Taxation of charitable trusts under section 12AB

What's Trust? What does Income tax Act say about it?

The term 'Trust' is not explicitly defined in Income tax Act.

Basically, its a legal arrangement where property is transferred by the settlor to trustees for the benefit of beneficiaries.

Types of trust:

Under the Income Tax Act, trusts can broadly be classified into:
Charitable Trusts, Religious Trusts, mixed-purpose trust, Private Trusts.

1. Charitable Trusts:

Charitable Trust under the Indian Income Tax Act is a trust established for carrying out activities that fall within the meaning of charitable purpose. Charitable purpose is defined under Section 2(15) as including relief to the poor, education, medical relief, preservation of environment/monuments, and advancement of general public utility.

2. Religious Trusts:

Created for promoting or maintaining religious activities (temples, gurudwaras etc).

3. Mixed-purpose Trust:

Trusts that carry out both charitable and religious activities. Also called Religious or Charitable trust

4. Private Trusts:

Created for the benefit of specific individuals or families.

Key Points on Registration

Registration is the gateway for charitable and religious trusts to claim exemptions under the Income Tax Act. Following are the key points wrt registration.

1. Section 12AB: Every charitable or religious trust must be registered under this section to avail exemption under Sections 11 and 12.
2. Registration is the legal recognition that allows the trust’s income to be treated as exempt, provided the trust complies with the application of income rules and other conditions prescribed in Sec 13
3. Application Form: Registration is done through Form 10A (or Form 10AB for re-registration/renewal).
4. Documents Required: Self-certified copy of the trust deed or instrument of creation. If created without an instrument, a document evidencing its creation and Registration certificate with Registrar of Societies (if set up as society)/Companies (if set up as sec 8 company), if applicable.
5. Registration is granted after verifying the genuineness of activities and objectives of the trust.
6. Renewal: Registration under Section 12AB is valid for a limited period (generally 5 years) and must be renewed before expiry.
7. Without Registration: The trust’s income is fully taxable, with no allowance for charitable expenditure.

History:

Until April 2021, Section 12AA was the primary framework for the registration charitable and religious trusts. Section 12AA is currently inoperative for new registrations.

Wef 1st April 2021, all trusts registered under the "old" Section 12AA were required to re-register under the new Section 12AB scheme to continue availing exemptions and that registration was valid for 5 years ie until 30th September 2025.

But Registration under Section 12AB is not perpetual; it requires renewal. Finance Act 2025 provided that, all the successful renewals going forward for trusts with a total annual income of ≤ ₹5 crore in each of the preceding two years, may now be granted for 10 years instead of 5 years.

Trusts are taxed under the Income Tax Act as what form of person?

Trusts are generally treated as an Association of Persons (AOP) or sometimes as an Artificial Juridical Person for taxation purposes.

Taxability of trust:

Let's see how different types of trusts are taxed under Income tax act.

Charitable Trusts: Both charitable trust and mixed- purpose trust are Eligible for exemption under Sections 11 and 12, subject to registration under Section 12AB and compliance with Section 13.
Also, Exemption will be denied if benefits are restricted to one community/caste.

Religious Trusts: Exempt under Sections 11 and 12, with special relief for anonymous donations (not taxable under Section 115BBC).

Private Trusts: Not eligible for exemption under Sections 11 and 12, as they do not serve public charitable/religious purposes.

Tax Exemptions

Registered trusts enjoy significant benefits under Sections 11 and 12, provided they satisfy the prescribed conditions given below:

The Rule is "85% application and 15% accumulation"

1. At least 85% of income must be applied to charitable/religious purposes, within India, in the same financial year.
2. Up to 15% of income in a FY, can be accumulated indefinitely without restriction for future use. Accumulation more than that requires compliance to specific conditions

Exceptions to the Exemption rule

While the general rule requires charitable trusts to apply at least 85% of their income and permits up to 15% accumulation, certain exceptions to this rule have been laid down to address practical difficulties and ensure compliance with broader regulatory objectives.

1. Exception to 85% application rule:

   Sometimes, due to practical reasons (like late receipt of income or administrative delays), the trust might not be in a position to spend it all .

   In such cases, Form 9A allows the trust to defer the shortfall in application to the immediately following year. Deferral is only for one year, not beyond. The income deferred must actually be applied in the following year.
   Form 9A must be filed before the due date of return filing. Without filing Form 9A, any shortfall in the 85% application rule becomes taxable.

