The treatment of excess application over income carried forward to future years has been a topic of debate with divergent views by various Courts. In this backdrop, the author, Mr. Manoj Kumar (Senior Partner, Manoj Kumar Mittal & Co) has elucidated the position pre and post the amendment introduced in the Finance Bill, 2021.

The author highlights that the position was settled by the SC ruling in Subros Educational Society, where it was held that excess expenditure by a trust is allowed to be set off against income of subsequent years. Remarks that the amendments in Sec. 10(23C) and Sec. 11, when read together, indicate that the Government has only amended the year of allowability of excess application of expenses over income carried forward from previous year without intending to disallow the claim. Explains that there are four sources of funds for application by a trust: (i) Corpus fund, (ii) Loan received during the year, (iii) fund accumulated out of 15% saved over a period, and (iv) pending creditors. Clarifies that post-amendment, the excess application of expenses will be allowed to be carried forward and set off “in the future years in which the amount withdrawn from corpus fund in earlier year is invested back into it.”

Disallowance of carried forward of excessive application of expenditure over income by FB 2021 is myth or reality

Sections 11 to 13 of the Income Tax Act, 1961 are self-contained codes for computation of income of a charitable trust. These sections provide proper guidelines as to how the total income of the trust should be calculated.

The computation of income of a charitable trust are not affected by the chapter VI, which provides for set off and carry forward of loss.

There have been disputes in the past years under the Income Tax Act as to whether excessive application of expenditure over income should be allowed to be carried forward or not, for to be set off against the income in successive years.

This issue was settled by the honorable SC in the case of Commissioner of Income-tax (Exemption) vs Subros Educational Society, New Delhi, [TS-5166-SC-2018-O]

In this case, the assessee filed the return of income on 30.09.2012 declaring Nil income which  was processed u/s 143(1) of the Income Tax Act, 1961.  Later on, the case was selected for scrutiny. The AO framed the assessment at a deficit of Rs.13,03,12,250/- but did not allow the carry forward the said deficit.

The question before the honorable SC was

Whether any excess expenditure incurred by the trust/charitable institution in earlier assessment year could be allowed to be set off against income of subsequent years by invoking Section 11 of the Income-tax Act, 1961?"

The Honorable SC dismissed the petition of the Income tax department and upheld the order of the DHC  that any excess expenditure incurred by the trust/charitable institution in earlier assessment year could be allowed to be set off against income of subsequent years by invoking Section 11 of the Income-tax Act, 1961.

Similar issue came before the honorable DHC in the case of M/s  DIT vs. Raghuvanshi Charitable Trust, [TS-133-HC-2010(Delhi)-O] where the question of law before the honorable court was

1. a) Whether the Income Tax Appellate Tribunal was correct in law in allowing the assessee to carry forward deficit of the current year and to set off the same against the income of subsequent years?
2. b) Whether the Income Tax Appellate Tribunal was correct in law in allowing the assessee to carry forward and set off the losses against the income of subsequent year ignoring that the determination of income under sections 11 to 13 is a separate code and does not contain such provisions as contained in Chapter-VI of the Act?
3. c) Whether adjustment of deficit (excess of expenditure over income) of current year against the income of subsequent year would amount to application of income of the Trust for charitable purposes in the subsequent year within the meaning of section 11(1)(a) of the Act?

The honorable DHC after analyzing the provision of the Act  held that in the case of a charitable trust, there was no provision for carry forward of the excess of expenditure of earlier years to be adjusted against income of the subsequent years. We do not find any merit in this argument of the Department. Income derived from the trust property has also got to be computed on commercial principles and if commercial principles are applied, then adjustment of expenses incurred by the trust for charitable and religious purposes in the earlier years against the income earned by the trust in the subsequent year will have to be regarded as application of income of the trust for charitable and religious purposes in the subsequent year in which the adjustment has been made with regard to the benevolent provisions contained in the section 11 of the Act and that such adjustment will have to be excluded from the income of the trust under section 11(1)(a) of the Act. Our view is also supported by the judgment of the Gujarat High Court in the case of CIT v. Shri Plot Swetamber Murti Pujak Jain Mandal [TS-5781-HC-1993(Gujarat)-O] .

Amendment in Income Tax Act to over rule this law

The government has tried to overrule this settled law by FB 2021 by inserting an explanation (2) to 12^th proviso to section 10(23C)  and explanation 5 in section 11(1) of the Income Tax Act which provides that while calculating income of the charitable trust, the effect of carried forward of excess application of expenses over income from previous year shall not be allowed.

