2022 (7) TMI 1599 - AT - Income Tax

Appellate authority decision upholds charitable trust exemption; on-site pharmacy surplus treated as incidental, not taxable

Dy. Commissioner of Income Tax (E) -1 (1), Mumbai Versus M/s. Karuna Medical Society

ITAT MUMBAI - AT upheld the appellate authority's decision in favour of the registered charitable trust, rejecting the AO's attempt to tax the surplus of ... Exemption u/s 11 - charitable activity u/s 2(15) - treating the running of a pharmacy as an activity incidental to the attainment of the objectives of the assessee society which is running a hospital - HELD THAT:- We find that the ld. AO had sought to treat the conduct of the assessee in running a pharmacy on commercial basis. AO on perusal of the financials of the pharmacy and the assessee society on overall basis observed that the surplus earned in pharmacy contributed substantially to the overall surplus earned by the assessee society. He also observed that the pharmacy sells medicines to outsiders also. With these observations, the AO concluded that assessee society running a pharmacy is not an activity incidental to the attainment of the objectives of the society and sought to bring to tax the surplus earned by pharmacy alone on commercial basis. It is not in dispute that assessee is a charitable trust duly registered u/s. 12A of the Act and entitled for exemption u/s. 11 of the Act. It is not in dispute that the main objective of the assessee trust is education and medical relief to the public at large, interalia among others. We find that in the case of Baun Foundation Trust [2012 (4) TMI 172 - BOMBAY HIGH COURT] squarely addresses the issue in dispute before us wherein it was held that the activity of Chemist / Pharmacy was held to be incidental or ancillary to the dominant object or purpose for running a hospital. Respectfully following the judicial precedents relied upon hereinabove, we do not find any infirmity in the order of the ld. CIT(A) granting relief to the assessee in the instant case - Decided in favour of assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether the running of a pharmacy by an assessee society that operates a hospital constitutes an activity incidental or ancillary to the attainment of the society's charitable objects for the purpose of Section 11(4A) of the Income Tax Act. 2. Whether the surplus earned by the pharmacy, including sales to outsiders, defeats exemption under Section 11 when the pharmacy operates alongside the hospital. ISSUE-WISE DETAILED ANALYSIS Issue 1: Characterisation of pharmacy as incidental/ancillary to hospital activity under Section 11(4A) Legal framework: Section 11(4A) and the general principles governing exemption of income of charitable institutions require that activities which are incidental or ancillary to the main charitable object be treated as part of the exempt activity, subject to statutory limits and established tests for incidentalness and dominance of primary object. Precedent treatment: The Tribunal relied on earlier orders in the assessee's own case and on binding and persuasive high court and supreme court authority establishing that commercial activities like an in-house chemist/pharmacy can be incidental to the main charitable purpose of running a hospital, where the pharmacy services are in furtherance of the hospital's dominant object. Interpretation and reasoning: The Assessing Officer characterised the pharmacy as commercial because (a) the pharmacy generated a substantial portion of the society's overall surplus, and (b) it sold medicines to outsiders. The Tribunal examined the record and prior determinations in the assessee's own case and applied the established legal test: whether the activity is ancillary to the dominant charitable object (hospital), not whether it yields surplus or serves some non-beneficiaries. The Tribunal accepted the view that providing medicines via a pharmacy serves the hospital's medical relief function and is therefore incidental or ancillary to the hospital's charitable objective. Ratio vs. Obiter: The core holding (ratio) is that an in-house pharmacy run in conjunction with and in aid of a hospital constitutes an activity incidental to the hospital's charitable object for purposes of Section 11(4A), even if it generates surplus and sells to outsiders, provided the activity is integrally connected to the hospital's primary purpose. Observations about the Assessing Officer's factual findings (quantum of surplus, outsider sales) are explanatory and ancillary to the ratio. Conclusion: The Tribunal upheld the appellate authority's conclusion that the pharmacy is incidental/ancillary to the hospital activity and thus falls within exemption parameters under Section 11(4A). Issue 2: Effect of surplus and outsider sales on exemption under Section 11 Legal framework: Exemption under Section 11 is not automatically negated by the generation of surplus from an activity incidental to the main charitable purpose; the essential inquiry is whether the activity is incidental and whether the surplus arises from an activity integrally connected with the charitable object. Precedent treatment: Earlier tribunal and higher court rulings considered comparable facts and held that surplus per se, or sales to non-beneficiaries, do not ipso facto convert an ancillary activity into a commercial undertaking outside exemption, where the activity is in furtherance of the dominant charitable purpose. Interpretation and reasoning: The Assessing Officer's reliance on the pharmacy's contribution to overall surplus and its sales to outsiders was held to be insufficient to displace the incidental nature of the pharmacy. The Tribunal followed prior determinations in the same assessee's case and authoritative decisions indicating that an activity serving the hospital's primary objective remains ancillary despite commercial features, so long as the dominant object remains charitable and the activity is integrally connected. Ratio vs. Obiter: The ratio establishes that commercial characteristics (surplus, outsider sales) do not automatically disentitle an ancillary activity to exemption under Section 11. Remarks on the extent of surplus or the precise accounting treatment are ancillary observations. Conclusion: The Tribunal concluded that the presence of surplus and sales to outsiders did not justify taxing the pharmacy's surplus separately; the activity remained incidental and within the scope of exemption under Section 11. Cross-references and Institutional Reliance The Tribunal explicitly followed its earlier orders in the assessee's own appeals and the decisions of superior courts addressing the same legal question, treating those authorities as dispositive on the incidental/ancillary test in the factual matrix of a hospital operating a pharmacy. The Tribunal found no infirmity in the appellate authority's application of those precedents and therefore dismissed the Revenue's grounds. Overall Conclusion The Tribunal upheld the appellate authority's determination that the pharmacy was incidental to the hospital's charitable purposes under Section 11(4A), and that the pharmacy's surplus and sales to outsiders did not negate exemption; accordingly, the Revenue's appeals were dismissed. (Unanimous decision.)