PREMIUM PAID ON KEYMAN INSURANCE POLICY - TAX TREATMENT UNDER INCOME TAX ACT

A Keyman insurance Policy, of the Life Insurance Corporation of India, etc. provides for an insurance policy taken by a business organisation or a professional organisation on the life of an employee, in order to protect the business against the financial loss, which may occur from the employee’s premature death.

Keyman insurance is an insurance taken by a company/firm on the life of an employee/ partner (keyman), whose services contribute substantially to the success of the business of the company/firm. The object of the keyman insurance is to cover the life of a Keyman for a monetary value so that on death of such keyman, the loss to the firm is recouped with monetary assistance (insured amount) received from the insurance company. 

Who can be a Keyman?

Keyman is individual whose skills, knowledge, experience or leadership are important to a business’ continued financial success. The “Keyman” is an employee or a director, whose services are perceived to have a significant effect on the profitability of the business. Generally a keyman could be a CEO, CIO, Chairman, MD, Directors or a key management person. But as there are several such one-man run companies across the world and there it is vital for companies to cover the single most important employee to hedge against any financial loss due to death of this keyman. Further anybody with specialized skills, whose loss can cause a financial strain to the company are eligible for Keyman Insurance. For example, they could be:

(i)            Chairman, Managing Director, Directors of a Company; or

(ii)          Key Sales People; or

(iii)         Key Project Managers; or

(iv)        People with Specific Skills

(v)          Partner of a firm

Taxability of receipts under a keyman Insurance Policy in the hands of company/firm, in the hands of keyman and in the hands of third persons are tabulated as under:-

S. No.	Particulars	Tax treatment
(i)	Any company or a firm buying keyman insurance for its employee	can claim a deduction for the premium paid for the policy as a business expense under Section 37(1) of the Income Tax Act. In other words, the premium paid on the Keyman Insurance Policy is allowed as business expenditure.
(ii)	If the policy, after attaining surrender value, is endorsed to the employee,	then the surrender value/maturity value is chargeable to tax under Section 17 of the Income Tax Act. This is because it is treated as `profit in lieu of salary’ in the hands of the employee.
	Taxation of a sum received under the keyman insurance policy ( i.e. Tax Liability at the time of Maturity) Tax liability at the time of maturity of keyman insurance policy depends on the person in whose hands it’s matured.
(iii)	Employer	Any amount received under a Keyman Insurance Policy either on maturity of the policy or due to death of Keyman is taxable under section 28 of the Act under the head “Profits and Gains from Business or Profession”.
(iv)	Keyman (Employee) If Keyman insurance policy has matured in the hands of employee	(i)  In case the proceeds of Keyman Insurance Policy are  received by the employee, Ø  the same will be taxable as salary in the year of receipt as it is a part of “Profits in liew of Salary”. (ii)  During the continuance of the policy, if the same is assigned to the employee, Ø  then the surrender value of the policy would be taxable in the hands of employee in the year of assignment. (iii)  If the employer continues to pay premium on the policy even assignment theeof to employee, Ø  the amount of premium so paid will be taxable as perquisite in the hands of the employee.
(v)	Third Party (say legal heirs of Keyman)	Any amount received by a third party with whom the employer does not have any employer-employee relationship under a Keyman Insurance Policy, the same amount will be chargeable to tax under section 56 of the Act under the head “Income from Other Sources”.

·          

KEY NOTE

v  The amount on claim or maturity under a keyman insurance policy is not exempt under Section 10 (10D) of the Income Tax Act if the company is paying the premiums. However, in case the policy has been assigned to the keyman and the keyman is paying the premiums, then the claim/maturity proceeds are exempt under Section 10 (10D).

v   As premiums are paid by the company, no tax benefit is offered to a key man. In case the policy is assigned to a key man, he/she can decide nominee of the policy. Consequently, in case of death of the insured during the policy tenure, his/her dependents would get death benefits which would be tax-free as per the Income Tax Act.

Premium paid on 'Keyman Insurance Policy' taken for benefit of directors and senior staff is allowable expenditure.

Dismissing the appeal of the revenue, the Tribunal held that; payment towards insurance premium under keyman policy was for protection of assessee's company from any risk that it may sustain by losing valuable services of their directors and its senior staff from any eventuality by any accident or death, it was an expenditure which was incurred wholly and exclusively for purposes of business, hence allowable. (Related Assessment year  2009-10)

[ITO v. Marcopolo Products (P) Ltd. (2016) 159 ITD 266 (ITAT Kolkata)]

Keyman insurance policy - Premium paid on Keyman insurance policy is allowable as deduction

The premium paid for Keyman insurance policy is allowable as deduction. The nature of expenditure is to be seen at the time it is incurred. Department could not sit on the armchair of the assessee and decide as to whether it was appropriate on business expediency for the assessee to incur such an expenditure or not. The argument of the department that it is a colourable device is rejected by the High Court. (Related Assessment year  1994-95 to 2000-01)

[CIT v. Escorts Heart Institute & Research Centre Ltd. (2012) 349 ITR 8 : 249 CTR 141 : 69 DTR 250 (Del), CIT v. Rajan Nanda (2012) 349 ITR 8 : 249 CTR 141 : 69 DTR 250 (Del)

Premium on the keyman insurance policy of a partner of the firm is wholly and exclusively for the purpose of business and is allowable as business expenditure.

