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Cancellation of tax exemption - Circumstances and Consequences

Background

Often times, a charity is far too worried about provisions relating to business income, hybrid structure, remuneration to directors, etc. While important, these issues relate only to the tax exemption for a particular year. A charity should consider other situations with more serious consequences under the Income Tax Act while making operational decisions.


One such aspect is the cancellation of tax registration granted to charities under section 12AB (previously under section 12A) of the Income-tax Act.


Through a series of articles, we would lay down the situations, consequences and some suggestions to better deal with this.


9 exhaustive circumstances under which the tax registration of a charity can be cancelled

In the past, the law regarding cancellation of registration was contained in section 12AA(4) of the IT Act. Effective April 1st, 2022, the Legislature amended the law relating to cancellation and revised the list of circumstances in which such cancellation can be initiated.


Under the amended law, the tax registration granted under section 12AB can be cancelled by the Commissioner of Income-tax if the tax department notices the occurrence of one or more “specified violations” during any previous year.


The situations which can be regarded as a “specified violation” have been defined in the IT Act as follows –


  1. Utilisation of income for an object which is outside the objects as contained in its constitution document (trust deed, MOA, etc.).

  2. Earning income from a business that is not incidental to attaining its objects.

  3. Non-maintenance of separate books of accounts in respect of an incidental business.

  4. Carrying on an activity that is not genuine.

  5. Carrying on an activity in violation of the conditions mentioned in registration certificate in Form No. 10AC.

  6. Non-compliance with the requirements of any other law.

  7. Application for registration was found to be not complete or contained false or incorrect information.

  8. Utilisation of income for the benefit of any particular religious community or caste.

  9. Utilisation of income towards private religious purposes which does not enure to the benefit of the public.

Some points to keep in mind for each of situations is given here.


A detailed analysis of the cancellation provision is given here.


Possible consequences of cancellations

Some of the major consequences of such cancellation are-


(a) “Exit tax” on the market value of assets


The charity will be liable to pay exit tax on the market value (and not book value) of its assets as on the date of cancellation (as computed under rule 17CB) at maximum marginal rate (plus surcharge) (currently, 39%).


(b) Loss of tax exemption


Tax exemption under section 11 will not be available vis-à-vis its entire income (including donations, etc.), and its income will be computed under the different heads of income under the IT Act and taxed accordingly, without the benefit of 15% basic accumulation and accumulation for 5 years under section 11(2), etc.


(c) Loss of approval under section 80G


The charity will lose its approval under section 80G, and consequently, the donors will not be entitled to a deduction under section 80G (after the date of cancellation).


(d) Taxability in the hands of the beneficiary


The donations/property received by the beneficiary from such charity could be taxed in his or her hands. For example, a scholarship given to a student or payment for medical treatment (exceeding INR 50,000) will be taxed in the hands of such beneficiary under section 56(2)(x).


(e) Deductibility of expenses on charity


A question may arise whether the income utilised towards charitable objects by the charity can be allowed as a tax deduction in its hands under the normal provisions of the IT Act. [While some Courts have held in favour of the assessees, litigation on this ground cannot be ruled out].


To illustrate, a charity registered under section 12AB is entitled to claim spending on its charitable objects as a deduction. However, if such a charity loses its tax registration, a question may arise as to whether it is entitled to claim such spending as a deduction under the normal provisions of the IT Act.


(f) Implications under CSR


Charity will not be able to act as implementing agencies for companies for their CSR funds. CSR Rules require such agencies to have registration under section 12AB / 80G [see rule 4(1) of the Companies (Corporate Social Responsibility Policy) Rules, 2014].


 

Related posts

1. Some points to keep in mind for each of situations is given here.

2. A detailed analysis of the cancellation provision is given here.


Disclaimer

This article is intended for general information only and does not constitute legal or other advice, and you acknowledge that there is no relationship (implied, legal or fiduciary) between you and the author and Aria CFO Services LLP. Aria CFO Services LLP and the author does not claim that the article's content or information is accurate, correct or complete, and disclaims all liability for any loss or damage caused through error or omission.

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