Reforming the Exit Tax Regime for non-profit organizations (NPOs) or charitable institutions : Clause 352 of the Income Tax Bill, 2025 Vs. Section 115TD of the Income-tax Act, 1961

Clause 352 Tax on accreted income.

Income Tax Bill, 2025

1. Introduction

Clause 352 of the Income Tax Bill, 2025 introduces a comprehensive regime for the taxation of "accreted income" of specified persons, primarily non-profit organizations (NPOs) or charitable institutions, upon certain triggering events such as cancellation of registration, modification of objects, merger, conversion, or dissolution. The legislative framework for taxing accreted income was first introduced by Section 115TD of the Income-tax Act, 1961, along with the supporting valuation methodology u/r 17CB of the Income-tax Rules, 1962. The proposed Clause 352 seeks to update, expand, and clarify this framework, reflecting policy developments, administrative experiences, and perhaps judicial interpretations since the original enactment. The significance of this regime lies in its role as an anti-abuse provision: it ensures that charitable assets, accumulated over time with the benefit of tax exemptions, are not diverted to non-charitable purposes upon the cessation of charitable status or other key events. The regime imposes an "exit tax" at the maximum marginal rate on the accreted income, defined as the net assets of the entity, thereby disincentivizing misuse of tax-exempt status. This commentary will analyze Clause 352(1) to (6) in detail, compare each provision with the corresponding parts of Section 115TD and Rule 17CB, and discuss their practical implications.

2. Objective and Purpose

The legislative intent behind both Section 115TD and Clause 352 is to protect the integrity of the charitable sector and the public revenue. The core policy concern is that assets accumulated by NPOs under tax-exempt status should continue to be used for charitable purposes, and not be appropriated for private or non-charitable interests if the organization ceases to be eligible for exemption. The "tax on accreted income" acts as a safeguard, ensuring that any benefit derived from the exemption is recaptured if the organization exits the charitable sector without proper transfer of assets to another eligible entity. The 2025 Bill appears to refine and expand the regime, providing more detailed scenarios, procedural clarity, and aligning the law with contemporary practices and administrative requirements.

3. Detailed Analysis: Clause-wise Examination and Comparison

Clause 352(1): Charge of Additional Tax on Accreted Income

Text: Every specified person, in addition to income-tax on total income, is liable to pay additional income-tax on accreted income at the maximum marginal rate in any of the cases specified in the Table in sub-section (5).

Comparison with Section 115TD(1): Section 115TD similarly imposes an additional tax at the maximum marginal rate on accreted income in specified events: conversion into a non-eligible form, merger with a non-eligible entity, or failure to transfer assets upon dissolution.

Key Points of Analysis:

- Both provisions establish the principle that accreted income is taxed at the highest rate applicable to individuals, firms, or companies (maximum marginal rate).

- The 2025 Bill, through its detailed Table, enumerates a broader set of triggering events than Section 115TD, which is relatively concise. The Bill covers not only conversion, merger, and dissolution, but also failures to apply for registration, modifications of objects, and appeals processes.

- The scope of "specified person" is maintained, referring to charitable entities registered under the relevant sections.

Implications:

- The expanded list of triggering events under the Bill increases the circumstances in which the exit tax will apply, closing potential loopholes.

- The explicit reference to the Table enhances legal certainty for both taxpayers and the administration.

Clause 352(2): Computation and Order for Tax on Accreted Income

Text: The Assessing Officer computes accreted income as of the specified date (per the Table), after affording a reasonable opportunity of being heard, and passes an order charging such income to tax.

Comparison with Section 115TD(2): Section 115TD(2) provides for computation of accreted income as the excess of aggregate fair market value of assets over liabilities, as on the specified date, as per prescribed valuation methods.

Key Points of Analysis:

- Clause 352(2) introduces an explicit requirement for the Assessing Officer to provide a reasonable opportunity of being heard before passing the order. This is not expressly stated in Section 115TD, though principles of natural justice would apply.

- Both provisions are similar in mandating computation as of a "specified date," but the Bill's Table (in sub-section 5) provides greater procedural clarity on what this date is for each scenario.

Implications:

- The explicit hearing requirement strengthens procedural fairness and may reduce litigation on grounds of violation of natural justice.

- The detailed Table clarifies the timeline and sequence of events, aiding compliance and enforcement.