[CIT v. B. N. Exports (2010) 323 ITR 178 : 231 CTR 227 : 190 Taxman 325 : 37 DTR 381 (Bom)]

CBDT Clarification on Admissibility of expenditure incurred by a Firm on Keyman Insurance Policy in the case of a Partner under section 37

The CBDT has clarified that expenditure incurred by a Firm on Keyman Insurance Policy in the case of a Partner is admissible under Section 37 of  Income Tax Act, 1961, as under:

CBDT Circular No. 38/2016 dated 22.11.2016 F.No.279/Misc./140/2015-ITJ

Subject: Admissibility of expenditure incurred by a Firm on Keyman Insurance Policy in the case of a Partner- Reg.

1. The issue relating to admissibility of expenditure incurred by a firm on Keyman Insurance Policy premium in the case of a partner has been a contentious one.

2. CBDT Circular no. 762/1998 dated 18.02.1998 clarifies that the premium paid on the Keyman Insurance Policy is allowable as business expenditure. However, in case of such expenditure incurred on a partner of a firm, the general approach of the assessing officers was to treat the expenditure as not incurred for the purpose of business and disallow the same.

3. High Courts have upheld the admissibility of the expenditure incurred by the firm in the case of the partners. Taking into account the Explanation to Clause (10D) of Section 10 of the Income-tax Act, 1961 and the CBDT Circular no. 762 dated 18.02.1998, Courts have held that a Keyman Insurance Policy is not confined to a policy taken for an employee but also extends to an insurance policy taken with respect to the life of another person who is connected in any manner whatsoever with the business of the subscriber (assessee).

4. The High Court of Punjab and Haryana in the case of M/s. Ramesh Steels, ITA No. 437 of 2015, vide judgement dated 2.2.2016 (NJRS citation 2016 -LL-0505-68), reiterating the above view held that, “the said policy when obtained to secure the life of a partner to safeguard the firm against a disruption of the business is equally for the benefit of the partnership business which may be effected as a result of premature death of a partner. Thus, the premium on the Keyman Insurance Policy of partner of the firm is wholly and exclusively for the purpose of business and is allowable as business expenditure”.

5. The above view has been accepted by CBDT and the judgment has not been further contested.

6. In view of this, it is a settled position that in case of a firm, premium paid by the firm on the Key-man Insurance Policy of a partner, to safeguard the firm against a disruption of the business, is an admissible expenditure under section 37 of the Act.

7. Accordingly, henceforth, on this settled issue, appeals may not be filed by the department and those already filed, may be withdrawn/ not pressed upon.

8. The above may be brought to the notice of all concerned

ALLOWABILITY OF PROVISION FOR PRIOR PERIOD EXPENSES UNDER INCOME TAX

Meaning of prior period expenses

Prior period expense are generally those expenses which are relating to the current year in the sense they are crystalised during the year, though relating to activities of an earlier year.

For accounting purposes these are generally known as prior period items and required to be shown separately.

Allowability of expenditure in year of crystallization

Normally where mercantile system of accounting is followed, expenses relating to relevant year are accounted for in that year. However prior period expenses had to be allowed in subsequent years because the expenses were crystallized only in that year.

What is a provision?

A provision is recognized when:

(a)   an enterprise has a present obligation as a result of a past obligating event;

(b)   it is probable that an outflow of resources will be required to settle the obligation;

(c)   a reliable estimate can be made of the amount of the obligation.

If these conditions are not met, no provision can be recognized. Hence, it is only the obligation arising from past events existing independently of the future conduct of the business of the enterprise that is recognized as provision.

What is an obligating event?

A past event that leads to a present obligation is called as an obligating event. The obligating event is an event that creates an obligation which results in an outflow of resources. When there is manufacture and sale of an army of items running into thousands of units of sophisticated goods, the past event of defects being detected in some of such items leads to a present obligation which results in an enterprise having no alternative except to settle that obligation.

What is a liability?

Liability is defined as a present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

Provision for warranty period expenses

Expenditure which is contingent on the happening of certain event is not allowable, unless it meets certain criteria. The provisions of the warranty expenditure is required to be estimated based on the past experience of the assessee demonstrated on the basis of past warranty liability on similar type of contracts and further it can be proved by incurring the warranty expenditure in subsequent period to the sales.

Estimates of the warranty provision

Estimates of the warranty provision depends upon a different industry in which assessee operates. There may be different manner of making a provision because of warranty services in different industry. There cannot be straightjacket formulae for warranty provision in each industry alike. Therefore, the reliable estimate made by the assessee is required to be looked from the perspective of the industry in which the assessee operates.

