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Undisclosed income of educational institutions

In the Raunaq Education Foundation case, the Delhi High Court dismissed the Department’s appeal and upheld the claim for exemption even in respect of the undisclosed income.

T. C. A. Ramanujam

Income-tax law confers the benefit of tax exemption in respect of any income of a university or other educational institution existing wholly for educational purposes and not for profit. Stringent conditions are laid down for getting this exemption. Such educational institution is treated on a par with a charitable trust. It will have to get the accounts audited. The Commissioner of Income-Tax (CIT) or the Central Board of Direct Taxes (CBDT) can always look into the claim for exemption.

Dubious credit entries

What happens when the educational institution is in receipt of monies for which the sources cannot be proved? In other words, if the accounts show dubious credit entries in the names of persons with doubtful financial resources, is it open to the income-tax officer (ITO) to bring such undisclosed or unexplained monies to tax and deny exemption?

This interesting question came up for consideration before the Delhi High Court in the Director of Income Tax (Exemption) vs Raunaq Education Foundation (294 ITR 76) case. The Foundation argued before the High Court that it was entitled to exemption under Section 10(22) of the Income-Tax Act, 1961 for the assessment year 1998-99.

While scrutinising the return, the assessing officer (AO) found cash credits in the books. The Foundation was not able to explain satisfactorily the source for the credit. The entire amount was brought to tax under Section 68 of the Act. The AO held that exemption was available only for the trust income and not for the undisclosed income.

On appeal, the Income Tax Appellate Tribunal (ITAT) considered the Sections 4 and 5 read with Sections 2(24) and 2(45) as well as Section 10(22) of the Act and came to the conclusion that the use of the word “income” in Section 10(22) is wide enough to include deemed income under Section 68 of the Act.

Exemption claim upheld

The Revenue was aggrieved by this decision. Appeal was made before the Delhi High Court, which ruled that Section 10(22) granted omnibus exemption to any income of educational institutions. The only condition was that the institution must exist solely for educational purposes and not for profit.

The section did not used the term “derived from”. Therefore, the word “income” as occurring in Section 10(22) cannot be given restrictive meaning and must be given its natural meaning or that ascribed to it in Section 2(24) of the Act. Exemption provision must be strictly construed.

This is no doubt true but if exemption is available, it must be given its full play. The Delhi High Court quoted in support the observations of the Supreme Court in P. R. Prabakar vs CIT (284 ITR 548) to the effect that although the exemption provisions are to be construed strictly as regards the applicability thereof to the case of the assessee. Once found applicable, the same are to be required to be interpreted liberally. An exemption is to be granted unless it is expressly taken away. That was a case concerning the interpretation of Section 80HHC. The Delhi High Court finally dismissed the Department’s appeal and upheld the claim for exemption even in respect of the undisclosed income of the educational foundation.

The case related to the AY 1998-99. Section 10(22) was omitted by Finance (No. 2) Act, 1998 with effect from April 1, 1999. But similar exemption is now available under Section 10(23C). The ruling should, therefore, be applicable even today.

Anonymous donation

There is, however, one rider to be considered. Finance Act, 2006 has inserted Section 115BBC to bring to tax income by way of any anonymous donation. Section 115BBC(3) defines anonymous donation to mean any voluntary contribution referred to in Section 2(24)(iia). There is no reference to Section 68.

It is public knowledge that quite a number of educational institutions will show cash credits, which could not be proved. The Delhi High Court ruling may help such institutions to claim exemption even in respect of such unproved credits. It will be difficult to treat cash credits on a par with anonymous donations. Capitation fees can easily be disguised as cash credits. The law may require amendment. All that is required will be to insert Section 68 also in Section 115BBC. One saving feature will be that exemption will be available subject to conditions for the application of such income wholly for the objects for which the institution is established. Section 10(23C) also requires approval from the prescribed authority about the genuineness of the activities of the institution.

All these safeguards built into Section 10(23C) may not suffice to nullify the Delhi High Court ruling conferring exemption even on amounts covered by Section 68. This is the first ruling of its kind and requires serious notice.

(The author is a former Chief Commissioner of Income-Tax.)

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