For-profit or not-for-profit…..NIKHIL BHATIA & POONAM PRABHU
THE PROPOSED REGULATORY REFORMS that promise to overhaul higher education in the country have come as a breath of fresh air in the stifling stranglehold of the extant education policy framework.However,the core education sector is expected to function in a not-for-profit format of trust or society,or Section 25 company.
In the backdrop of this,the substantial changes proposed by the Direct Taxes Code (DTC) Bill,2010,in relation to the taxation of non-profit organisations (NPOs) merit attention.The DTC seeks to simplify and consolidate the taxation regime applicable to charitable,religious and educational institutions in a single chapter containing special provisions relating to the computation of total income of NPOs.
Broadly,there will be three categories of NPOs.In the first category are certain notified NPOs of public importance that will be completely out of the tax net and require no specific compliance.In the second category are public religious institutions that will be required to comply with most provisions of the DTC except some relating to income accumulation,prescribed method of accounting,taxation of unutilised accumulated income and the like.Then there are other NPOs that will need to comply with all the requirements of the DTC to qualify for concessional tax treatment.
While the provisions of the DTC are seemingly similar to those governing charitable institutions,it contains some far-reaching changes as discussed below that will impact NPOs going forward.Income accumulation: Income accumulation will be restricted to the extent of higher of (a) 15% of total income before accumulation or (b) 10% of gross receipts,as against up to 100% accumulation currently permitted.Thus,unspent income for the year in excess of 1 lakh will be taxable at 15% rate.The timeline for application of accumulated income will be restricted to three years vis–vis the current limitation of five years.Method of accounting: NPOs registered as Section 25 companies will mandatorily need to follow mercantile system of accounting.Thus,if income such as rental income is accrued but not received before the end of the year,it may be taxed due to inability of the NPO to spend it during the year.
Currently,institutions have the flexibility to apply income derived at any time of the year in the immediately following year.However,under the DTC,such option is available only in respect of income received in the last month of the year.Withdrawal of benefits/disqualification: Today,an institution does not jeopardise its exemption status if non-specified investments are acquired such as received as donation subject to liquidation of the same within a year from the date of acquisition.However,the requirement under the DTC to keep the NPOs funds invested in specified modes at all times,without exception,may result in withdrawal of this leeway.
Rollover relief will not be available for capital gains on sale of investments even if reinvested in a similar instrument such as government securities.Exemption will now be available only if the gain is applied for carrying on charitable activity or capital expenditure on an incidental business.
Similarly,an NPO carrying on business not incidental to charitable activity will be disqualified.
Today,related-party transactions that are not at arms length,by themselves,do not disqualify the institution from claiming tax benefit in respect of its other qualifying income.However,the DTC will disqualify such NPO from claiming an NPO status.
An NPO that converts or merges with a non-NPO will be liable to pay tax at 30% of the net worth,resulting in taxation of appreciation in the value of investments and net worth created out of exempted income and not only the current years income.
An NPO that ceases to be one at any time during the year will be required to pay tax as per the normal provisions of the DTC.
Open issues and lack of grandfathering provisions: There is lack of clarity on the following matters in the DTC:
* How partly-charitable,partly-religious NPOs would be treated.
* To what extent investment modes specified will be expanded.
* Whether existing investments to the extent not specified in the DTC need to be liquidated and the timeframe thereof.
* Whether past accumulations of income would be grandfathered.
* Whether existing non-specified investments can be held for the unexpired period of one year.
* If an extension of time will be allowed for accrued income under the Mercantile System,required to be invested,though not received.
While NPOs are expected to take a lot of burden off the government in providing infrastructure for sectors such as healthcare and education,the amended provisions applicable to such institutions will cause hardship and uncertainty in many areas.Provisions relating to accumulation and rollover relief should be restored in their original form and the DTC should clarify the position on the open issues and those requiring grandfathering.
The authors are executive director and manager,respectively,for tax and regulatory services at PwC