Direct Tax Alert - SC interprets the term ‘solely’ referred in the conditions for claiming tax exemption by educational institution

BACKGROUND

The Income-tax Act, 1961 (IT Act) contains various provisions to exempt the income of Trusts/Institutions if their activities are of charitable nature. Such Trusts/Institutions are required to comply with the specified conditions to claim the exemptions. Institutions engaged in providing education (including universities) can claim an exemption under Section 10(23C) of the IT Act provided it fulfills specified conditions. A key condition that needs to be satisfied is that it is existing solely for the purposes of education and not for the purpose of profit. Further, such Institutions/Trusts need to obtain the approval of the Principal Commissioner/Commissioner. As the term ‘solely’ is not defined in the IT Act, support needs to be taken from judicial precedence. In this regard, the Supreme Court¹ has granted an exemption under the IT Act even when the Trusts/Institutions were not existing solely for the purpose of education but satisfied the ‘predominant test’.

Recently, the Supreme Court² had an occasion to interpret the term ‘solely’ appearing in Section 10(23C)(vi) of the IT Act and also to visit its earlier decisions¹. We, at BDO in India, have summarised the ruling of the Supreme Court and provided our comments on the impact of this decision.  

FACTS OF THE CASE

The taxpayer, an educational institution, made an application for registration under section 10(23C)(vi) of the IT Act which was rejected by the Tax Officer on the following grounds:

1. Not all objects mentioned in the chartered documents were solely for the purpose of education, and

2. It was not registered under the state-specific law applicable to charitable institutions.   

Aggrieved, the taxpayer filed an appeal before the Andhra Pradesh High Court which upheld the order of the Tax Officer. Hence, the taxpayer filed an appeal before the Supreme Court.              

SUPREME COURT RULING

While upholding Andhra Pradesh High Court’s order, the Supreme Court made the following observations:

• Re. Institutions existing ‘solely’ for education
  • The plain and grammatical meaning of the term ‘sole’ or ‘solely’ is ‘only’ or ‘exclusively’. Referring to its dictionary meaning, it is clear that the term ‘solely’ is not the same as ‘predominant/mainly’. It means the exclusion of others.
  • None of the rulings (American Hotel and Queens Education Society) referred by the taxpayer explored the true meaning of the expression ‘solely’. In these rulings, the Supreme Court referred to its earlier decision on the Surat Art Silk Cloth which was decided in the context of a society that did not claim to impart education. It claimed charitable status as an institution set up to advance objects of general public utility. The Surat Art Silk Cloth decision picked the first among the several objects (some of them being clearly trading or commercial objects) as the ‘predominant’ object which it had to consider while judging the association’s claim for exemption.
  • The approach and reasoning applicable to charitable organisations set up for the advancement of objects of general public utility are entirely different from charities set up for the object of imparting education. The basis of exemption in the latter case as per the requisite provisions of the IT Act compulsorily mandates the positive condition ‘solely for educational purposes’ and the negative injunction ‘and not for purposes of profit’. Therefore, the expression ‘solely’ is important and thus, a trust, university or other institution imparting education, should necessarily have all its objects aimed at imparting or facilitating education.
  • To support the above view, the Supreme Court referred to its previous decision in the case of Dilip Kumar and Company & Ors³ and stated that it is only in cases of ambiguity that the court can use other aids to discern the true meaning. Where the statute is clear and the words are plain, the legislation has to give effect in its own terms.    
  • Thus, the reasoning and conclusions in an earlier decision of American Hotel and Queens Education Society (supra) so far as they pertain to the interpretation of the expression ‘solely’ are disapproved and overruled to that extent.
  • From Aditanar Educational Institution’s decision⁴, what can be gleaned is that a society may not by itself carry on educational activities, however, if it sets up and governs such institutions, and its object is solely educational, it would be regarded as a charity set up solely for the purpose of education. 
     