Therefore, whether the provision of the assessee of warranty expenditure is reliable estimate or not the authorities should have looked into the basis of the estimate made by the assessee. It is further required to be seen that what kind of expenditure have been incurred by the assessee in subsequent years that will give the best picture with the original provision made by the assessee’s reliable estimate or not. 

ICDS vis-à-vis prior period expenses

The notified ICDS does not provide anything on allowability of prior period expenditure. Hence, it can be presumed that the treatment of prior period expenditure shall be decided as per judicial precedents and the provisions of the Act.

Liability in respect of provision for warranty claims is not a contingent liability

The warranty provision was computed as a three step process to quantify such provision: (a) the assessee determines, on the basis explained above, percentage of defects likely to occur in the product sold by the assessee; (b) the assessee determines, based on the past experience and the repair cost estimate received from the vendors, average per unit likely repair costs; and (c) the assessee determines the likely number of units which are likely to have such defects, by adopting percentage: (a) to the total units sold, and estimates the provision required by multiplying the number of units so likely to receive warranty service, with the average cost incurred on such service as a result of, (b) above. This method, in our considered view, a fairly scientific basis, supported by historical data, and it meets the tests laid down by the Hon’ble Supreme Court in Rotork Controls India (P) Ltd. v. CIT (2009) 180 Taxman 422 (SC). The Assessing Officer ought to have reconciled to the fact that, as is the legal position as on now, the liability in respect of provision for warranty claims is not a contingent liability but rather a reasonably estimated, to borrow the felicitous words employed by Their Lordships, “present obligation as a result of past events (i.e. sale of products) resulting in an outflow of resources (in future)”. Learned CIT(A) was, therefore, quite justified in granting the impugned relief. We uphold his action and decline to interfere in the matter. Accordingly, provision for warranty claims made by assessee in respect of software products on scientific basis and historical data, was to be allowed as deduction. (Related Assessment year: 2012-13)

[DCIT v. Elitecore Technologies Private Limited - ITA No.508/Ahd/2016 – Date of order : 31.03.2017 (ITAT Ahmedabad)]

Where prior period expenses on account of repair and maintenance were related to earlier years but crystallized when bills were received during current year, same were to be treated as current year’s expenses and hence allowable.

[DCIT v. Enercon India Ltd. (2016) TaxPub (DT) 2867 : 48 ITR 362 (ITAT Mumbai)]

Where prior period expenses were debited on basis of receipts of bills and were in the nature of routine expenses duly authorized by company’s authorized body, the same could not be disallowed on the basis of tax audit report.

[DCM Limited v. DCIT 2015 TaxPub (DT) 4649 (ITAT Delhi)]

Where from historical trend it was evident that provision for warranty made by assessee in respect of after sale services was a fair and reasonable estimate of post sales expenses to be incurred by assessee in respect of goods supplied by it, same was to be allowed.

[JCIT v. Mil India Ltd. (2015) 59 taxmann. com 334 (ITAT Delhi)]

It was held that in the light of the admitted position that the expenditure in question was wholly and exclusively for the purpose of business and that the same was genuine, the fact that the expenditure relates to an earlier period could not be a ground to deny the deduction, especially when factually crystalisation of liability during the previous year had not been disputed. Therefore, the expenses claimed by the assessee were directed to be allowed, as such these expenses were allowed though related to prior period.

[Bearingpoint Property Services (P) Ltd. v. DCIT (2014) TaxPub (DT) 4064 : 35 ITR 177 (ITAT Bangalore)]

Information as regards expenses with evidence where received after closure of accounts

The assessing officer observed that as per audit report, prior period expenses had been debited to Profit and Loss Account. It was held that the genuineness of the expenses had not been doubted by the lower authorities. Thus, these expenses of previous year were allowable in respective year to which they pertained but information as regards such expenses with evidence was received by the assessee from the various branches after closing of books of account. Hence, these expenses are allowable during the year under consideration.

[State Bank of Bikaner Jaipur v. ACIT 2014 TaxPub (DT) 4331 : 166 TTJ 244 (ITAT Jaipur]

It was held that  the real question concerning us is the year in which the assessee is required to pay tax. There is no dispute that in the subsequent accounting year…. where that the rate of tax remained the same in the present assessment year as well as in the subsequent assessment year. Therefore, the dispute raised by the Revenue is entirely academic. There was, therefore, no need for the Revenue to continue with this litigation when it was quite clear that not only was it fruitless (on merits) but also that it may not have added anything much to the public coffers. ”

[CIT v. Excel Industries Limited (2013) 358 ITR 295 (SC)]

In the case of Woodward Governor India Ltd. v. CIT , the Delhi High Court ruled that provision for warranty made on basis of principle of matching can be allowed but the amount claimed should have some rational and scientific basis and it cannot be an ad hoc amount. The matter was remanded to Assessing Officer for disposal afresh.

