Test to Determine the Real Purpose of the Activities of an Educational Institution

Queen’s Educational Society v. Commissioner of Income Tax

 CIVIL APPEAL NO.5167 OF 2008

Recently, the Supreme Court delivered an important ruling on the “exemptions” claimed by the Educational institutions u/section 10 (23C) (iiiad) of the Income Tax Act 1961. Under the challenge were rulings from the Punjab and Haryana High Court[1] taking one view, and another other from the Uttarakhand High Court opting for the opposite view. The latter judgment was overruled in the present case. Though the provision in question in Punjab and Haryana Case was s. 10 (23C) (vi), but the provision, for the purposes of this post, was same in the material and relevant purposes to that u/s. 10 (23C) (iiiad).

The provision, whose interpretation was in question in the present case, runs as follows:

“Section 10: In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included-

(23C) any income received by any person on behalf of –

(iiiad) any university or other educational institution existing solely for educational purposes and not for purposes of profit if the aggregate annual receipts of such university or educational institution do not exceed the amount of annual receipts as may be prescribed...”

A.    Issues

The important questions for interpretation that arose before the Supreme Court were:

   (a)    What if an educational institution makes profit in a previous year, would that make the educational institution, an institution existing only for profit purposes?

  

   (b)   What if an Educational institution makes profit in successive years,[2] and that excess profit is spent for Institutional Requirements only, would that take the Institution out of the purview of exemption?

B.     Judgment of the Court

On Issue (a)

The Court, firstly, answered the true interpretation of the phrase “for educational purposes” and “not for profit purposes”, for which it sought to construe the meaning of term “for” as used in the provision. So, the predominant object of the activity undertaken was referred to, which in essence means that an activity when done reference to something as end, is an activity done for that purposes. The Court held, therefore, that if the activity is not pervaded by profit motive but is carried primarily for serving the charitable purposes, the activity is not for profit. The Court, relying on the case of CIT v. Surat Art Silk Cloth Manufacturers Associations,[3] held exemption clause does not require that the activity must be carried on in such a manner that it does not result in any profit as that would be not only be difficult but also reflect unsound principle of management. Mere occurrence of incidental surplus, would not make the institution existing for the purposes of making profit.

On Issue (b)

In the case of American Hotel and Lodging Association Educational Institute v. CBDT,[4] the Court laid down the test for ascertaining the object of an institute, in the context of application of the surplus generated to an Institution, as the following:

“In order to ascertain whether the institute is carried on with the object of making profit or not it is the duty of the prescribed authority to ascertain whether the balance of income is applied wholly an exclusively to the objects for which the applicant is established... The test is—the nature of activity. If the activity like running a printing press takes place it is not educational. But whether the income/profit has been applied for non-educational purpose has to be decided only at the end of the financial year.”[5]

In the impugned judgment of the Uttarakhand High Court, the Court had earlier overruled the ITAT order, which had allowed exemption to the Educational Institute on the ground that earlier, the assessee (institution) trust was initially running the school in a rented building and had generated the surplus, i.e. the excess of the receipts over expenditure. The ITAT had reasoned that the assessee had acquired its own property, computers, library, sports equipment etc. for the benefit of the students and no part of such surplus was utilized by the members of the society for their own benefit. So, such surplus was held to not come within the ambit of denying exemption u/s 10(23C) (iiiad) of the Act.

The Supreme Court in the present case, was unequivocal in its opinion when, while overruling the Uttarakhand High Court, it stated:

“The final conclusion [of the High Court] that if a surplus is made by an educational society and ploughed back to construct its own premises would fall foul of Section 10(23C) is to ignore the language of the Section and to ignore the tests laid down in the Surat Art Silk Cloth case, Aditanar case and the American Hotel and Lodging case. It is clear that when a surplus is ploughed back for educational purposes, the educational institution exists solely for educational purposes and not for purposes of profit.” [emphasis mine]

  So, in the end what matters is as to for what purpose the surplus is spent, and not whether surplus is generated year after year (as wrongly advocated by the CIT, Chandigarh, whose order was set aside in the upheld judgement of the Punjab and Haryana High Court in the present case).

Observations on the ‘Presumption of Profit- oriented activity, unless otherwise shown’ concept

The Court also referred to the observations made in the cases of Sole Trustee, Loka Shikshana Trust[6] and Indian Chamber of Commerce[7] where were on the lines that if a trust consists of carrying on business with no restrictions on them making profits, then, the court would presume that the activity is undertaken for profit purposes, unless otherwise shown.

The Court reiterated the disagreement over such presumption being made and quoted, the observations made in the case of Surat Art Silk Cloth Manufacturers Associations (supra) where the Court had held that it is not necessary that there must be a provision in the constitution of the trust or the institution that the activity shall be carried on no profit or loss basis. So, even if there is no such express provision, the nature of the charitable purpose/ manner in which the activity is carried on/ surrounding circumstances may clearly indicate that the activity is not propelled by a dominant profit motive.

---

[1] Judgment in the case of Pine Grove International Charitable Trust v. UOI, (2010) 327 ITR 273.

[2] See para 20 of the present case, where the para 6 of the overruled order passed by the Chief, CIT is quoted. The order was set aside by the Punjab and Haryana High Court and this judgment was upheld in the present case.

[3] (1980) 121 ITR 1.

[4] (2008) 301 ITR 86.

[5] Ibid, paras 29, 30.

[6] (1975) 101 ITR 234.

[7] (1976) 1 SCC 324.