The application of income in the context of charitable and religious trusts plays a central role in determining whether such institutions qualify for exemption under the Income-tax Act. Section 11 lays down the framework that allows income derived from property held under trust for charitable or religious purposes to be exempt, provided the income is applied for the approved purposes within India. The legislation recognises both capital and revenue expenditure in fulfilling this requirement, and over time, judicial interpretations have expanded and clarified its scope.
The provision is designed to ensure that trusts deploy their income effectively towards their objectives rather than allowing it to accumulate indefinitely. By requiring a substantial portion of annual income to be applied for approved purposes, Section 11 seeks to balance operational flexibility with accountability in the charitable sector.
Meaning of Application of Income
Application of income refers to the utilisation of the trust’s resources to carry out its charitable or religious purposes. It covers spending on day-to-day operations, as well as capital investments directly serving those purposes. This concept is broader than simply recording an expense; it extends to any deployment of funds that advances the trust’s objects.
Under the statute, a trust is generally required to apply at least 85 percent of its income in the year it accrues or is received. This ensures that funds generated are actively used for charitable or religious activities rather than retained without justification. The application requirement is assessed in light of the actual use of funds, with specific legislative amendments ensuring that only payments actually made during the year are considered.
Legislative Framework under the Income-tax Act
Sections 11 to 13 govern the computation of income for charitable and religious trusts. Unlike the computation of income for other entities under the five heads in Section 14, the income of such trusts is assessed in terms of eligibility for exemption under Section 11 or under Section 10(23C).
The scope of Section 11 includes:
- Application of income for charitable or religious purposes in India
- Treatment of voluntary contributions as part of income, with certain exceptions
- Conditions for accumulation or setting apart of income beyond the 15 percent allowed without formal approval
- Restrictions on application to benefit specified persons or for non-charitable activities
Judicial pronouncements have clarified that the expression “applied” is used instead of “spent” to reflect the focus on purpose-based utilisation rather than mere expenditure.
85 Percent Application Requirement
A trust must apply at least 85 percent of its income, including voluntary contributions other than those forming part of the corpus, during the previous year to qualify for exemption. The requirement is not merely a numerical target but a substantive condition to ensure that the trust’s resources are actively deployed for its stated purposes.
Historically, courts had allowed trusts to set off excess applications from earlier years against the requirement in subsequent years. However, this practice was curtailed by the insertion of Explanation 5 to Section 11(1) through the Finance Act, 2021, which expressly prohibits carrying forward excess application.
Distinction Between Application and a Charge on Income
In income computation, a distinction is drawn between application of income and a charge on income. Application refers to deploying income for charitable or religious purposes after it has been determined as surplus. In contrast, a charge on income represents expenses that must be met before arriving at the amount available for application.
For example, establishment expenses directly linked to running the trust’s activities may be considered application, while expenses incurred for generating income, such as investment management fees, are treated as charges and deducted before determining the amount to be applied.
Eligible Expenditures for Application
The range of expenditures that qualify as application is broad. They include:
- Revenue expenses directly linked to charitable or religious activities
- Capital expenditure on assets used for the trust’s objectives
- Grants and donations to other eligible charitable institutions, subject to conditions
- Loan repayments where the borrowed funds were used for charitable purposes, subject to legislative amendments
Courts have repeatedly emphasised that capital expenditure directly furthering the trust’s objects qualifies as application. This interpretation recognises that charitable activities often require significant infrastructure investment.
Ineligible or Disqualified Expenditures
Certain expenditures do not qualify as application for the purposes of Section 11. These include:
- Payments in violation of the provisions of Sections 40(a)(ia), 40A(3), and 40A(3A)
- Payments made for the benefit of specified persons under Section 13
- Application of income outside India unless permitted under specific provisions
- Utilisation of corpus funds without replenishment in accordance with statutory requirements
The legislative scheme aims to prevent misuse of the exemption by imposing clear disqualifications where the expenditure is not aligned with charitable purposes or statutory compliance.
Payment Basis Rule after Finance Act, 2022
Prior to the Finance Act, 2022, the application of income could be recognised on the basis of accrual in certain circumstances. This meant that once a liability was incurred for charitable purposes, it could be treated as application even if payment was made in a subsequent year. Judicial precedents such as CIT v. Trustees of H.E.H. Nizam’s Charitable Trust supported this interpretation, provided the liability was genuine and irrevocable.