[Woodward Governor India Ltd. v. CIT (2013) 357 ITR 673 : 37 taxmann.com 419 (Del)]

In the case of CIT v. Forbes Campbell Finance Ltd., the Madras High Court found that provision for service charges payable by assessee by way of warranty provision was not made on any scientific data but on an ad hoc basis. Added to that, more than 60 per cent of provision remained unpaid after more than two years from date of sale. On these grounds, the High Court decided in favour of the Revenue.

[CIT v. Forbes Campbell Finance Ltd. (2013) 352 ITR 602 44 taxmann.com 342 (Mad)]

Warranty expenditure - Deduction allowed if provision made on scientific basis

Assessee had acquired personal computer and laptops division of IBM India and continued business of trading and manufacture of PCs and MCs. It provided either 1 year or 3 years warranty on sale of PCs and laptops made to its customers in India. Assessee debited actual warranty expenditure incurred during year and also made additional provision on basis of assessment of warranty liability on sales made for unexpired period to profit and loss account and claimed it as deduction. It was held that since IBM was carrying on business in India in earlier assessment years and it was making provision for warranty on basis of its global data, assessee could use data used by IBM for past years for making estimation and if assessee had made provision on a scientific basis, it had to be allowed as deduction.

[Lenovo India (P) Ltd. v. ACIT (2013) 140 ITD 127 (ITAT Bangalore)]

In the case of Mahindra & Mahindra Ltd. v. DCIT, the ITAT was not satisfied with the explanations of the assessee of the manner of providing for warranties. Where the provision was made for Rs.44.20 crores, the actual amount that was settled in the relevant assessment year was only Rs.28.19 crores. In these circumstances, the ITAT after considering a significant amount of case law  was not convinced that the provision was made on a scientific basis and therefore remitted the matter back to the file of the Assessing Officer to decide the matter afresh, as per the guidelines laid down in the Rotork Controls India (P) Ltd.  v. CIT (2009) 180 Taxman 422 (SC) case.

[Mahindra & Mahindra Ltd. v. DCIT (2012) 24 taxmann.com 267 (ITAT Mumbai)]

Expenditure incurred as continuous flow

It was a continuous process to incur expenditure and to account for in the books of account. Therefore, even though they were treated technically as prior period expenses, it related to a continuous flow of expenditure. Therefore, there was no justification in disallowing the expenditure, otherwise normally eligible for deduction.

[Union Bank of India v. ACIT (2011) 49 SOT 32 (ITAT Mumbai), Bank of India v. DCIT (2012) 139 ITD 493 (ITAT Mumbai)]

When the department was taxing prior period income, deduction of expenses, which had crystalized during the relevant previous year, should have also been allowed to the assesses. In a going concern, certain bills are received late and pertained to the business transaction and are crystalized during the relevant accounting period. These types of expenses are revenue in nature and are allowable in the previous year in which they are crystalized.

[DCIT v. Khurana Engineering Ltd. ITA No. 571 (Ahd) of 2010 (ITAT Ahmedabad)]

It was held that a provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when: (a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision can be recognized. The apex court went on to say that in order to create a provision, the appropriate historical trend should be determined. For that,  it is important that the company has a proper accounting system for capturing relationship between the nature of the sales, the warranty provisions made and the actual expenses incurred against it subsequently. Thus, the determination of the amount of provision for warranty should be based on past experience of the company. In other words, the assessee should create the provision on a scientific basis based on empirical data, trends, projections etc. Further, there is a second condition of writing back the unutilized provision when the warranty period expires.

[Rotork Controls India (P) Ltd.  v.  CIT (2009) 180 Taxman 422 (SC)]

The Hon’ble Supreme Court had laid down three conditions for provision to be regarded as liability. The Hon’ble Supreme Court while answering the question as to what is a provision opined that a provision is a liability which can be measured only by using a substantial degree of estimation. A provision is recognized when:

(a) an enterprise has a present obligation as a result of a past event;

(b) it is probable that an outflow of resources will be required to settle the obligation; and

(c) a reliable estimate can be made of the amount of the obligation.

The Hon’ble Supreme Court held that if the above three conditions are not met, no provision can be recognized.

Assessees are advised caution to ensure that their claims do not fail for want of a scientific basis and further, to ensure that the unsettled amounts are written back and offered to tax once the warranty period expires. But before that, one must ensure that one has a good system of accounting which captures the required data. Assessees quite often fail on this count.

Where warranty clause is a part of the sale document and it imposes a liability on the assessee to discharge its obligation for the period of warranty, the liability could be capable of being construed in definite terms and therefore could be deducted while working out the profits and gains of business

[CIT v. Hewlett Packward India Ltd. (2008) 171 Taxmann 13 (Del)]

Prior period expenses - Held to be not allowable

Since assessee had failed in proving crystallization of prior period expenditure which included professional fee during the relevant year, assessing officer was justified in disallowing deduction claimed by assessee.

