News Bulletin >> May 2004

TAXABILITY OF EDUCATIONAL INSTITUTIONS

V.K. Subramani
FCA

1. Introduction:

Educational institutions are not subject to tax in respect of the incomes earned by them. S.10(22) which provided for the exemption of such educational institutions was omitted by the Finance (No. 2) Act, 1998 and S. 10(23C) was amended for accommodating the exemption in respect of those institutions.

The issues as to the taxability of educational institutions in respect of incomes from investments and deposits or income from properties have been the subject matter of controversy. This write-up discusses some of the court decisions and covers the taxability of such educational institutions.

2. Classication of non-profit educational institutions:

2.1 Any income of a university or other educational institution existing solely for educational purposes and not for purposes of profit was exempt u/s. 10(22). The Finance (No. 2) Act, 1998, while deleting S. 10(22) and amending S. 10(23C), has classified educational institutions into three categories.

2.2 S. 10(23C) (iiiab) provides that any income of any university or other educational institution existing solely for educational purposes and not for purposes of profit is eligible for exemption, provided it is wholly or substantially financed by the Government.

2.3 Where the educational institution is not financed by the Government and the aggregate annual receipt of the university or educational institution does not exceed Rs. 100 lakhs, then any income of such educational institution or university is also exempt, subject to the condition that it exists solely for educational purposes and not for purposes of profit [S. 10(23C) (iiiad)].

2.4 Any university or other educational institution existing solely for educational purposes and not for purposes of profit and which is not financed wholly or substantially by the Government and the aggregate annual receipt of such institution exceeds Rs. 100 lakhs, then the income will be exempt from tax, subject to approval by the prescribed authority. [S. 10(23C) (vi)].

3. Some pertinent issues:

3.1 Where an educational institution running a hostel makes a surplus from such activity or receives voluntary contributions, whether such surplus (from hostel) or voluntary contributions are eligible for exemption u/s. 10(23C)?

The Apex Court, in Aditanar Educational Institution v. Addl. CIT, (1997) 224 ITR 310 (SC), has held that the availability of exemption must be evaluated by finding out whether the educational institution existed during the relevant year solely for educational purposes and not for purposes of profit. If the institution, after meeting the expenditure, makes surplus incidentally from the activity lawfully carried out, then such surplus is also exempt from tax.

However, if the educational institution has carried on the activity of running a hostel accomodating any public without discrimination, then such activity cannot be treated as incidental to education. But still, if the surplus is meant for education, then such income will also be exempt from tax.

In Rao Bahadur AKD Dharmaraja Education Charity Trust v. CIT, (1990) 182 ITR 80 (Mad.), it was held that for the purpose of granting the benefit of exemption, the main criteria to be looked into is the application of income, solely for educational purposes. Hence, even if the hostel run by the educational institution results in profit and if such profit is applied only for educational purposes, the income from such activity will be exempt from tax.

In the case of educational institutions covered by S. 10(23C) (vi), separate books of accounts have to be maintained in respect of activities which are not incidental to attainment of its objectives. Hence, where the activity is not incidental to the objectives of the institution, then separate books have to be maintained [Seventh proviso to S. 10(23C)].

3.2 Where the educational institution does not carry on any educational activity and merely publishes books for enlightening the humanity - whether such income is taxable or exempt ?

Where an existing educational institution, meant solely for education, engages in publication of periodicals, books, etc., then income from such activity is also eligible for exemption. Refer Gujarat State Co-operative Union v. CIT, (1992) 195 ITR 279 (Guj.).

However, the activity of publication must be incidental with educational purposes. Where institution, meant solely for education, does not carry on any educational activity in India during the relevant period, then it will not be eligible for exemption in respect of other incomes, in view of the decision given in Oxford University Press v. CIT, (2001) 247 ITR 658 (SC).

Also, a trust created for establishing educational institution will not be eligible for exemption, unless during the relevant previous year it has commenced the activity of imparting education. Initiation of steps for establishing an educational institution will not insulate the assessee from tax consequences, when it has income chargeable to tax during the relevant previous year [CIT v. Devi Educational Institution, (1985) 153 ITR 571 (Mad.)].