The Finance Act, 2022 introduced a significant change by mandating that application will be recognised only in the year in which the payment is actually made, irrespective of when the liability accrued. This amendment was aimed at enhancing transparency and reducing the scope for manipulation through provisions and accrual entries without corresponding payments.
Under the amended law, once an amount is claimed as an application in a given year, it cannot be claimed again when the payment is actually made in a later year. This prevents double counting and ensures accurate tracking of charitable expenditure.
Judicial Interpretations Before and After Amendments
Before the 2022 amendment, courts often allowed earmarking of funds as sufficient application if it was genuine and irrevocable. In CIT v. Thanthi Trust, it was held that mere earmarking without actual utilisation was insufficient unless supported by concrete steps towards execution. Similarly, in CIT v. V.G.P. Foundation, it was emphasised that disbursement must serve charitable purposes rather than being a mere transfer of funds.
After the legislative change, these interpretations have to be read in light of the payment-based recognition rule. Actual cash outflow has become the decisive factor, replacing earlier reliance on liability recognition.
Impact on Revenue and Capital Expenditure
The application of income concept covers both revenue and capital expenditure. Revenue expenditure includes routine operational costs such as salaries for staff involved in charitable activities, program expenses, and utilities for facilities used in charitable operations. Capital expenditure may involve acquiring land, constructing buildings, purchasing equipment, or developing infrastructure necessary for carrying out the trust’s objectives.
Courts have consistently supported the inclusion of capital expenditure within application, provided the assets are directly used for charitable purposes. For instance, in the case of Mool Chand Sharbati Devi Hospital Trust, expenditure on constructing a hospital building was accepted as valid application. Similar principles were applied in S. RM. M. CT. M. Tiruppani Trust, where the purchase of hospital premises was treated as application.
Role of Accumulation and Set Aside
While the law requires application of at least 85 percent of income, the remaining 15 percent may be accumulated without specific conditions. If a trust seeks to accumulate more than this limit, it must comply with the conditions under Section 11(2), including filing prescribed forms and specifying the purpose of accumulation.
Historically, trusts could adjust excess application in one year against the requirement in another year. However, the Finance Act, 2021 closed this route, mandating year-by-year compliance without offsetting. This change requires trusts to plan their expenditure more carefully to meet the annual application target.
Administrative Expenses in the Context of Application
Administrative and establishment expenses often form a substantial part of a trust’s expenditure. The department has historically viewed such expenses as a charge on income rather than application. However, courts have recognised that if such expenses are incurred for carrying out charitable purposes, they can qualify as application.
In CIT v. Birla Janahit Trust, it was held that establishment expenses that contribute to the achievement of charitable objectives may be treated as application. The ITAT Kolkata Bench has further held that the 15 percent accumulation limit should be computed on gross receipts before deducting administrative expenses, reflecting a trust-friendly interpretation.
Donations to Other Charitable Institutions
Donations made to other registered charitable trusts or institutions are treated as application in the hands of the donor trust, provided both entities are eligible under the law. However, the Finance Act, 2023 has modified this treatment by allowing only 85 percent of such eligible donations to be counted as application.
This ensures that a portion of the transferred funds is ultimately used for charitable purposes in the year of transfer rather than indefinitely deferred. This rule requires donor trusts to reassess their inter-trust donation strategies to ensure compliance with the application requirement while supporting other institutions.
Specific Rules and Practical Scenarios under Section 11
The practical application of Section 11 of the Income-tax Act requires an understanding not only of the general principles but also of specific rules and scenarios that arise in the operation of charitable and religious trusts. These rules address situations such as capital expenditure, inter-trust donations, loan repayments, administrative costs, compliance with withholding tax provisions, and limitations on cash payments.
Each of these aspects has been shaped by legislative amendments and judicial decisions, creating a detailed framework that trustees and administrators must navigate. The focus is on the treatment of different categories of expenses and receipts, compliance requirements, and their impact on the 85 percent application threshold.
Capital Expenditure as Application
Capital expenditure that directly furthers the trust’s objectives qualifies as application of income under Section 11. This interpretation ensures that investments in long-term assets, which are essential for the trust’s activities, are not excluded from the application requirement.
Examples include the purchase of land for a school, construction of a hospital building, or acquisition of medical equipment for charitable healthcare services. Judicial precedents such as Mool Chand Sharbati Devi Hospital Trust and S. RM. M. CT. M. Tiruppani Trust confirms that such expenditures qualify, provided the assets are used for charitable purposes and not for generating unrelated income.
