes u/s 11(1)(a) of the Act. When capital expenditure is treated as application of income for charitable purposes, the appellant virtually enjoys a 100 per cent. write off of the cost of assets. However, since medical service is a business activity held in trust, the appellant claimed all the benefits under the Act including depreciation in the computation of net income. In the course of assessment for the year 2005-06, the Assessing Officer noticed that the appellant has claimed depreciation for Rs. 2,16,27,776, out of which Rs. 18,38,645 represents depreciation on assets acquired during the relevant previous year and the balance towards depreciation on assets held as on the first date of the previous year. According to the Assessing Officer, when the assessee claims expenditure for acquisition of assets as application of income of the charitable trust for charitable purposes, then the assessee is not entitled to claim depreciation in the computation of income. In other words, according to the Assessing Officer, when acquisition of assets is treated as application of income for charitable purposes, the value of assets stands fully written off, and over and above, if depreciation is allowed, the same will result in double deduction of capital expenditure leading to violation of the provisions of section 11(1) which requires availability of actual income for charitable purposes. Even though the appeal filed against the assessment was allowed by the Commissioner of income tax (Appeals), the Tribunal by following the judgment of the Supreme Court in the case of Escorts Limited and Others Vs. Union of India and others, , allowed the Departmental appeal and restored the assessment with the disallowance. After hearing both sides what we notice is that if the assessee treats the expenditure on acquisition of assets as application of income for charitable purposes u/s 11(1)(a) and if the assessee claims depreciation on the value of such assets, then in order to reflect the true income to be available for application for charitable purposes, the assessee should write back in the accounts the depreciation amount to form part of the income to be accounted for application for charitable purposes. This is obviously not done by the assessee and so much so, the income which should be available for application for charitable purposes gets reduced by the depreciation amount which is not permissible u/s 11(1)(a) of the Act. In fact the net effect is that after writing off full value of the capital expenditure on acquisition of assets as application of income for charitable purposes and when the assessee again claims; the same amount in the form of depreciation, such notional claim becomes cash surplus available with the assessee, which goes outside the books of account of the trust unless it is written back which is not done. We do not think it is permissible for a charitable institution to generate income outside the books in this fashion.

Learned counsel for the assessee has relied on the following decisions of various High Courts in their favour.

(1) Commissioner of Income Tax Vs. Rao Bahadur Calavala Cunnan Chetty Charities, ;

(2) Commissioner of Income Tax Vs. Institute of Banking Personnel Selection (IBPS), ;

(3) Commissioner of Income Tax, Karnataka-I Vs. Society of the Sisters of St. Anne, ;

(4) COMMISSIONER OF Income Tax Vs. RAIPUR PALLOTTINE SOCIETY., ;

(5) Commissioner of Income Tax Vs. Sheth Manilal Ranchhoddas Vishram Bhavan Trust, ;

(6) Commissioner of Income Tax-I Vs. Manav Mangal Society, SLP filed by the Department against this decision dismissed by the Supreme Court in (2010) 328 ITR9 (St.) ;

(7) CIT v. Market Committee, Pipli reported in [2011] 330 ITR 16 (P&H); and

(8) Commissioner of Income Tax Vs. Tiny Tots Education Society, .

We do not find in any of these decisions this aspect is considered and discussed by any of the High Courts. Learned senior counsel though referred Circular No. 5P (LLX-6), dated June 19, 1968 (See endnote 1 on page 349), which is with regard to computation of income of charitable trusts, strangely depreciation is not specifically dealt with in the circular. No decision is seen rendered by the Supreme Court on the merits on this issue, even though one of the special leave petitions filed by the Department against one of the above decisions was dismissed by the Supreme Court. No amendment is seen made to the statute requiring the trust claiming depreciation to write back the depreciation as income of the previous year, if payment for acquisition of assets is treated as application of income for charitable purposes.

It is settled position through several decisions of High Courts and the Supreme Court that when business is held in trust by charitable institutions income from business has to be computed by granting deductions provided under sections 30 to 43D as provided u/s 29 of the income tax Act.

Senior counsel, Sri A.K.J. Nambiar, appearing for the assessee, submitted that the assessee has been filing income tax returns for several years including the assessment year 2005-06, and disallowance is made only for this year. Since business income has to be as stated in section 29 by granting all deductions provided under sections 30 to 43D which includes depreciation u/s 32, the assessee is entitled is the case pressed before us by the senior counsel appearing for the assessee. We have no doubt in our mind that business income of charitable trust also has to be computed in the same manner as provided u/s 29 of the income tax Act. However, the issue that requires consideration is when the expenditure incurred for acquisition of depreciable assets itself is treated as application of income for charitable purposes u/s 11(1)(a) of the Act, should not the cost of such assets to be treated as nil for the assessee and in that situation depreciation to be granted turns out to be nil. However, if depreciation provided is claimed on notional cost after the assessee claims 100 per cent. of the cost incurred for it as application of income for charitable purposes, the depreciation so claimed has to be written back as income available. In fact, going by the several decisions of the various High Courts, we are sure that based on these decisions all the charitable institutions will be generating unaccounted income equal to the depreciation amount claimed on an year to year basis which is nothing but black money. This aspect is not seen considered in any of these decisions. We, therefore, sought the views from the Central Board of Direct Taxes. Senior standing counsel, Sri P.K.R. Menon appearing for the Revenue, produced clarification obtained from the Central Board wherein they have stated as follows :