3.3 Where an educational institution existing solely for education makes surplus by way of sale of textbooks and notebooks to its students - whether such surplus is chargeable to tax ?

It the educational institution makes surplus by selling textbooks and notebooks to the students and such surplus is used solely for educational purposes, then such income is also eligible for exemption. In Brahmin Educational Society v ACIT, (1997) 227 ITR 317 (Ker.) it was held that income from any source is exempt, provided such income is used for educational purposes.

Where a trust has multiple activities and sale of text books and note books is done to the general public, then such income cannot be attributed to educational activity. Such income, hence, will have to be applied towards pursuing the objects of the trust and would be governed by S. 11 to S. 13 of the Act.

3.4 Where an educational institution allows the school building for public, in return for rent - whether such rental income is chargeable to tax?

Applying the above analogy of the decision given in Brahmin Education Trust (supra), the income of the educational institution from letting out its building for rent, if meant for application of such income for educational purposes, then such income will also be exempt from tax {Birla Vidhya Vihar Trust v. CIT (1982) 136 ITR 445 (Cal.)]. However, if the trust owning the educational institution has multiple objectives, then such income from let out of school building will be governed by S. 11 to S. 13 of the Act.

3.5 Where an educational institution pursuing only objects of education, constructs buildings and earns rental income therefrom - whether such rental income is chargeable to tax ?

Where the educational institution earns rental income by constructing buildings, then such rental income is also exempt from tax, subject to the condition that the income so earned is meant for application towards educational purposes. Where the institution has other charitable objectives in addition to education, then such institution will have to satisfy the requirements of S. 11 for the purpose of obtaining exemption.

3.6 Where an educational institution has deposited surplus funds with private borrowers for interest, - whether such interest income is taxable?

An educational institution existing solely for educational purposes is not subject to any of the conditions prescribed in Section 11(5) and such institution may deposit the funds in any manner and the income thereof will be exempt from tax, provided such income is meant for educational purposes. Circular No. F. No. 194/16/17-IT (A-I).

However, educational institutions with aggregate annual receipt above Rs. 100 lakhs have to deposit or invest the funds in the mode prescribed in S. 11(5).

3.7 Where an educational institution makes a deposit to comply with the pre-condition of the regulating authority for obtaining recognition and earns interest income from such deposit whether such deposit interest is taxable?

An educational institution making deposit to comply with the requirements of the regulating authority can also claim exemption in respect of the income from such deposit, provided it is meant for application towards educational purposes. Where the educational institution is covered by S. 10(23C) (vi), then such income will also be reckoned for the purpose of application given in clause (a) of third proviso to S. 10(23C).

Deposit made by the educational institution for the purpose of satisfying the norms of the regulating authority, will also be treated as application of income in respect of institutions covered by S. 10(23C) (vi).

3.8 Where an educational institution carries out any other charitable activity in addition to education - whether it would be subject to tax in the above referred situations?

Where an institution is engaged in any other charitable activity in addition to education activity, then such institution will be governed by S.11 to S.13 of the Income-tax Act, 1961.

However, income from the educational institution will be totally exempt, provided such income is retained for application towards educational purposes.

Where the aggregate annual receipt of the educational institution exceeds Rs. 100 lakhs, then the conditions prescribed in provisos to S. 10(23C) as regards mode of investment, accumulation and application in the future years, have to be satisfied.

Where the educational institution has aggregate annual receipt below Rs. 100 lakhs, then the conditions as regards investment or accumulation or application will not apply and the promoting charitable trust need not pay tax on the income of the educational institution as well. This is because income from the activity of education (not meant for profit) is exempt from tax in the hands of recipient. Birla Vidhya Vihar Trust v. CIT, (1982) 136 ITR 445 (Cal.).