Clause 352(3): Formula for Computation of Accreted Income

Text: Accreted income = Aggregate fair market value of assets (B) - Total liabilities (C), as on the specified date, computed as per prescribed valuation methods.

Comparison with Section 115TD(2): The formula and concept are identical: accreted income is the net asset value, with both assets and liabilities valued as per prescribed methods.

Rule 17CB: Provides the detailed methodology for valuation of assets and liabilities, including special rules for shares, securities, immovable property, business undertakings, and other assets.

Key Points of Analysis:

- The Bill maintains the same basic formula as Section 115TD and continues to rely on prescribed rules for valuation (which would likely be similar to Rule 17CB).

- The Bill's reference to "such method of valuation, as prescribed" suggests continuity in the use of detailed rules for consistency and fairness.

Implications:

- The continued reliance on prescribed valuation rules ensures objectivity and reduces scope for manipulation or disputes.

- The formula is simple, but the practical application can be complex due to the diversity of assets and liabilities in NPOs.

Clause 352(4): Exclusion of Certain Assets and Liabilities

Text: Accreted income is to be reduced by amounts attributable to specified assets and related liabilities.

Comparison with Section 115TD(2): Section 115TD(2) contains detailed provisos excluding from accreted income assets directly acquired from exempt income, or assets acquired before registration (if no exemption was allowed in that period), and assets transferred to another eligible entity upon dissolution.

Key Points of Analysis:

- Clause 352(4) is concise, delegating the specifics of exclusion to the prescribed rules or subsequent clarifications.

- Section 115TD(2) is more elaborate, listing the precise categories of assets and liabilities to be excluded.

- The Bill's approach may allow for more flexibility and adaptation through subordinate legislation, but could create interpretive uncertainty unless rules are promptly issued.

Implications:

- The principle is to avoid double taxation or taxing assets that were not accumulated from exempt income.

- The Bill's brevity could be a double-edged sword: it allows for adaptability but may require prompt rule-making to avoid confusion.

Clause 352(5): Timing and Payment of Tax on Accreted Income

Text: Specifies, via a detailed Table, the cases in which the tax is payable, the specified date for computation, and the due date for payment. The Table covers nine scenarios, including cancellation of registration (with and without appeal), modifications of objects (with and without application for fresh registration and appeals), failure to apply for registration, conversion, merger, and failure to transfer assets on dissolution.

Comparison with Section 115TD(3) & (5):

- Section 115TD(3) defines conversion events and scenarios triggering the tax, but in a more summary manner.

- Section 115TD(5) provides for payment of tax within 14 days from the relevant event (appeal expiry, order received, end of year, etc.), but does not use a tabular format.

Key Points of Analysis:

- The Bill's Table is a major structural improvement, offering clarity and precision for each scenario, including appeals and procedural nuances.

- The Table covers more nuanced scenarios, such as failure to apply for registration under specific clauses, and details the relevant dates for computation and payment.

- This approach reduces ambiguity about when the tax is triggered and when it is due, which has been a source of confusion under the current law.

Implications:

- The Table format improves administrative efficiency and taxpayer understanding.

- The inclusion of appeals processes and deadlines ensures that the tax is triggered only after due process is exhausted or waived.

Clause 352(6): Finality of Tax Payment

Text: Payment of tax on accreted income is deemed final; no further credit or deduction is allowed for such tax under any other provision.

Comparison with Section 115TD(6) & (7): - Section 115TD(6) and (7) similarly provide that the tax is final and no deduction or credit is allowed for the income or tax paid thereon.

Key Points of Analysis:

- Both provisions are aligned in ensuring that the accreted income tax is a terminal levy, precluding double benefits.

- The Bill consolidates the rule into a single sub-section, whereas Section 115TD splits it into two.

Implications: - This prevents any attempt to claim the tax paid as a deduction or credit in the hands of the NPO or any other person, closing potential avenues for tax avoidance.

4. Practical Implications

4.1 For Non-Profit Organizations and Trusts

- The provisions create a strong compliance incentive, as any deviation from the qualifying conditions or misuse of accumulated assets results in a substantial tax outgo.

- Entities must ensure that their registration status, objects, and compliance with conditions are continuously monitored to avoid inadvertent triggers.

- The requirement to pay tax within 14 days of the triggering event or appeal outcome imposes a strict timeline, necessitating robust internal controls and legal oversight.

