Computation of profit on sale of capital assets is different in case of Trust: CA Naresh Jakhotia

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There is a special provision to levy the tax arising on sale of capital assets in case of all the taxpayers. In such cases, gain is required to be computed in the prescribed mode under the heading “Income From Capital Gain”.  However, the same mode is not applicable if the capital assets is sold by charitable trust. For trust, capital gain is required to be computed not as per chapter of “capital gain” computation.

Before we read further, it may be noted that the definition of “Income” under section 2(24) includes Capital Gains and so, obviously, for the purposes of section 11, Capital Gains will be forming the part of the income of trust as well.

Result: It has to be treated at par with other income under section 11.

Now, for charitable trust there is a special provision in Chapter III in section 11 to 13B.  More particularly, Section 11(1A) deals with it.  It may be noted that section 11(1A) was not there during the inception of the Act and in absence of any provision related to it, all Charitable trust were required to apply the Capital Gains for charitable purposes under the provisions of section 11(1)(a) only. Requirement of utilizing capital gains on fulfillment of the objects of the trust was resulting in the depletion of the basic corpus of the trust only. It was felt necessary to allow an option to the charitable trust whereby they can invest the sale proceeds from Capital Assets in new Capital Assets so that the corpus would remain intact in the end.

This issue was aptly recognized by the CBDT in Circular No. 2-P(LXX-5), Dt.15-05-1963 wherein it was stated that when the capital assets is forming part of the corpus is transferred with a view to acquire further capital assets for the use and benefit of the Trust then Capital Gains should be regarded as having been applied for charitable purposes within the meaning of section 11(1).  CBDT further vide its Circular No. 52, dt. 30-12-1970 has rightly clarified that the intent of the legislature was not in favour of imposing tax liabilities in cases where the Capital Gains as well as the consideration is applied for acquisition of new Capital Assets.

To overcome the burden of tax in such cases, Charitable Trust are conferred the option of saving tax by claiming benefits of re-investment with regard to profit arising on sale of capital assets. This is done by section 11(4A) by the Finance (No.2) Act, 1971.

Section 11(1A) provided that the Capital Gains will be deemed to have been utilized for the purposes of section 11(1)(a) if the net consideration received is re-invested in another capital asset.  Addition of section 11(1A) is nothing but logical outcome of the earlier. All the more important, section 11 (1A) in 1971 was given retrospective effect right from 01-04-1962 i.e. the date of commencement of the Income Tax Act-1961

The relevant part of section 11(1A) is produced hereunder for better understanding:

Income from property held for charitable or religious purposes.

  1. 11. (1) 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;

 (b) income derived from property held under trust in part only for such purposes, the trust having been created before the commencement of this Act, to the extent to which such income is applied to such purposes in India; and, where any such income is finally set apart for application to such purposes in India, to the extent to which the income so set apart is not in excess of fifteen per cent of the income from such property;

 (c) income derived from property held under trust—

  (i) created on or after the 1st day of April, 1952, for a charitable purpose which tends to promote international welfare in which India is interested, to the extent to which such income is applied to such purposes outside India, and

  (ii) for charitable or religious purposes, created before the 1st day of April, 1952, to the extent to which such income is applied to such purposes outside India:

Provided that the Board, by general or special order, has directed in either case that it shall not be included in the total income of the person in receipt of such income;

 (d) income in the form of voluntary contributions made with a specific direction that they shall form part of the corpus of the trust or institution.

Explanation 1.—For the purposes of clauses (a) and (b),—

 (1) in computing the fifteen per cent of the income which may be accumulated or set apart, any such voluntary contributions as are referred to in section 12 shall be deemed to be part of the income;

 (2) if, in the previous year, the income applied to charitable or religious purposes in India falls short of eighty-five per cent of the income derived during that year from property held under trust, or, as the case may be, held under trust in part, by any amount—

   (i) for the reason that the whole or any part of the income has not been received during that year, or

  (ii) for any other reason,

then—

  (a) in the case referred to in sub-clause (i), so much of the income applied to such purposes in India during the previous year in which the income is received or during the previous year immediately following as does not exceed the said amount, and

  (b) in the case referred to in sub-clause (ii), so much of the income applied to such purposes in India during the previous year immediately following the previous year in which the income was derived as does not exceed the said amount,

may, at the option of the person in receipt of the income (such option to be exercised before the expiry of the time allowed under sub-section (1) of section 139 for furnishing the return of income, in such form and manner as may be prescribed) be deemed to be income applied to such purposes during the previous year in which the income was derived; and the income so deemed to have been applied shall not be taken into account in calculating the amount of income applied to such purposes, in the case referred to in sub-clause (i), during the previous year in which the income is received or during the previous year immediately following, as the case may be, and, in the case referred to in sub-clause (ii), during the previous year immediately following the previous year in which the income was derived.