Hence, by inserting this explanation, the carried forward of excess application of expenses over income of any previous year against the income of the succeeding year is tried to be  not allowed to be set off.

There is furthers relevant amendment in section 11 and 10(23C)  by inserting Explanation 2 to 2nd proviso to section 10(23C) and explanation 4 inserted into the Sec 11(1) of the Income Tax Act; which provides that where the source for fund for excessive application of expenses  over income is from corpus or loan and advances; then it will not be treated as application of income in that year but it will be treated as application of income in the year in which the fund so withdrawn from corpus  is  invested or deposited back, into one or more of the forms or modes specified in sub-section (5) of section 11 maintained specifically for such corpus, from the income of that year and to the extent of such investment or deposit

Similarly, if the fund is taken out of loan or borrowing for excessive application of expense over income, then it will not be treated as application in that year but in the year, in which it is the loan or borrowing, or part thereof, is repaid from the income of that year and to the extent of such repayment:”

If we read the above amendments together, then we shall find that what has been changed from the earlier position of law to current position is year of allowability of excess application of expenses over income carried forward from previous years.

The author has tried to explain this with the examples below but before that it is necessary to understand what could be possible source of fund other than voluntary donation that could cause excessive expenditure over income.

These are as follows:

1. The corpus fund;
2. The loan received during the year;
3. The fund accumulated out of 15% saved over the period
4. Pending creditors

Under the pre amended position of law, the if the excess is incurred in a particular year ,say, out of fund derived from corpus fund; then it was allowed to be set off against the income in future year irrespective of the fact that whether the amount withdrawn from corpus fund in earlier year is invested back into it or not.

But the post amendment position is that  if the excess is incurred in a particular year ,say, out of fund derived from corpus fund; then it is allowed to be set off against the income in future year in which the  amount withdrawn from corpus fund in earlier year is invested back into it.

So the difference between the pre and post amendment position of law is the year of set of carried forward of application of excessive expenses over income. Further, there is no limitation of time in claiming such set off of such excess application of expenses over income.

We shall more understand this with the help of an examples:

Examples:

For F.Y. 2020-21,

The trust has a receipt of Rs. 10 lakh. The corpus fund is 15 lakh and expenditure incurred is Rs. 12 lakh.

Now since this excess has been incurred out of the 15 lakh corpus fund, thus the remaining corpus fund at the end of 31.03.2021 will be 13 lakh.

For F.Y. 2021-22

The trust has a receipt of Rs. 8 lakh. The corpus fund 13  lakh and expenditure incurred is Rs. 5 lakh.

Then out of 8 lakh, 5 lakh is incurred.

For F.Y. 2022-23,

The trust has a receipt of Rs, 10 lakh, the expenditure is of Rs. 6.5 lakh.

The two lakh out of the receipt of Rs.10 lakh is transferred to corpus fund.Thus the corpus fund is of now 15 Lakh.

Now the tax position is  like this

F.Y. 2020-21

The two lakh excess application will not be allowed to be carried forward as per the normal provision or commercial system.

Further there will no be any tax liability.

For F.Y. 2021-22

Now the position at the end of 2022 will be as follows:

Total receipt                                                                       8.00 lakh

Expenditure                                                                        5.0 lakh

The fund that can be accumulated (upto 15%)                  1.2 Lakh

Total application                                                                  6.2 Lakh

Hence taxable income                                                        1.8 Lakh

Now in F.Y. 2022-23,

The trust has a receipt of Rs, 10 lakh, the expenditure is of Rs. 6.5 lakh.

The two lakh out of the receipt of Rs.10 lakh is transferred to corpus fund and thus the total corpus will be replenished and will be treated as application of income.

Now the position at the end of 2023 will be as follows:

Total receipt                                                                                  10.00 lakh

Expenditure                                                                                    6.5 lakh

Replenishment of corpus fund treated as application of income    2.0 lakh

The fund that can be accumulated (upto 15%)                               1.5 Lakh

Total application                                                                            10.00 Lakh

Corpus Fund                                                                                 15.00 Lakh

Hence, there will not be any tax liability in the year 2022-23 as carried forward of 2 lakh is allowed.

Therefore, in view of the above, it can be easily said that the excess of application of expenditure over income is still allowed to be carried forward and set off against the income in future year in which the corpus fund is replenished or loan  is repaid.

Disclaimer

The above write up is totally personal opinion of the author. The author is not at all responsible for any loss if caused to any one by relying on it.