3.9 What will be the consequence in the case of an educational institution having annual receipt below Rs. 100 lakhs in the earlier years and has deposited in private companies, has received aggregate annual receipt above Rs. 100 lakhs in the subsequent year?

The Fifth and Sixth provisos to S. 10(23C) provide that the investments made by any university or other educational institution, otherwise than in the mode or form prescribed in S. 11(5), will have to be converted into any one or more of the forms or modes specified in S. 11(5).

The time limit for conversion is one year from the end of the previous year in which the asset or investment was acquired. Hence, when the institution covered by S. 10(23C)(iiiad) falls into the category covered by S. 10(23c)(vi), then within one year from the end of the previous year in which the asset was acquired, it must be converted into an asset or investment of the form or mode specified in S.11(5).

Also, it is possible to argue that the investments made by the institution in the earlier year [covered by S. 10(23C)(iiiad)] being a totally exempt income, should not be subjected to conditions applicable for S.10(23C)(vi) institutions and such investments may be allowed to continue in the same form even after being covered by S. 10(23C)(vi).

In such situations the educational institution, instead of claiming S. 10(23C) benefit, may opt for S.11 in which case the provisions of S.11 to S.13 would be applicable to such institution.

3.10 Conditions as regards application of income by educational institutions.

In the case of institutions which are wholly or substantially financed by the Government covered in S.10 (23C)(iiiac), the statute does not mandate for application of income by such educational institutions.

Where such institutions are covered by S.10(23C)(iiiad), there is no condition for application of income or for accumulation of income.

Where such educational institution is covered by S.10(23C)(vi), then the institution has to apply 85% of its income towards educational objects. It can accumulate 15% of its income for future uses, if such accumulation is made on or after 1-4-2002. Such accumulated sum will have to be used within a period of 5 years.

The tenth proviso to S. 10(23C) provides that if the institution does not apply its income but accumulates it, then any payment from such accumulation to any institution or trust or fund will not be treated as application of income.

Also, it is worth noting that if an educational institution obliged to apply 85% of the income, accumulates more than the maximum of 15% of its income, then such excess will be chargeable to tax. For example, if the institution has Rs. 200 lakhs as income and accumulates Rs. 50 lakhs for future uses, then the excess accumulation of Rs. 20 lakhs (Rs. 30 lakhs is only allowed for accumulation) is chargeable to tax. However, the entire Rs. 50 lakhs must be kept in investments specified in S.11(5). [Please refer Circular No. 29 dated 23-8-1969 (74 ITR (St.) 7).

3.11 Tax deduction in respect of interest payments made to educational institutions.

Educational institutions can obtain a certificate for non-deduction or lower deduction of tax at source as prescribed in S. 197. The CBDT Circular No. 4/2002 dated 16-7-2002 provides for exemption in respect of educational institution from tax deduction, only where such institution is wholly or substantially financed by the Government.

In other words, educational institutions covered by S.10 (23C)(iiiab) are eligible to receive incomes without deduction of tax at source. In respect of other educational institutions, the tax deduction provisions are applicable subject to lower or non-deduction at source authorised by their assessing officers.

4. Conclusion:

Institutions existing solely for educational purposes can claim exemption in respect of any income without any conditions, so long as their aggregate annual receipt does not exceed Rs. 100 lakhs. However, if the aggregate annual receipt exceeds Rs. 100 lakhs, then conditions similar to S.11 to S.13 will have to be complied with.

The statute presently provides the conditions for big educational institutions by means of provisos to S.10(23C) and it would be better if a simple omnibus clause is inserted in S. 10(23C) for providing the application of S.11 to S.13 to such institutions having aggregate annual receipt above Rs. 100 lakhs.

Educational institutions covered by S. 10(23C) (iiiad) need not file return of income in view of the blanket exemption given in the statute. However, the tax deduction at source provisions are fully applicable to such institutions. It is strange that the statute on the one hand, provides for exemption without conditions and on the other hand, seeks the assessees to obtain a certificate from the assessing officer for receiving incomes without tax cuts.

Source: Bombay Chartered Accountants Society Journal