2. Exception to Up to 15% accumulation for future use:

Trusts may want to accumulate income beyond the 15% limit for a specific project (eg building a hospital, school, or long-term charitable activity).

Filing form 10 allows trusts to accumulate income for up to 5 years for a defined purpose. Must specify the purpose and ensure investments are made only in modes allowed under Section 11(5).
Without filing Form 10 (at least two months before the ITR due date), accumulation beyond 15% is treated as non-compliance and taxed.

Compliance requirements: Section 13

The conditions for compliance that a charitable or religious trust must follow are primarily laid down in Section 13 of the Income Tax Act. Charitable trusts are required to follow specific compliance requirements to retain their tax-exempt status as well as ensuring transparency and accountability

1. Audit: Audit of accounts is mandatory if total income (before Section 11/12 exemptions) exceeds the basic exemption limit.
2. Audit report: Audit reports in Form 10B for larger trusts and those receiving foreign funding OR form 10BB (All Others) must be furnished at least one month before the ITR due date.
3. Return Filing: The trust must file its income tax return (typically ITR-7) by the stipulated deadline (October 31) of the relevant assessment year
4. Investment of Funds (Section 11(5) : Trusts must invest or deposit their funds only in specified modes (government savings certificates, post office savings, scheduled banks, etc) Any investment outside these modes can lead to denial of exemption.
5. Filing of statements: trusts must file Form 9A if they want to defer application of income to the following year and Form 10 must be filed for specific accumulation beyond 15%.

Treatment of different types of Income

1. Voluntary donations:

   Voluntary donations received by charitable or religious trusts are not all treated alike under the Income Tax Act. Their taxability depends on the nature of the contribution, as outlined below.

   1. General Voluntary Donations → Exempt, but subject to the 85% application rule.
   2. Contributions to Corpus: Voluntary contributions with specific directions to form part of the corpus are fully exempt. They are not subject to 85% application rule, provided they are invested in modes specified under Section 11(5).
   3. Anonymous Donations: Taxable at 30% under Section 115BBC, subject to certain exceptions for religious/charitable institutions.
      What are those exceptions:
      --> Anonymous donations received by Wholly Religious Trusts, are not taxable. Eg: offerings in temple, gurudwara etc
      --> If the trust runs educational or medical institutions, anonymous donations received for such purposes are also exempt.

2. Income from property held under trust.

Income from property (immovable or movable) held for charitable/religious purposes like like rent, interest, dividends etc are exempt to the extent it is applied for such purposes in India. They are also subject to 85% application in current year, 15% accumulation for future


3. Business income:

Treatment of business income differs according to the type of Trust:

1. General Charitable Trusts → exempt if business is incidental to attainment of trust’s objectives and separate books are maintained for such business. Eg Hospital running a pharmacy.
2. Trusts with Objective of General Public Utility → considered a subset of charitable trusts under Income tax Act. They face an extra restriction: if business receipts exceed 20% of total receipts, the exemption is lost, even if the business is incidental.
3. Religious Trusts → business income exempt only if incidental to religious objectives and separate books are kept.

Violations:

Income of Charitable trusts are exempted subject to compliance with legal provisions. Any breach of these requirements can lead to penalties or withdrawal of exemptions. The following are the major violations and their consequences

1. If the Trust is Unregistered trust:

   Taxed as AOP, at standard slab rates or the Maximum Marginal Rate, if any of the member's income exceeds the basic limit.

2. Receipt of Anonymous Donations:

   Taxed at a flat 30% (plus surcharge/cess) if they exceed ₹1 lakh or 5% of total donations, whichever is higher.

3. Section 115BBI Violations:

   Income used for prohibited purposes or not invested in 11(5) modes) is taxed at a flat 30%.

4. No longer charitable (115TD):

   If a trust converts to a non-charitable form or registration is cancelled, tax at MMR (42.744%), is levied on its "accreted income" (net fair market value of assets).

5. Income Applied Outside India :

   Income applied outside India generally does not qualify for exemption unless prior approval is obtained from the CBDT.

6. Benefit to Specified Persons (Section 13):

   Exemption is denied if trust income or property is used directly or indirectly for the benefit of specified persons (such as trustees, founders, or their relatives). Usage includes: excessive payments, loans, or allowing use of assets.