2022 (12) TMI 1088 - AT - Income Tax

Charitable trust appeal partly allowed, notional rental income disallowed, exemption denied, income assessed at max rate.

The Tribunal partly allowed the appeal, ruling that the charitable trust could not be assessed on notional rental income but upheld the denial of ... Notional income versus commercial (real) income of a charitable trust - application and accumulation under section 11(1)(a) - violation of section 13(1)(c) read with section 13(2)(b) - assessment of annual value for rent (computation of notional rent) - taxation at maximum marginal rate under section 164(1)Notional income versus commercial (real) income of a charitable trust - application and accumulation under section 11(1)(a) - Whether notional rent (accrual-based/annual value) can be assessed as income of the charitable trust for the purpose of exemption under section 11. - HELD THAT: - The Tribunal held that the expression 'income' in section 11(1)(a) must be understood in its commercial sense and that 'application' or 'accumulation' under section 11(1)(a) must relate to real income actually available to the trustees. The CBDT Circular No.005P(LXX-6) dated 19.6.1968 and precedents of High Courts (including Madras and Gujarat decisions relied upon by the assessee) support the view that notional income computed on mercantile/accrual basis, which cannot be actually applied or accumulated by the trust, should not be treated as income for the purpose of section 11. Applying this principle, the Tribunal held that the trust cannot be assessed on notional rental income and that exemption under section 11 cannot be denied on the basis of such notional computation alone. [Paras 7]Notional rental income cannot be the basis for denying exemption under section 11; income for section 11 must be commercial (real) income actually available to the trust.Violation of section 13(1)(c) read with section 13(2)(b) - assessment of annual value for rent (computation of notional rent) - taxation at maximum marginal rate under section 164(1) - Whether the lease arrangements with the two lessees (specified persons) attract disallowance under section 13(1)(c) and consequent denial of exemption and taxation at maximum marginal rate. - HELD THAT: - On the material before it, the Tribunal found that the two lessee companies were specified persons (relatives/concerns in which trustees or their relatives had substantial interest). The Tribunal accepted the AO/CIT(A)'s conclusion that the trust had not charged fair market rent to those specified persons and thereby breached the prohibition in section 13(1)(c) read with section 13(2)(b). While the Tribunal agreed with the assessee that notional rent generally cannot be the basis for section 11 denial, it nevertheless held that, on the facts, the provisions of section 13(1)(c) are violated and exemption under section 11 must be denied in respect of income declared; the AO is to assess the income (the income declared by the assessee) to tax accordingly and apply the maximum marginal rate as provided in section 164(1). The Tribunal noted that CIT(A) correctly limited computation to the land portion where appropriate (finding recorded at 5(I)). [Paras 5, 7]Findings of violation of section 13(1)(c) r.w.s. 13(2)(b) are sustained; exemption under section 11 is denied in respect of the income so affected and the income is to be assessed to tax at the maximum marginal rate.Final Conclusion: The appeal is partly allowed: the Tribunal held that a charitable trust cannot be denied exemption on the basis of notional rental income (income for section 11 must be real/commercial), but on the facts the trust's leases to specified persons contravened section 13(1)(c) r.w.s. 13(2)(b), so exemption is denied for the income concerned and it is assessable to tax at the maximum marginal rate. Issues Involved:1. Assessment of notional lease rent.2. Applicability of Section 13(1)(c) and 13(2)(b) of the Income Tax Act.3. Denial of exemption under Section 11 of the Income Tax Act.4. Computation of fair market rent for leased properties.5. Application of CBDT Circular No.005P(LXX-6) dated 19th June 1968.6. Taxation under Section 164(1) of the Income Tax Act.Issue-Wise Detailed Analysis:1. Assessment of Notional Lease Rent:The primary issue in this appeal was whether the Department could assess notional rent for a charitable trust under Section 11 of the Income Tax Act. The AO assessed the lease rent from the land leased out to specified persons on a notional basis by adopting the market value of the lease rent, comparing it with the rent paid by the Income-tax Department for a building in Vijayawada. The Tribunal held that the trust could not be assessed on notional rental income, referencing CBDT Circular No.005P(LXX-6) and the decision of the Hon'ble Madras High Court in the case of Rao Bahadur Calavala Cunnan Chetty Charities.2. Applicability of Section 13(1)(c) and 13(2)(b) of the Income Tax Act:The AO noted that the trustees and their relatives held substantial interests in the companies leasing the land, making them specified persons under Section 13(3). Consequently, the provisions of Section 13(1)(c) were applicable, leading to the denial of exemption under Section 11. The Tribunal confirmed that the assessee violated these provisions as the trust received rent from specified persons, thus breaching Section 13(1)(c) read with Section 13(2)(b).3. Denial of Exemption under Section 11 of the Income Tax Act:Due to the violation of Section 13(1)(c), the AO denied the exemption under Section 11, treating the trust as an Association of Persons (AOP). The Tribunal upheld this denial, stating that the assessee was not entitled to claim exemption under Section 11 due to the violation of the specified provisions.4. Computation of Fair Market Rent for Leased Properties:The AO compared the market rent in the area and assessed the rent for the properties leased to Southern Roadways and TVS & Sons Ltd. based on the prevailing market rates. The CIT(A) recomputed the lease rentals, considering only the land portion and excluding the superstructure constructed by the lessee. The Tribunal did not disturb the CIT(A)'s findings on the fair market rent computation.5. Application of CBDT Circular No.005P(LXX-6):The Tribunal referred to CBDT Circular No.005P(LXX-6), which states that the word 'income' in Section 11(1)(a) should be understood in its commercial sense, i.e., book income. The Tribunal emphasized that the trust's income should be assessed based on actual income recognized and realized, not on notional income. This interpretation was supported by the decisions of the Hon'ble Madras High Court and the Hon'ble Gujarat High Court.6. Taxation under Section 164(1) of the Income Tax Act:The Tribunal directed that the AO should deny exemption under Section 11 and assess the income declared by the assessee at Rs. 8,25,510/- under Section 164(1) of the Act. This section mandates that income in violation of Section 13(1)(c) should be taxed at the maximum marginal rate.Conclusion:The appeal was partly allowed, with the Tribunal holding that the assessee trust could not be assessed on notional rental income but confirming the denial of exemption under Section 11 due to the violation of Section 13(1)(c). The Tribunal directed that the income should be assessed under Section 164(1) at the maximum marginal rate.