4.2 For Assessing Officers and Tax Administration

- The explicit procedure for computation and the mandate to provide a hearing reduce the risk of arbitrary assessments and enhance accountability.

- The clear Table of triggers and timelines aids in uniform enforcement and reduces administrative ambiguity.

4.3 For Beneficiaries and the Public

- The mechanism ensures that public funds and donations intended for charitable purposes are not diverted for private gain or non-charitable uses.

- The provisions bolster public trust in the regulatory regime governing NPOs.

4.4 Compliance and Procedural Requirements

- Entities must maintain accurate and up-to-date records of assets, liabilities, and sources of funds to substantiate the computation of accreted income and to avail exclusions where eligible.

- The prescribed methods of valuation (per Rule 17CB or its successor) require engagement of qualified professionals (registered valuers, merchant bankers, accountants), adding to compliance costs but ensuring accuracy.

5. Comparative Analysis with Existing Law and Rules

5.1 Legislative Evolution and Alignment

- Clause 352 builds directly on the structure and content of Section 115TD, incorporating lessons from its implementation and judicial interpretations.

- The Table format in Clause 352(5) is a notable advancement, offering better clarity over the narrative style of Section 115TD.

- The explicit procedural safeguard of a hearing in Clause 352(2) is a welcome addition, ensuring due process.

5.2 Method of Valuation (Rule 17CB)

- Rule 17CB prescribes detailed methods for determining FMV of various asset classes and for identifying excluded liabilities.

- The Bill's reference to "prescribed" methods indicates that similar or identical rules will be adopted under the new regime. - The valuation rules ensure that the tax is levied on the true economic accretion, not on book values or arbitrary estimates.

5.3 Scope and Breadth of Triggers

- Both the Bill and Section 115TD cover a wide range of events, including cancellation, merger, conversion, modification of objects, and failure to apply for registration.

- The Bill's expanded and clarified triggers (especially around appeals and timelines) address several practical scenarios that have arisen under the current law.

5.4 Procedural and Substantive Safeguards

- The requirement of a hearing, clear computation formula, and exclusion of certain assets/liabilities demonstrate a balance between revenue protection and taxpayer fairness.

- The finality of the tax payment and prohibition of deductions or credits prevent tax arbitrage.

5.5 Enforcement and Recovery

- Both regimes make the specified person, principal officer, or trustee jointly and severally liable for the tax.

- The Bill further clarifies the liability of transferees of assets in dissolution scenarios, limiting liability to the value of assets received.

6. Ambiguities and Potential Issues

6.1 Interpretation of "Specified Person" and "Specified Provision"

- The definitions, while comprehensive, may require further refinement to address edge cases, such as entities with hybrid or evolving objects, or those undergoing partial mergers.

6.2 Valuation Disputes

- The reliance on FMV and professional valuations, while necessary, may give rise to disputes, especially for illiquid or unique assets.

- The rules attempt to standardize valuation methods, but subjective elements remain.

6.3 Timelines and Compliance Burden

- The 14-day payment window, though administratively efficient, may be onerous for entities facing complex asset/liability positions or protracted appeal processes.

6.4 Overlap with Other Provisions

- There may be overlap or conflict with other provisions relating to dissolution, amalgamation, or conversion of NPOs, necessitating harmonization.

7. Conclusion

Clause 352(1) to (6) of the Income Tax Bill, 2025, is a comprehensive and modernized provision for the taxation of accreted income of specified persons, primarily registered non-profit organizations. It builds upon and refines the existing regime under Section 115TD of the Income-tax Act, 1961 and u/r 17CB of the Income-tax Rules, 1962, introducing greater clarity, procedural safeguards, and operational detail.

The provision is significant for the charitable sector, tax authorities, and policymakers, as it seeks to ensure that the benefits of tax exemption are preserved for genuine charitable purposes and that accumulated assets are not diverted for private gain. The detailed tabular approach to triggering events and payment timelines is a notable improvement, though challenges remain in the areas of valuation, interpretation, and compliance.

Future developments may include further refinement of the rules for valuation, clarification of ambiguities, and judicial interpretation of contentious issues. The provision represents a robust framework for the regulation of tax-exempt entities and the protection of public interest in the charitable sector.

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Full Text:

Clause 352 Tax on accreted income.

 

Dated: 7-5-2025