January 20, 2025

Charitable institutions accept donations from the public, get themselves registered with the Income Tax department and allow income tax exemptions to donors. Their own incomes are also largely exempted from income tax. But many times, these charitable institutions convert from “not-for-profit” to “for-profit” after amassing a huge tax-free corpus and owning large properties with rental income valued in crores. There existed a loophole where these institutions escaped tax altogether. Not anymore.

The Finance Bill, 2016 proposes to tax charitable entities if they change their constitution from not-for-profit to for-profit. In all such cases, the accreted income of the entity will be taxed at the existing maximum marginal rate of taxation, regardless of the amount and without any exemptions. To arrive at the accreted income, the income tax department will take the fair market value of its assets and deduct its liabilities.

This is a good move by the Finance Minister as many such charitable entities were becoming dens of converting black money. This government is slowly but surely moving to plug as many loopholes of black money generation as it can and sham charities needed to be taxed. Having tax free corpus and other assets and putting them to commercial use is just a street-smart method of converting black money as most of these entities used to plough back tainted cash from dubious sources as donations. Several of these entities are started with the intention to build up a large corpus on tax free funds and then use it to do business.

Some experts have called this provision retrospective by saying that it is unfair to tax properties at current market value as the charitable entity might have got it many years ago when the value was much less. These experts have not understood the logic behind the tax. The basic premise is that since the entity is now opting to shed its charitable tag, it has no right to enjoy tax breaks. If the new, non-charitable entity gets a property at current market price, the old charitable entity can only transfer it after paying the exit tax. Call it transfer tax, if you will. As for retrospective taxation, there will be no tax at all if it continues with its charitable objects. One cannot have one’s cake and eat it too.

But other experts have pointed out that the exit tax is also to be levied on entities if they are deemed to have exited. This can happen if the registration of the entity under section 12AA of the I T Act is cancelled or if it fails to file a fresh registration application if the charitable objects are modified. This is a draconian provision that will put genuine charities at great risk. It will also breed enhanced and chronic corruption. As I-T officials have wide discretionary powers in both granting and cancelling registration under sec 12AA, this deemed provision will be misused. The government must find a way out where genuine charities are not made to suffer.