[Adani Gas Ltd. v. ACIT 2016 TaxPub (DT) 843 (ITAT Ahmedabda)]

Expenditure to be disallowed where assessee failed to prove as to crystallization in current year

It was held that while upholding the disallowance of the expenses, the Commissioner (Appeals) has noted that the assessee had not submitted any evidence to  prove that the expenses crystallized during the year either before assessing officer or before the Commissioner (Appeals). The statement of expenses very clearly indicated that the expenses were related to assessment year 2000-01. Therefore there was no reason to interfere with the order of the Commissioner (Appeals) disallowing the prior expenses, after offsetting the income of earlier year.

[ACIT v. Adani Wilmar Ltd. (2014) TaxPub(DT) 3727 : 64 SOT 122 (ITAT Ahmedabad)]

Assessee claimed deduction in respect of audit fee and purchase of raw material – Assessing Officer rejected assessee’s claim holding that said expenses were prior period expenses. Tribunal held that as regards audit fee, since audit was carried out in earlier years, even if bill was not received in previous year, expenses should have been considered in respective year and hence deduction was not allowable in year under consideration. As regards raw material cost, since assessee failed to bring any material on record to show in support of its case that there was any dispute regarding payment to be made to supplier and said dispute was settled in relevant year, no case was made out for deduction, hence disallowance was held to be justified.

[Cadila Pharmaceuticals Ltd. v. ACIT (2012) 53 SOT 356 (ITAT Ahmedabad)]

Assessee had failed to establish that the related expenses were actually crystallised during the year under consideration. Since assessee was following the mercantile system of accounting it has to establish that these liabilities pertaining to the previous year were actually crystallised during the year under consideration. Since the assessee had failed to do so the order of Commissioner (Appeals) was sustained.

[DCIT v. Cosmo Films Ltd & Ors. (2012) 13 ITR (Trib) 340 : 139 ITD 628 (ITAT Delhi)]

EXEMPTION FOR ACCUMULATION OF INCOME IN EXCESS OF SPECIFIED LIMIT [SECTION 11(2)]

According to section 11(2) of Income Tax Act 1961, if 85% of income of a charitable or religious trust is not utilised in the previous year, then it can be accumulated for 5 years

Conditions to be satisfied for exemption for Accumulation of Income in excess of Specified Limit [Section 11(2)]

Where 85% of income derived from trust property is not applied or is not deemed to have been applied to charitable or religious purposes, but is accumulated or set apart for application to such purposes in India, exemption can be claimed for the income so accumulated or set apart in excess of 15% limit, provided the following conditions are complied with:

(a)   The trust/institution must apply in Form 10 as per Rule 17 to the Assessing Officer for permission to accumulate the income, specifying the purpose and period of accumulation setting apart, which shall, in no case, exceed 5 years. As per Rule 17, the notice has to be given on or before the due date of filing the return under section  139(1).

(b)   With effect from 01.04.2014, notice in Form 10 should be submitted electronically.

(d)    From assessment year 2016-17, the benefit of accumulation is not available if return of income is not furnished before due date of filing return as per Section 139(1).

(c)  With effect from assessment year 2016-17, the benefit of accumulation is not available, if Form 10 is not uploaded before the due date of filing return of income specified under section 139(1) for the fund or institution.

(d)   The money so set apart or accumulated should be invested or deposited in any one or more of modes  or forms specified in Section 11(5).

(e)   The time limit for filing Form 10 is the same time as for filing return under section 139(1). This time limit is prescribed in Rule 17. In case the Form 10 is not submitted before this date, then the benefit of accumulation would not be available and such income would be taxable at the applicable rate.

(f)    If in any year the accumulated income ceases to remain invested or deposited in the manner given above, it will be liable to tax as income of that year.

       MEANING OF ”15% INCOME”

S. No.	Particulars	Amount (in Rs.)
(i)	Gross Receipts	4,00,000
(ii)	Less : (i) Administration Expenses = 50,000           (ii) Depreciation                 = 25,000	75,000
(iii)	Balance	3,25,000
(iv)	15% of 3,25,000/- (to be accumulated)	81,250

Thus, section 11(2) grants exemption to income accumulated for specific objects up to a period of 5 years under certain conditions. As per section 11(2), where 85% of income is not applied to charitable or religious purposes in the aforesaid manner, the charitable trust or institution may accumulate or set  apart either the whole or part of its income for future application for such purposes in India. Such income so accumulated or set apart will not be included in the total income of the trust or institution in the year of receipt of income, provided such trust or institution has specified by means of notice to the Assessing Officer in Form 10, the purposes and period (which in no case can exceed 5 years) for which the income is accumulated or set-apart. Further, the money so set apart or accumulated should be invested or deposited in any one or more of modes or forms specified in section 11(5). In other words,

(a)  15% of the income can be accumulated indefinitely by the trust or institution, and

(b)   Where 85% of income is not applied to charitable or religious purpose in India during the previous year but as accumulated or set apart, either in whole or in part or application to such purposes in India. Such income, so accumulated or set apart shall not be included in the total income of the previous year of person.

KEY NOTE:—

In computing the period of 5 years, the period during which the income could not be applied for the purposes for which it was accumulated or set apart due to an order or injunction of any court shall be excluded.