The principle applies equally to expenditure incurred from funds accumulated under Section 11(2). In Guru Nanak Foundation, it was held that capital expenditure from such accumulated funds also counts as application, subject to fulfilment of statutory conditions.
Revenue Expenditure and Day-to-Day Operations
Revenue expenditure includes the recurring costs necessary to run the trust’s activities. These may cover staff salaries, utilities, maintenance, educational program costs, medical supplies, and welfare distributions. The expenditure must be directly linked to charitable or religious purposes to be counted as application.
The distinction between revenue and capital expenditure is important because, while both may qualify as application, capital expenditures often involve larger amounts and strategic planning, whereas revenue expenses are part of the trust’s regular operational cycle.
Administrative and Establishment Costs
Administrative expenses, such as office rent, clerical salaries, audit fees, and general management costs, can be treated as application if they are necessary for achieving the trust’s objectives. However, expenses incurred solely for managing investments or generating income are treated as a charge against income, not as application.
Circular No. 5-P (1968) clarified that administrative expenses are generally a charge on income, but judicial rulings have allowed them to be considered as an application where they directly support charitable activities. In CIT v. Birla Janahit Trust, such expenses were recognised as part of application when they facilitated the trust’s work.
The approach taken by the ITAT Kolkata Bench that the 15 percent accumulation limit should be computed on gross receipts before deducting administrative expenses offers a more favourable interpretation for trusts.
Loan Repayment as Application
Repayment of loans taken for charitable purposes qualifies as application when the repayment is made from current year’s income. This is based on Circular No. 100, dated 24 January 1973, and judicial confirmation in Maharana of Mewar Charitable Foundation.
However, significant changes were introduced by the Finance Act, 2021 and Finance Act, 2023. Application from borrowings is no longer counted in the year of borrowing; only repayment from current income qualifies. The Finance Act, 2023 imposes additional conditions:
- The loan must be used exclusively for charitable or religious purposes
- It must be repaid within five years from the year of borrowing
- No corpus donations should be made to other trusts from the borrowed funds
- Compliance with TDS and restrictions on cash payments is mandatory
- The repayment must not confer any benefit to specified persons under Section 13
Loans utilised before 1 April 2021 are excluded from qualifying upon repayment under the amended rules.
Inter-Trust Donations
Donations from one registered trust to another can be treated as application of income by the donor trust, provided both trusts are eligible under Section 11 or Section 10(23C). Such donations allow charitable institutions to collaborate in achieving common objectives.
However, from the assessment year 2024–25, the Finance Act, 2023 limits the eligible amount to 85 percent of the donation made. This means that if a trust donates 10 lakh rupees to another eligible trust, only 8.5 lakh rupees will be counted as application for the donor trust.
The measure aims to prevent indefinite deferment of application by circulating funds among trusts without actual deployment in charitable activities.nThe donor trust must also ensure that the recipient trust uses the funds for its approved purposes to avoid any challenge from the revenue authorities.
Compliance with Withholding Tax Provisions
If a trust makes payments that are subject to tax deduction at source but fails to deduct or deposit TDS as required, 30 percent of such expenditure is disallowed under Section 40(a)(ia). This disallowance affects the computation of application because the expenditure is not recognised until the TDS compliance is completed.
The law provides that the expense can be allowed in the year in which TDS is deducted and deposited. This timing rule requires careful monitoring of compliance to ensure that payments to contractors, professionals, or other service providers do not reduce the trust’s eligible application in the intended year.
Restrictions on Cash Payments
Payments exceeding ten thousand rupees in cash are disallowed under Sections 40A(3) and 40A(3A), except in prescribed circumstances. This restriction applies to charitable trusts in the same way it applies to other entities. Any disallowed amount cannot be counted as application until it is paid through acceptable modes such as cheque, bank draft, or electronic transfer.
Trusts operating in rural or cash-dependent environments must adapt their payment practices to meet this requirement. This may involve negotiating with suppliers and beneficiaries to accept non-cash modes of payment to protect the trust’s tax-exempt status.
Use of Corpus Funds and Replenishment
Corpus funds are capital contributions received by a trust with a specific direction that they form part of the corpus. Under Section 2(24)(iia), such contributions are considered income, but Section 11(1)(d) exempts them from tax if they are invested in modes specified under Section 11(5).
The use of corpus funds for charitable purposes is not treated as application unless the amount is replenished from current year’s income and reinvested in approved modes. This requirement, introduced by the Finance Act, 2021 and reinforced in 2023, ensures that corpus funds maintain their intended capital nature and are not eroded by operational expenses without replacement.
