Understanding Charitable Purpose under Section 2(15) of the Income Tax Act
The way you define the purpose of existence of your NGO in your Trust Deed or Memorandum of Association (MOA), will help decide its ability to sustain itself. Infact, the future of your social enterprise is determined the day you choose to set it up because the way you define your ‘Charitable Purpose will help you attract funds and maintain those tax benefit registrations.
Limbs of Charitable purpose
We know most of the new NGO’s try not to look onto the path of engaging in commercial activities for fear of losing their charitable character before tax officer and be levied by a massive burden of taxes. However, lack of funding forces social enterprises to pursue some mercantile projects to sustain themselves.
Do note that the government cannot focus on every concern of its citizens. Therefore NGOs allow citizens to voluntarily tackle these inadequately addressed or unaddressed concerns. As long as these NGOs function with integrity and share the burden of responsibility, they can carry out business activities incidental to certain charitable activities. The government through the Income -Tax department tracks the genuineness of these tasks by laying down charitable objectives which are dear to the government. Let us get a clear picture by producing the definition of Charitable purpose u/s 2(15) of the Income-Tax Act:
|Charitable purpose||Percentage of commercial activity tax exempt|
|1. Relief of the poor||100%|
|4. Medical relief||100%|
|5. Preservation of the environment||100%|
|6. Preservation of monuments||100%|
|7. Advancement of general public utility||20%|
Essentially, if your stated objectives for running an NGO include relief to the poor, education, yoga, medical relief, preservation of the environment or protection of monuments, then 100% of the commercial activities related to these charitable objectives will 100% tax-exempt.
Do note that you specifically need to mention these ‘charitable objectives’ in your trust deed or memorandum of association. If you don’t, then even though that commercial activity may be genuinely assistive to society, it will not be tax-exempt and your NGO may end up paying tax every year as they cannot attain charitable character without specific charitable objectives .
Let’s look at some simple examples:
|An NGO in India is running a school. For the assistance of students, they are running bus services for them and charging bus fees separately. They earn profits out of this service. Will the profit be taxable for being commercial in nature?||No. Any commercial activity that aids in providing education to the students will be considered as a charitable activity even when that activity earns a profit. For that matter, running a canteen or hostel or even bus service will not be taxable.|
|If an NGO is undertaking commercial activities such as renting out its premises, earning interest on FDR, earning capital gains but applies all such income for the welfare of poor and unprivileged, what will be the tax treatment on various profits earned?||If the charitable objective of the NGO is providing relief to the poor, and the NGO is expending at least 85% of total receipts earned from various sources (such as rent and interest) towards relief work, then such income is not taxable in the hands of the NGO. In other words, the NGO can claim exemption u/s 11 of the Income Tax Act, 1961|
|A person running a taxi service also provides ambulance services to many hospitals. Can there be a possibility that he register an NGO and after that claim that his NGO provides medical relief under section 2(15) of Income-Tax act?||No. Only if a hospital or clinic while providing medical relief also provides the incidental commercial activity of ambulance service, will it be considered as a charitable activity.|
The six limbs in detail
So, we can say six out of the seven limbs mentioned above allow 100% receipts from commercial activity incidental to the main charitable objectives. These six limbs are very dear to the government. Although these limbs may look restrictive; only if we correctly decipher each one would we be able to understand the broad scope it offers. We will help understand each of these six limbs from the eyes of a tax officer. Let us discuss them one by one.
|Six limbs of section 2(15)||How is this limb perceived by NGO’s?||What does it imply?|
|1. Relief of the poor||Ask for donations and apply those donations to feed poor with food, clothing and other immediate essentials.||Apart from receiving donations, NGO’s may even take up a commercial activity such as rent a place /sell sanitary napkins/ earn interest on FDR. Proceeds from these business activities will be considered as incidental to the objective of relief of the poor if they are applied in a prescribed manner to raise the living standards of the poor.|
|2. Education||Covers schools, colleges, other institutions imparting academic knowledge through books||Education is an inclusive term and includes vocational courses and skill development also. The exemption under section 10(23C) already covers schools/ colleges. Education here implies helping someone become more skilled even though such teaching may take place in a camp or temporary structures such as tents.|
|3. Yoga||Cover NGO's promoting Yoga by conducting classes free of cost or at nominal charges to prove their charitable motives. Any commercial activity, such as the sale of yoga books or mats, will be taxable as a business activity.||Yoga can be an alleviating experience and to create an ambience for such expertise, NGOs may expend much money towards it. Hence, in return, they can charge a higher fee which is commensurate with the benefits offered by such classes. Yoga centres may also sell yoga mats and yoga manuals;earn profits as these commercial activities are incidental to the main objective of promoting yoga.|
|4. Medical relief||Covers Hospitals, medical clinics and large setups to aid medical relief||Medical relief is also a term with broad meaning. An exemption covers hospitals and other medical institutions under section 10 (23C). Hence, the objective of stating medical relief as a charitable purpose here is to include different efforts made in the field of medicine such as psychology, homoeopathy, physiotherapy, naturopathy or even by selling herbal medicines.|
|5. Preservation of the environment||Includes massive-scale efforts towards preserving the environment, such as: - global warming - water harvesting - pollution control - tree plantation - preventing deforestation - preserving rare wildlife species||Preservation of the environment is not limited to only substantial scale efforts. Even small initiatives such as conducting environmental programs aimed at improving the health of people, providing sanitation and maintenance of the clean environment, garbage recycling, finding alternatives to plastic, and maintaining nurseries or orchards or even providing horticulture services are all covered under preservation of the environment.|
|6. Preservation or conservation of monuments or places or objects of artistic or historical importance||This limb is generally understood by NGO's in real sense. However, we would like to emphasize that monument or places or objects of historical objects are the ones notified by the government and do not include creating a model of ancestral homes.|
Let’s understand the 7th limb
Now let us look at the seventh limb: Advancement of general public utility. Why is this limb so special to be given a separate treatment from rest of the limbs? It is because this is a residuary limb, in other words – not so dear to the government. Due to its inclusive nature, it covers any and every charitable activity imaginable. It thus is hurt by the disability created by the proviso to section 2(15) of the Income-Tax Act. Any commercial business from the advancement of general public utility is eligible to be treated as a charitable purpose only if it fulfils the following two conditions:
|Commercial activity undertaken is incidental to the main object of the advancement of general public utility.||+||Revenue from such commercial activity does not exceed more than 20% of total receipts of the NGO.||=||Commercial activities incidental to the object of the advancement of general public utility is considered as charitable activities.|
Even after laying down the above provisions, confusion has still prevailed. Nobody has experienced this situation more than new NGO’s who have practically been held in this situation right at the very start. However, to help you gain a better understanding, we have produced frequently asked questions (FAQ’s).
Frequently asked questions
Yes, NGO in India will be considered to be carrying non-charitable activities for the year in which receipts exceed 20% and shall be taxable as a business entity.
If the Charitable Trust in India has mixed activity then the income coming from any of the first six limbs will be completely tax exempt. For the income coming from the seventh limb, upto 20% of total receipts will be tax exempt and the balance 80% will be fully taxable.
No, the charitable character of a charitable trust for Income-tax purposes is determined every year. If in one year, the NGO exceeds 20% receipt limit, it will become taxable like a business entity. However, in the next year, if the 20% limit remains intact, the NGO gains back the charitable character.
When a charitable activity passes through all the six limbs and still cannot fit in any, then it is classified under the residuary limb. For example: If an NGO sets up a “Chamber of Commerce” will necessarily fall into the advancement of general public utility unless receipts from such proceeds are utilized towards the relief of the poor.