Not-for-profit (NFP) entities, established for charitable purposes, play a crucial role in reducing the burden on the government by implementing welfare and development delivery systems. In recognition of their contribution, the Income-tax Act, 1961 (IT Act), provide certain exemptions to these entities, subject to specific conditions. However, over the years, the IT Act has undergone various amendments to make the conditions for claiming such tax exemption more stringent to prevent misuse and have checks and balances on the functioning of such NFPs.
Broad conditions for exemption
Contributions, donations, funds received by an NFP entity are exempt, subject to conditions specified under the IT Act. These include:
The entity must be formed for the purposes of carrying out activities which fall within the meaning of ‘charitable purpose’.
It should have obtained the relevant exemption registrations.
The exemption is confined to only such portion of NFP’s income which is ‘applied’ for charitable or religious purposes or is accumulated for applying to such purposes in India.
85% of the income is required to be applied for the approved purposes. The unapplied income and the money accumulated or set apart (subject to certain specified conditions and compliances), in excess thereof, should be invested in the specified forms or modes as per section 11(5) of the IT Act.
No part of the income should ensure, directly or indirectly, for the benefit of the specified related parties. This means related party transactions should be on an arm’s length basis.
The NFP entity should maintain books of account and other documents as per prescribed rules, get its accounts audited by a Chartered Accountant and furnish the audit report within the prescribed timeline.
Possibility of cancellation of registration
Notably, the IT Act also contains provisions for cancellation of registration of an NFP entity if the prescribed tax authority notices occurrence of one or more ‘specified violation’ which means, inter alia, income of the NFP entity being applied for purposes other than its objects, activities of the NFP entity found to be not genuine or not in accordance with the conditions subject to which it obtained registration etc. For completeness, it is to be noted that prior to cancellation of registration, the NFP entity is required to be given an opportunity of being heard.
Exposure to ‘exit tax’
NFP entities registered under the IT Act maybe exposed to ‘exit tax’ on accreted income (Fair Market Value of assets less registration) at maximum marginal rate in certain specified scenarios. These include conversion of the NFP entity into any form which is not eligible for grant of exemption registration under the IT Act, merger of the NFP entity with an unregistered entity or an entity which does not have similar objects or undertaking a modification of objects which does not conform to the conditions of registration, and for which prescribed approval is not obtained.
Tax relief for donors
With a view to incentivise donations to NFP entities, donors can claim relief or a deduction in respect of donations made to NFP entity, if the NFP entity obtains the specified approval for this purpose. This approval enables donors to claim tax relief or deduction in respect of the donations made to such NFP entity to the extent of 50% of the amount donated, subject to the limits specified therein.
Foreign contributions
NFP entities seeking contributions or donations from a ‘foreign source’ must obtain registration or prior permission from the Central Government under the Foreign Contribution (Regulation) Act, 2010 (FCRA). The FCRA governs and regulates the acceptance and utilisation of foreign contribution of the NFP entities. Furthermore, NFP entities are required to maintain ‘FCRA Account’ with only one State Bank of India, Branch in New Delhi for receipt of foreign contribution.
