Taxation — the ground floor

Why a tax chapter in a social impact exam?

The Social Stock Exchange (SSE) lets social enterprises — both for profit and not for profit — raise money through a regulated route. That route brings accountability, transparency and periodic reporting of impact.

But people need a reason to give through it. The workbook's point is simple: to build a vibrant, deep and liquid market for social investments, investors need tax incentives. So this chapter looks at tax from two sides:

The section numbers in this chapter are from the Income Tax Act, 1961, as the workbook uses them.

How NPOs are set up and funded

NPOs take different legal forms: societies, trusts and not-for-profit companies.

Two steps sit at the base of everything:

1. All NPOs must be registered under Section 12AB of the Income Tax Act and file income tax returns. When those returns are assessed, the entity is granted tax-exempt status for that particular year.
2. An NPO can pass a tax deduction to its donors only once it is approved under Section 80G.

Funding for NPOs comes mainly from four sources:

• Individual donations
• Contributions under the Foreign Contribution (Regulation) Act, 2010 (FCRA)
• CSR grants
• Grants from government schemes

Section 80G — the donor's deduction

Section 80G lets a taxpayer claim a deduction for donations to specified relief funds and charitable institutions.

• The deduction is claimed when filing the income tax return.
• It can be claimed by individuals, partnership firms, HUFs, companies and other taxpayers, whatever the type of income they earn.
• An institution registered under 80G gets a registration number from the Income Tax Department. The donor should make sure it is on the receipt.
• That number must be valid on the date of the donation. Give while the registration is not valid, and the donation is not eligible for deduction.

The four categories

Two ideas are mixed together here, and keeping them apart is the whole trick:

• The percentage (100% or 50%) — how much of the gift counts.
• The qualifying limit (none, or 10% of adjusted gross total income) — a ceiling linked to the donor's income.

Adjusted gross total income is the gross total income reduced by the income on which tax is not payable and by amounts eligible for deduction under the Act. Gross total income is the total of income under all heads before any tax relief.

Two more 80G rules

• Cash limit. No deduction is allowed for a donation of any sum exceeding ₹2,000 unless it is paid by a mode other than cash.
• No double claim. A deduction under 80G, once claimed and allowed for an assessment year, cannot be claimed again — in the same or any other year, under any other provision of the Act.

Taxpayers must also follow the guidelines the Income Tax Department prescribes from time to time.

A note on the SSE route

The workbook notes that NSE's SSE introduced bidding for ZCZP instruments on the e-IPO platform, for Self-certified Syndicate Banks and Syndicate Members with 3-in-1 accounts. Donors can contribute from ₹10,000 through registered brokers and avail 80G benefits.

Section 12AB — registering the NPO

Not-for-profit social enterprises must obtain registration under Section 12AB to get the benefit of exemptions.

• Institutions already registered under Section 12AA, and all new entities, must apply for a fresh registration under 12AB. (The workbook cites the CBDT's Income Tax (6th Amendment) Rules 2021, notified 26th March 2021.)
• The procedure, power and scope of verification under the new section remain similar.
• Provisional registration: valid for a maximum of 3 years.
• Subsequent registration: for 5 years.

After registration, the NPO must:

1. Maintain proper books of accounts and documents.
2. File its income tax return on time and get its accounts audited by a Chartered Accountant.
3. Strictly follow the conditions on which registration was granted.
4. Furnish details under Rule 18AB of the Income Tax Rules for each financial year.
5. Issue a certificate to the donor in Form 10BE.

When is an NPO's income tax-free?

The income of an NPO is exempt, subject to conditions. The primary condition: the organisation must be established in accordance with law, and its object must fall within "Charitable Purpose" as defined in Section 2(15).

Section 11 and the 85% rule

Section 11 exempts income derived from property held by the NPO. The NPO must apply 85% of its income earned during the year towards its objectives.

• If application is below 85%, the shortfall can be accumulated and applied within a maximum of 5 years.
• If it is below 85% because the income was not received (or any other reason), the NPO can apply it in the year the income is received or the year immediately after.

If the NPO chooses to accumulate:

• It must file specific forms on or before the due date of filing the return.
• The accumulated amount must be invested in specified investments.

Two more rules:

• Expenditure can be claimed only when actually paid.
• Corpus donations — given with a specific direction that they form part of the corpus — are exempt, but must be invested in specified investments.

Business income

Exemption does not cover profits and gains of business, unless both:

• the business is incidental to the attainment of the NPO's objectives, and
• separate books of accounts are kept for that business.

For an NPO whose object is the advancement of any other object of general public utility, trade, commerce or business activity for a fee is dealt with by an "unless" test. The two conditions in the workbook are:

• the activity is undertaken in the course of actually carrying out that object, and
• aggregate receipts from such activity in the previous year do not exceed 20% of the NPO's total receipts for that year.

Capital gains and anonymous donations

• Capital gains on transfer of a capital asset are exempt if invested in other capital assets.
• Anonymous donations (donor identity not available) are taxable at a flat 30% — except for an NPO established wholly for religious purposes.

When the exemption is lost

An NPO loses its exemptions if:

• Income or property is applied for the benefit of specified persons — the author or founder; a substantial contributor (₹50,000 or more at the end of the financial year); a trustee or manager; or a relative of a trustee.
• It is converted into a form not eligible for registration, including when registration is cancelled for non-compliance.
• It merges with an entity that does not have similar objectives and is not registered under the Act.
• On dissolution, it fails to transfer all its assets to another registered or approved NPO within 12 months from the end of the month of dissolution.