The Central Board of Direct Taxes is of the considered view that where an assessee has acquired an asset through application of income and has also claimed this amount as expenditure in its income expenditure account, depreciation on such asset would not be allowable to the assessee. Such notional statutory deductions like depreciation, if claimed as deduction while computing the income of the ''the property held under trust'' under the relevant head of income, is required to be added back while computing the income for the purpose of application in the income expenditure account. This would imply that a correct figure of surplus from the trust property is reflected in the income and expenditure account of the trust to determine the income for the purpose of application u/s 11 of the income tax Act. This would reduce the possibility of revenue leakage which may be a cause for generation of black money.

From the above, what is clear is that the Central Board also confirms the view taken by us that after allowing cost of acquisition as application of income for charitable purposes and over and above if depreciation is claimed on such assets, so much of the depreciation allowed will generate income outside the books of account and unless the depreciation is simultaneously written back by the assessee as income available for application for charitable purposes in the next year, there will be violation of section 11(1)(a) of the Act. We find that the hon''ble Supreme Court has clearly stated this position, though not in the same context. In the decision in Escorts Limited and Others Vs. Union of India and others, relied on by the Tribunal wherein the hon''ble Supreme Court states as follows (page 60) :

The mere fact that a baseless claim was raised by some over enthusiastic assessees who sought a double allowance or that such claim may perhaps have been accepted by some authorities is not sufficient to attribute any ambiguity or doubt as to the true scope of the provisions as they stood earlier.

For the forgoing reasons, we dispose of the appeal by confirming the order of the Tribunal. However, as rightly pointed out by the counsel for the assessee the system of allowing depreciation was followed by the assessee for several years and it was consistent with the view taken by several High Courts in India in the decisions above cited. We find force in this contention because assessee cannot be taken by surprise by disallowing depreciation which was being allowed for several years and to demand tax for one year after making disallowance. We feel the assessee should be allowed to write back the depreciation for this year and even for previous and then allow the same to be carried forward for application for subsequent years. It is for the assessee to write back depreciation and if done the Assessing Officer will modify the assessment determining higher income and allow recomputed income with the depreciation written back by the assessee to be carried forward for subsequent years for application for charitable purposes. The appeal is disposed of as above by answering the question in favour of the Revenue but by granting the relief to the assessee as above.

________________________________________________

1 Circular No. 5-P (LXX-6) of 1968, dated 19-6-1968.

Subject: Section 11--Charitable trusts--Income required to be applied for charitable purpose--Instructions regarding.

In Board''s Circular No. 2-P(LXX-5) of 1963, dated the 15th May, 1963, it was explained that a religious or charitable trust claiming exemption u/s 11(1) of the income tax Act, 1961, must spend at least 75 per cent. of its total income, for religious or charitable purposes. In other words, it was not permitted to accumulate more than 25 per cent. of its total income. The question has been reconsidered by the Board and the correct legal position is explained below.

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... ". The reference in sub-section (a) is invariably to "income" and not to "total income". The expression "total income" has been specifically defined in section 2(45) of the Act as "the total amount of income... computed in the manner laid down in this Act". It would accordingly be incorrect to assign to the word "income" used in section 11(1)(a), the same meaning as has been specifically assigned to the expression "total income" vide section 2(45).

In the case of a business undertaking held under trust its "income" will be the income as shown in the accounts of the undertaking. u/s 11(4), any/income of the business undertaking determined by the income tax Officer in accordance with the provisions of the Act, which is in excess of the income as shown in its accounts, is to be deemed to have been applied to purposes other than charitable or religious, and hence it will be charged to tax under sub-section (3). As only the income disclosed by the account will be eligible for exemption u/s 11(1), the permitted accumulation of 25 per cent. will also be calculated with reference to this income.

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 u/s 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 u/s 11(1).

To sum up, the business income of the trust as disclosed by the accounts plus its other income computed above, will be the "income" of the trust for purposes of section 11(1). Further, the trust must spend at least 75 per cent. of this income and not accumulate more than 25 per cent. thereof. The excess accumulation, if any, will become taxable u/s 11(1).