Purpose of Accumulation must be specified

The provision of section 11(2) is a concession provision to enable a charitable trust to meet the contingency where the fulfillment of any project within its object or objects needs heavy outlay calling for accumulation to amass sufficient money to implement it. Section 11(2) requires specification of the purpose, which must be a concrete one, an itemized purpose or a purpose instrumental or ancillary to the implementation of the object or objects. Thus a trust cannot list all its objects as purposes for accumulation of income under section 11(2).

[DIT(E) v. Trustee of Singhania Charitable Trust (1993) 199 ITR 819 (Cal)

Accumulation – Specific purpose The assessee had accumulated a sum for promotion of its charitable objects. The Assessing Officer denied the exemption as the accumulation was not for a specific purpose. The Hon’ble High Court held that exemption could not be denied to the assessee in the present case as accumulation of income can be made by the assessee trust for plurality of purposes.

[DIT v. Raghuvanshi Charitable Trust (2006) 193 Taxation 334 (Del)]

Where out of 29 purposes/ objects stipulated in memorandum of association, assessee had specified eight purposes in Form No. 10 for which it was accumulating unspent income while claiming benefit under section 11, just because more than one purpose had been specified and just because details about plans which assessee had for spending on such purposes were not given, that may not be sufficient to deny exemption admissible to it under section 11.

[DIT (Exemption) v. Daulat Ram Education Society (2005) 278 ITR 260 : (2006) 156 Taxman 399 (Del)]

Plurality of the purposes for accumulation is not precluded but it depends on the precise purpose for which the accumulation is intended. (Related assessment year 1992-93)

[CIT v. Hotel & Restaurant Association (2003) 261 ITR 190 : 182 CTR 374 : 132 Taxman 76 (Del)]

Option to be exercise to spend the income in the next year

OPTION – 1 : CLAUSE (2) OF EXPLANATION 1 TO SECTION 11(1) [ACCUMULATE AND SPEND IN ONE YEAR]

If, in the previous year, the income applied to charitable or religious purposes in India falls short of eighty-five per cent of the income derived during that year from property held under trust, or, as the case may be, held under trust in part, by any amount—

(i)  for the reasons that the whole or any part of the income has not been received during that year, or

(ii) for any other reason,

      then—

(a) in the case referred to in sub-clause (i), so much of the income applied to such purposes in India during the previous year in which the income is received or during the previous year immediately following as does not exceed the said amount, and

(b) in the case referred to in sub-clause (ii), so much of the income applied to such purposes in India during the previous year immediately following the previous year in which the income was derived as does not exceed the said amount,

may, at the option of the person in receipt of the income (such option to be exercised in writing before the expiry of the time allowed under sub-section (1) of section 139 for furnishing the return of income), in such form and manner as may be prescribed be deemed to be income applied to such purposes during the previous year in which the income was derived; and the income so deemed to have been applied shall not be taken into account in calculating the amount of income applied to such purposes, in the case referred to in sub-clause (i), during the previous year in which the income is received or during the previous year immediately following, as the case may be, and, in the case referred to in sub-clause (ii), during the previous year immediately following the previous year in which the income was derived.”

   PROVISION ILLUSTRATED:— INCOME NOT RECEIVED IN THE YEAR

In some cases, the full income is not actually received during the year. Such income can be spent in the year in which it is actually received. Or it can be spent in the next year. A Charitable Trust’s accounts show Rs. 10,00,000 as income in the year 2016-17 of this actually only Rs. 4,00,000 has been received in 2016-17. Balance amount is due. What will happen to its tax position.

SOLUTION :—
Total Income	10,00,000
Less : 15% allowed to be set apart	1,50,000
Balance	8,50,000
Less : Actually spent in the year	3,00,000
Shortfall	5,50,000
Less : Amount not realized	6,00,000
TAXABLE INCOME	Nil

Now suppose that the amount of Rs. 6,00,000 is realised in the year 2018-19. The Charitable Trust will be allowed to spend it in the year of receipt (2018-19) and in the next year (2019-20).

Ø  It will have to pay tax only if it is unable to spend the full Rs. 6,00,000/- in those two years.

OPTION – 2 : SECTION 11(2) (ACCUMULATE FOR YEARS FOR SPECIFIC PURPOSE)

(a)   Application in Form 10 before due date of filing of return of income under section 139(1).

(b)   Investment in modes specified in section 11(5).

Ø  If not spent in this time span, then taxable as income.

Such option is to be exercised in a prescribed form for the said accumulation is Form No. 9A read with Rule 17(1).

The said form is to be filled before the due date of filling of return under section 139 and it is to be furnished electronically either under Digital Signature or Electronic Verification Code. This application in Form No 9A is effective from assessment year 2016-17.

