Application of Income under Section 11 – Tax Exemption Rules for Charitable Trusts

The Application of Income under Section 11 of the Income-tax Act refers to the requirement that charitable or religious trusts must apply at least 85% of their income each year towards their specified charitable or religious purposes in India to claim tax exemption. This includes both revenue and capital expenditure, such as administrative costs, establishment expenses, or even construction of assets like schools or hospitals, provided they are used for charitable objectives. Repayment of loans taken for charitable purposes is also treated as an application of income. However, the application is recognized only on a payment basis and must comply with statutory conditions, ensuring that income genuinely benefits the charitable purpose without benefiting related parties.

Table of Contents

1. Meaning of Application of Income
2. Application of Income to be Allowed on Payment Basis
3. Capital Expenditure Is Also Treated as an Application
4. Administrative and Establishment Expenses
5. Repayment of Debt/Loan for Charitable Purposes
6. Text of Department Circular
7. Useful Tips

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1. Meaning of Application of Income

Section 11(1)(a) state that the income derived from property held under trust wholly for charitable and religious purposes to the extent to which such income is applied to such charitable purposes in India shall be exempt from tax. According to section 11(1) of the Income-tax Act in order to claim exemption on the income derived from property held under trust or on receipts from voluntary contributions the trust must spend the income for charitable purposes as mentioned in the Trust Deed.

In order to claim exemption 85 percent of the income derived from property held under trust, including the amount received as voluntary contributions (other than voluntary contributions towards the corpus of the trust) in the previous year, has to be applied/spent for such purposes in the previous year.

Furthermore, following income shall not be included in the total income of the previous year of the Trust where such income is accumulated or set apart for application to such purposes in India to the extent it is not in excess of fifteen percent of the income from such property. However, no set-off or deduction or allowance of any excess application, of any of the year preceding the previous year, shall be allowed.

2. Application of Income to be Allowed on Payment Basis

The application of income includes all payments and expenditures for the purpose of charitable and religious purposes in India.

The application of income shall be allowed only on a payment basis. This is irrespective of the previous year in which the liability to pay such sum was incurred by such trust even if it was following accrual method of accounting.

3. Capital Expenditure Is Also Treated as an Application

The term ‘application’ has a relatively wider for purposes of section 11, therefore even capital expenditure like procurement of computers which is otherwise not considered as an allowable expense is a

lso treated as application of income as per section 11 of the Act.

For e.g. Trust construct school building of INR 100 Lakh during FY 2024-2025. Trust can claim construction cost as application of income. However trust cannot claim deprecation as application of income

4. Administrative and Establishment Expenses

Can administrative and establishment expenses be considered as an application for charitable or religious purposes and to what extent their establishment expenditure would be permitted? Circular No. 5-P (LXX-6) of 1968, dated June 19, 1968, states that the income should be computed on the basis of normally accepted commercial principles. Therefore, it implies that establishment expenses should be deducted in order to determine the net income available for application purpose.

5. Repayment of Debt/Loan for Charitable Purposes

For example: During FY 2023-24 trust constructed a building for INR 80 lakhs out of loan taken from bank. Trust repaid loan of INR 30 lakhs out of income of PY 24-25 ` 30 lakhs treated as application for PY 24-25

Repayment of any debt or loan has been considered as application. CIT v. Maharana of Mewar Charitable Foundation [1986] 29 Taxman 476/[1987] 164 ITR 439 (Raj.)]. The Court approved the usage of departmental Circular No. 100, dated 24-1-1973 which has expressed the view that the repayment of the loan if taken for fulfilment of the charitable objects shall be treated as application for the purpose of section 11(1).

6. Text of Department Circular

As long as the expenditure is incurred out of the income of the trust it would be considered as a valid application of income, even if such expenditure is for capital purposes. And therefore, all expenditures, whether revenue or capital, for charitable purposes shall be considered as an application of income.

The application out of loans and borrowings shall not be considered an application of income for charitable or religious purposes. However, when a loan or borrowing is repaid from the previous year’s income, such repayment shall be allowed as an application in the previous year in which it is repaid to the extent of such repayment and subject to following specified restrictions.

(a) Such an application should not be in the form of a corpus donation to another trust.
(b) TDS, if applicable, should be deducted on such application.
(c) Where payment or aggregate of payments made to a person in a day exceeds INR 10,000 in other than specified modes (such as cash) than such payment are not allowed.
(d) Carry forward and set off of excess application is not allowed.
(e) Application is allowed in the year in which it is actually paid.
(f) The application should not directly or indirectly benefit any related/interest person referred to in section 13(1) and the income of the trust or institution should not ensure any benefit to such related/interested persons.
(g) The application should be in (except with the approval of the Board) in accordance with the provisions of section 11(1)(c) i.e as per additional riders.

• There is a cap of 5 years to repay the loan or borrowings. Therefore, the application will be granted in the year of repayment if the repayment happens with a period of 5 years and
• Where loans were granted prior to 01-04-2021 any applications henceforth out of these loans shall not be allowed in the year of repayment.

7. Useful Tips

1. The application of income can be claimed of amounts which are actually paid on or before 31st March each year. Therefore in case of trust and society following accrual method of accounting have to ensure that all payments are made prior to the year end to claim the application of income.
   For Section 8 Company, will have to maintain accountants under the accrual method of accounting as mandated by the Companies Act, 2013. Therefore they should ensure that payment are actually done rather than accruing the application of income to claim the same.
2. Where the application of income is 85% or more of the total income, then the balance amount received is deemed to have been spent and therefore the remaining income is not taxable. However, this exemption is not to be construed as a “Standard deduction” as it is conditional on the application of income (Min 85%) done by the NGO and therefore the balance amount shall become taxable.