• Manner of considering any gains, surplus or profit by an educational institution for income tax purpose
  • Section 10(23C) of the IT Act requires that the trust or educational institution must solely exist for the object it professes (in this case, education or educational activity only), and not for profit. The seventh proviso however carves an exception to this rule, and permits the trust or institution to earn profits, provided the business is restricted to education or educational activities incidental thereto. To explain the term ‘incidental’, the Supreme Court referred to its previous decision in the case of Delhi Cloth & General Mills Co. Ltd⁵ and stated that ‘Incidental’, in the context of the present case means something connected with the activity of education.  
  • Trusts, universities or other institutions imparting education, as the case may be, should necessarily have all their objects aimed at imparting or facilitating education. Having regard to the plain and unambiguous terms of the statute and the substantive provisions which deal with exemption, there cannot be any other interpretation. 
  • The trust or educational institution, which seeks approval or exemption, should solely be concerned with education, or education-related activities. If incidentally, while carrying on those objectives, the trust earns profits, it has to maintain separate books of account. It is only in those circumstances that ‘business’ income can be permitted provided that the activity is education, or relating to education.
  • Activities incidental to education can be sourcing and providing textbooks, providing school bus facilities, providing hostel and allied facilities only for its students, providing summer camps for pupils’ special educational courses, such as relating to computers, etc. which may benefit its pupils in their pursuit of learning. However, where institutions provide their premises or infrastructure to other entities, trusts, societies, etc. for the purpose of conducting workshops, seminars or even educational courses (which the concerned trust is not actually imparting) and outsiders are permitted to enrol in seminars, workshops, courses, etc. then the income derived from such activity cannot be characterised as part of education or ‘incidental’ to the imparting education.
     
• Enquiry by a prescribed authority at the stage of approval
  • Section 10(23C) of the IT Act requires the Commissioner (prescribed authority) to make enquiries to specify about the genuineness of the activities of the fund, trust or institution and compliance with requirements of other laws in force for such institution. Before granting approval, the Commissioner may call for such documents including audited annual accounts or information from the institution, etc. as is deemed necessary for recording satisfaction about the genuineness of its activities.
  • While considering an application for approval, the Commissioner should confine the inquiry ordinarily to the nature of the income earned and whether it is for education or education-related objects of the society. If surplus/profits are generated by the institution while imparting education or related activities, disproportionate weight should not be given to such activities if they are incidental. Therefore, the focus is on the activity and not the proportion of income.
       
• Registration under other law
  • The requirement of registration of every charitable institution is not optional. Aside from the fact that the consequences of non-registration are penal thereby indicating the mandatory nature of provisions, such local laws provide the regulatory framework by which annual accounts, manner of choosing the governing body, acquisition and disposal of properties, etc. are constantly monitored. Besides this, they also contain provisions to protect the interests of trusts, especially funds and properties.
  • Thus, charitable institutions and societies, which may be regulated by other state laws, have to comply with them. Such compliance or registration under local laws is a relevant consideration for Commissioner while deciding applications for approval under section 10(23C) of the IT Act.
     
• Applicability to earlier year/matters:
  • Since the Supreme Court has departed from its prevailing view regarding the meaning of the term ‘solely’, it has stated that this judgement will apply prospectively to give time to potentially affected institutions to make suitable changes in their activities and/or charter documents, etc.             

BDO COMMENTS

With most of the Colleges/Universities housed under Trusts/Institutions, this decision will have a far-reaching impact. While the Supreme Court in its wisdom has held that this decision will have a prospective effect, all the existing Trusts/Institutions that have the main object of education should evaluate the impact of this decision especially when its registration is up for renewal. Further, this decision has dealt with the term ‘solely’ in great detail and hence will have an impact on other charitable activities.

Furthermore, the Supreme Court has also observed that it is a mandatory requirement for Trusts/Institutions to comply with the local law (say registration, etc.), non-compliance of which may result in the rejection of an exemption request.

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