Procedure of obtaining permission for accumulation of funds

The trust(s) is required to apply in Form 10. The Form 10 shall be filed before the due date of filing return of income specified under section 139 of the Income Tax Act for the fund or institution. In case the Form 10 is not submitted before this date, then the benefit of accumulation would not be available and such income would be taxable at the applicable rate. Further, the benefit of accumulation would also not be available if return of income is not furnished before the due date of filing return of income.

Withdrawal of Exemption granted to Income accumulated under section 11(2)  [Section 11(3)]

Section11(3) specifies the circumstances under which the accumulations made under section 11(2) would be withdrawn.

The following are the circumstances where the accumulated income would be deemed as the income of the organization and exemptions will not be available:—

CONSEQUENCES IF SUCH ACCUMULATED INCOME IN EXCESS OF 15% IS NOT APPLIED/INVESTED IN THE PRESCRIBED MANNER

S. No.	CIRCUMSTANCES	CONSEQUENCES
(i)	If in any year the accumulated income is applied to purposes other than charitable or religious purposes or ceases to be accumulated or set apart for application to such purposes, [Section 11(3)(a)]	it will be subjected to tax as the income of that year.
(ii)	If in any year the accumulated income ceases to remain invested or deposited  in any of the modes of investment prescribed under section11(5). [Section 11(3)(b)]	it will be liable to tax as income of that year
(iii)	If the accumulated amount or any part thereof is not utilised for the purpose for which it is so accumulated or set apart during the period specified or in the year immediately following thereof (i.e. maximum up to 5 years). [Section 11(3)(c)]	the amount which has not been so utilised will be liable to tax as income of the previous year immediately following the expiry of the accumulation period.
(iv)	Where any amount, out of income accumulated or set apart is credited or paid to any trust or institution registered under section 12AA or to any specific fund or institution or trust or any university or other educational institution or any hospital or other medical institution referred to in section 10(23C)(iv), (v), (vi) and (via). such amount shall not be treated as application of income for charitable or religious purposes, either during the period of accumulation or thereafter. [Section 11(3)(d)]	the amount which has not been so utilised will be liable to tax as income of the previous year immediately following the expiry of the accumulation period.

In other words, under any of the aforesaid circumstances, the amount involved shall be deemed to be the income of such person of the previous year in which it is so applied or ceases to be so accumulated or set apart or ceases to remain so invested or deposited or credited or paid or as the case may be, of the previous year immediately following the expiry of the specified accumulation period.

FOR EXAMPLE:—

In the instant case, the institution accumulated Rs. 25,00,000 in the previous year 2014-15 for acquiring and developing a land of construction of a new school for a period of 2 years. The assessee was required to utilize this amount by 31.03.2018. The assessee has spent Rs. 19,00,000 (out of accumulated sum Rs. 25,00,000) in the previous year 2017-18. Therefore, the unutilized amount of Rs. 6,00,000 is deemed to be income of the previous year 2017-18 (Assessment Year 2018-19).

KEY NOTE:—

However, in computing the aforesaid period of 5 years, the period during which the income could not be adopted for the purposes for which it is so accumulated or set apart due to an order or injunction of any court shall be excluded.

Purpose can be amended by a specific application to Assessing Officer [Section 11(3A)]

CIRCUMSTANCES WHERE THE ACCUMULATED INCOME IN EXCESS OF 15% CAN BE UTILIZED FOR A PURPOSE OTHER THAN THAT FOR WHICH IT WAS ACCUMULATED

Where the income invested or deposited in approved modes cannot be applied for the purposes for which it was accumulated or set apart, due to circumstances beyond the control of the assessee, such assessee can make an application to the Assessing Officer specifying such other purpose for which he wants to utilize such accumulated income. Such other purposes should also be inconformity to the objects of the trust.

The Assessing Officer in this case, may allow the application of such income to such other purposes. However, the Assessing Officer shall not allow application of such income by way of payment or credit made for donation to other trust or other institutions.

Delay in filing application Form No. 10 can not be condoned

In view of the amendments made in Section 11(2) and Section 13(9) of the Act, the exemptions under Section 11 of the Act to a trust recognized under Section 12(A) of the Act would be admissible only if the Form -10 and income-tax returns are filed within the time prescribed under Section 139(1) of the Act.

CBDT authorizes Commissioners of Income-tax (CIT), to admit belated applications in Form 9A and Form No. 10 in respect of Assessment year 2016-17 where such Form No. 9A and Form No.10 are filed after expiry of  time allowed under relevant provisions of the Act.

CBDT’s Circular No. 7/2018 dated : 20.12.2018

Subject: Condonation of delay under section 119(2)(b) of the Income-tax Act, 1961 in filing of Form no. 10 and Form No. 9A for Assessment year 2016-17

Under the provisions of section 11 of the Income-tax Act, 1961 (hereafter Act’) the primary condition for grant of exemption to trust or institution in respect of income derived from property held under such trust is that the income derived from property held under trust should be applied for the charitable purposes in India. Where such income cannot be applied during the previous year, it has to be accumulated and applied for such purposes in accordance with various conditions provided in the section.

