NGOs’ business activity puts charity on backseat, taxpayers should watch out

It is a well-known fact that non-governmental organizations (NGOs) claim tax exemption under section 11 of the Income Tax Act on the incomes and donations received for charitable activities undertaken by them. Their philanthropic activities extend beyond the fields of education and healthcare and are mainly aimed at providing relief to the poor.

Educational institutions, including medical colleges, are exempt from taxes if they are registered under section 10(23C) or section 11 of the I-T Act. Yet, they are allowed to charge fees for offering their services to the needy. Though such fees is intended to recover their operating costs, at times, these activities generate profits. These profits, if used again for charitable purposes, are also entitled for tax exemption. Donations paid to institutions registered under section 10(23C) or section 11 are also tax deductible in the hands of the donors. Taxpayers can claim deduction under section 80G for any such donations while filing their income tax returns (ITR).

Commercial profits entitled to exemption

The situation becomes tricky when fees and charges collected by the charitable institutions for the service rendered are of commercial standards or if the profits that they generate are very high. The supreme court and high courts have hitherto held that even if any business activity is carried out by the NGOs, an exemption would not be denied as long as the profits generated from their business activity is used for charitable purposes.

SC ruling on excessive profits by charitable institutions

The Supreme Court recently revisited its earlier judgement and, on 19 October 2022, held that educational institutions, which seek approval or exemption u/s. 10(23C) of the I-T Act, should ‘solely’ be concerned with education or education-related activities. Further, if the objective of the institutions appears to be profit-oriented, they would not be entitled to tax exemptions. In another judgement delivered on the same date, in the context of institutions claiming exemption u/s. 11/12, the court stated that charging any amount for any service or charitable activity on cost-basis or nominally above cost may not be a business activity; but if the charges are significantly high, it may tantamount to business activity. These observations are likely to affect the tax exemptions claimed by the institutions.

These two recent decisions of the Supreme Court have overturned the legal principles so far adopted by authorities assessing the income of these NGOs. It has also narrowed the scope of business activities that the institutions were hitherto eligible for. Perhaps, that’s the reason why the supreme court has expressly declared that the said decisions will not affect any past deals and will only be applicable to future transactions.

Effect of the ruling on the donations made by taxpayers

These findings of the court would have far reaching implications not only on the exemptions claimed by NGOs, but also on the deductions claimed by donors u/s. 80G. Though the court has laid down broader principles, there appears to be no clarity as to what level of profits would constitute a business activity and how such profits would be computed. There remains a grey area on the manner in which the said directives of the court would be applied by the administrative authorities.

It is important that NGOs avail of tax exemptions for individuals to be eligible for deduction u/s. 80G. In view of the Court ruling, donations made to an institution held to be carrying out commercial activity may not be exempt from deductions Though deduction u/s.e 80G may not be withdrawn in respect of past donations, such protection under the law is not free from doubt and can lead to unintended litigation.

Taxpayers should therefore be careful and make proper enquiries about the tax exemption status of institutions before making donations. They can also check on the I-T portal at https://incometaxindia.gov.in/Pages/ utilities/exempted-institutions.aspx wherein the names of the tax exempted institutions are provided.

Dharmesh Shah is a chartered accountant