Explanation 2.—Any amount credited or paid, out of income referred to in clause (a) or clause (b) read with Explanation 1, to any other trust or institution registered under section 12AA, being contribution with a specific direction that they shall form part of the corpus of the trust or institution, shall not be treated as application of income for charitable or religious purposes.

21[Explanation 3.—For the purposes of determining the amount of application under clause (a) or clause (b), the provisions of sub-clause (ia) of clause (a) of section 40 and sub-sections (3) and (3A) of section 40A, shall, mutatis mutandis, apply as they apply in computing the income chargeable under the head “Profits and gains of business or profession”.]

(1A) For the purposes of sub-section (1),—

 (a) where a capital asset, being property held under trust wholly for charitable or religious purposes, is transferred and the whole or any part of the net consideration is utilised for acquiring another capital asset to be so held, then, the capital gain arising from the transfer shall be deemed to have been applied to charitable or religious purposes to the extent specified hereunder, namely:—

   (i) where the whole of the net consideration is utilised in acquiring the new capital asset, the whole of such capital gain;

  (ii) where only a part of the net consideration is utilised for acquiring the new capital asset, so much of such capital gain as is equal to the amount, if any, by which the amount so utilised exceeds the cost of the transferred asset;

 (b) where a capital asset, being property held under trust in part only for such purposes, is transferred and the whole or any part of the net consideration is utilised for acquiring another capital asset to be so held, then, the appropriate fraction of the capital gain arising from the transfer shall be deemed to have been applied to charitable or religious purposes to the extent specified hereunder, namely:—

   (i) where the whole of the net consideration is utilised in acquiring the new capital asset, the whole of the appropriate fraction of such capital gain;

  (ii) in any other case, so much of the appropriate fraction of the capital gain as is equal to the amount, if any, by which the appropriate fraction of the amount utilised for acquiring the new asset exceeds the appropriate fraction of the cost of the transferred asset.

Explanation.—In this sub-section,—

  (i) “appropriate fraction” means the fraction which represents the extent to which the income derived from the capital asset transferred was immediately before such transfer applicable to charitable or religious purposes;

 (ii) “cost of the transferred asset” means the aggregate of the cost of acquisition (as ascertained for the purposes of sections 48 and 49) of the capital asset which is the subject of the transfer and the cost of any improvement thereto within the meaning assigned to that expression in sub-clause (b) of clause (1) of section 55;

(iii) “net consideration” means the full value of the consideration received or accruing as a result of the transfer of the capital asset as reduced by any expenditure incurred wholly and exclusively in connection with such transfer.

Section 11(1A) refers to two cases:

  1. where the capital asset is property held under a Trust wholly for charitable  purposes;
  2. where the capital asset is held under a Trust in part only for such purposes

Now, a question emerges whether the profit arising from sale of capital assets can be saved if it is applied in accordance with 11(1)(a) and not 11(1A)?

It may be noted that there is no bar and it is at the discretion of the Trust to apply the Capital Gains for charitable purposes u/s 11(1)(a) or towards purchase of a new Capital Asset in accordance with 11(1A).  Obvious purpose for introduction of section (1A) was to provide an option to the assessee of keeping its corpus safe. It never meant withdrawal of exemption of Capital Gains under section 11(1)(a).

In short, in my view, Trust can utilize the Capital Gains for charitable purposes under section 11(1)(a) and the portion of Capital Gains which is not so utilized only shall be deemed to have been applied for charitable purposes under section 11(1A). In this regard, the following two observation are worth noting:

  1. Investment in fixed deposit is also considered as an investment in Capital Asset. The CBDT instruction no. 883, dated 24.09.1975, specifies that, such fixed deposits should be for 6 months or more. It may further be noted that few High Courts have held that even such 6 months time limit is legally not valid. The nature of asset is important and not the time frame.
  2. No time limit has been provided under section 11(1A) for retention of the new asset as is there in the case of capital gain exemption u/s 54EC, 54F etc.

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