2. The Finance Act, 2015 amended section 11 and section 13 of the Act with effect from 01.04.2016 (Assessment year 2016-17). Consequently, Income-tax Rules, 1962 (hereafter ‘Rules’) were also amended vide the Income-tax (1^st Amendment) Rules, 2016. As per the amended provisions of the Act read with rule 17 of the Rules, while 15% of the income can be accumulated indefinitely by the trust or institution, 85% of income can only be accumulated for a period not exceeding 5 years subject to the conditions, inter alia, that such person submits the prescribed Form No. 10 electronically to the Assessing Officer within the due date specified under section 139(1) of the Act.

3. Further, where the income from the property held under trust and applied to charitable or religious purposes falls short of 85% of the income derived during the previous year for the reason that the income has not been received during that year or any other reason, then on exercise of the option by submitting in Form No.9A electronically by the trust/institution on or before the due date of furnishing the return of income, such income shall be deemed to have been applied for charitable or religious purpose.

4. Representations have been received by the Board/ field authorities stating that the Form No. 9A and Form No.10 could not be filed in the specified time for AY 2016-17, which was the first year of e-filing of these forms. It has been requested that the delay in filing of Form No. 9A and Form No.10 for AY 2016-17 may be condoned under section 119(2) (b) of the Act.

5. Accordingly, in supersession of earlier Circular/ Instruction issued in this regard, with a view to expedite the disposal of applications filed by trusts for condoning the delay and in exercise of the powers conferred under section 119(2)(b) of the Act, the Central Board of Direct Taxes hereby authorizes the Commissioners of Income-tax, to admit belated applications in Form 9A and Form No. 10 in respect of AY 2016-17 where such Form No. 9A and Form No.10 are filed after the expiry of the time allowed under the relevant provisions of the Act.

6. The Commissioners will, while entertaining such belated applications in Form No. 9A and Form No.10, satisfy themselves that the assessee was prevented by reasonable cause from filing of applications in Form No. 9A and Form No.10 within the stipulated time. Further, in respect of Form No. 10 the Commissioners shall also satisfy themselves that the amount accumulated or set apart has been invested or deposited in any one or more of the forms or modes specified in sub-section (5) of section 11 of the Act.

Property held for charitable purposes – Advance to sister concern was out of surplus accumulated – No violation of provisions of section 11(2) – Exemption was to be allowed

Where assessee-trust spent 85 per cent of its income for construction of building to be used for educational purpose, mere fact that it advanced certain amount to its sister concern out of surplus accumulated which remained at its disposal, there was no violation of provisions of section 11(2) and, thus, assessee's claim for exemption of income was to be allowed. (Assessment year 2004-05)

[Chawara Educational Trust v. ITO (2016) 157 ITD 281 (ITAT Pune)]

Requirement of section 11(2)(b)

Setting off of deficit of earlier year against surplus of subsequent year under section 11 cannot qualify for exemption under section 11(2). In order to satisfy the requirements of section 11(2)(b), the investment must necessarily come out of the current year’s income, an investment made in the past obviously cannot satisfy this requirement; when income accumulated in an earlier year cannot qualify for exemption under section 11(2), the excess income applied in earlier assessment year will also not qualify for exemption.

[Pushpawati Singhania Research Institute for Liver, Renal & Digestive Diseases v. Dy. DIT (Exemption) – ITA No. 4481 Delhi of 2007 dated 18.07.2008 (ITAT Delhi)]

Certain amount set apart as provision was not actually applied for charitable purposes – Not entitled to exemption under section 11.

[Nachimuthu Industrial Association v. CIT (1999) 235 ITR 190 : 156 CTR 187(SC)]

 Explanation to Section 11(2) - Prohibits the donations to other charitable trusts out of accumulated funds

The Finance Act, 2002 has inserted an Explanation to Section 11(2), that prohibits the donations to other charitable trusts out of accumulated funds.

Inter charity donations out of accumulated funds will be permissible in case of dissolution of charitable organization [Proviso to Section 11(3A)]

The Finance Act, 2003 has inserted another proviso to section 11(3A) which provides that inter charity donations out of accumulated funds will be permissible in case of dissolution of charitable organization.

If income is accumulated for more than one purpose, it is not necessary to specify all of those purposes particularly  

It is enough if the assessee seeks accumulation for the objects of the trust. That the assessee had sought to accumulate the sum for purposes of the trust and had specified such objects.

[Bharat Krishak Samaj v. Deputy Director of Income-tax (Exemption) (2008) 306 ITR 153 (Del), Director of Income-tax v. Mitsui and Co. Environmental Trust (2008) 303 ITR 111 (Del), Bharat Kalyan Pratisthan v. Director of Income-tax (Exemption) (2008) 299 ITR 406 (Del)]

Benefit of Accumulation is available for more than one purpose  

[DIT (Exemption) v. Eternal Science of Man’s Society (2007) 290 ITR 535 (Del), Director of Income-tax (Exemption) v. Daulat Ram Education Society (2005) 278 ITR 260 (Del)]