Failure to replenish corpus funds used for application results in the loss of exemption for the amount withdrawn. Trusts must, therefore, maintain accurate tracking of corpus utilisation and replenishment.
Impact of the Payment Basis Rule
The payment basis rule introduced by the Finance Act, 2022 has changed the way trusts plan their application of income. Since only amounts actually paid in the year are recognised, trusts can no longer rely on creating provisions or recognising liabilities to meet the 85 percent requirement.
This has practical implications for large projects that span multiple years. Trusts must ensure that payments to contractors, suppliers, or service providers are made within the year to be counted towards application. Deferred payments will shift the application to subsequent years, potentially affecting compliance in the current year.
Judicial Emphasis on Purpose and Utilisation
Courts have repeatedly stressed that the purpose and actual utilisation of funds are the key determinants in assessing application. In CIT v. V.G.P. Foundation, it was held that mere transfer of funds without actual charitable use does not constitute application. The decision in CIT v. Thanthi Trust similarly underlines that earmarking of funds must be accompanied by concrete steps to achieve the charitable purpose.
Post-amendment, the emphasis on actual payment complements the judicial focus on genuine utilisation. Trusts must be able to demonstrate both the charitable purpose and the actual disbursement of funds.
Coordination of Application Across Activities
Many trusts undertake a combination of charitable and religious activities, or operate multiple programs such as education, healthcare, and relief work. The application requirement applies to the overall income of the trust, not to individual programs, but the expenditure must be for approved purposes.
Where a trust operates internationally, only application within India qualifies unless specific approval is obtained under Section 11(1)(c). This requires careful tracking of expenditure by geographic location to ensure compliance.
Strategic Planning for Annual Application
Given the restrictions on carry-forward of excess application, trusts must plan their spending to meet the 85 percent target each year. This may involve scheduling capital projects, timing donations to other trusts, and ensuring timely payments for contracted services.
Trusts with fluctuating income, such as those dependent on donations or seasonal activities, face particular challenges in aligning income and application. In such cases, maintaining a pipeline of ready-to-implement projects can help ensure compliance in years of higher income.
Interaction with Accumulation Provisions
Where a trust is unable to apply 85 percent of its income in a given year, it can accumulate the unspent portion for specific purposes under Section 11(2), provided it follows the prescribed procedure. This includes filing Form 10, specifying the purpose and period of accumulation, and investing the accumulated amount in approved modes.
Non-compliance with these requirements results in the accumulated amount being treated as taxable income in the year of non-compliance. Trusts must integrate accumulation planning into their overall financial strategy to ensure both compliance and operational effectiveness.
Understanding Applied versus Spent
One of the central shifts brought by the Finance Act, 2022 is the insistence on the payment basis for recognising application. Under this rule, expenditure is considered applied only when it is actually paid during the year, regardless of when the liability arises. This contrasts with earlier practice, where the creation of a liability was often sufficient for recognition.
This change requires trusts to align their cash flows with their application targets. For example, if a trust enters into a contract for construction work in March but pays only an advance before the year-end, only that advance will be treated as application for the year. The balance payment in the following year will contribute to application for that year.
Year of Application and the No-Carry-Forward Rule
Another significant development is the prohibition on carrying forward excess application of income to future years. Previously, trusts could spend more than their income in one year and treat the excess as application in subsequent years. This allowed for flexibility in funding large projects and managing uneven income patterns.
Now, each year is treated independently for application purposes. This means that if a trust applies more than 100 percent of its income in a year, the excess has no tax benefit in later years. This rule demands careful scheduling of large expenditures, spreading them across years where possible to maximise the utilisation of the exemption.
Accumulation under Section 11(2) and its Interaction with Application Rules
Section 11(2) provides a mechanism for trusts to accumulate income for specific purposes beyond the general 15 percent permitted under Section 11(1)(a). To use this provision, the trust must:
- Specify the purpose for accumulation in Form 10 before the due date for filing the return
- State the period of accumulation, which cannot exceed five years
- Invest the accumulated amount in modes specified under Section 11(5)
These accumulated funds, when spent, will count as application in the year of expenditure. However, if the accumulated amount is not utilised within the specified period or is used for purposes other than those stated, it becomes taxable in the year of default. This provision is often used to fund large capital projects while maintaining compliance with annual application requirements.
Documentation and Record-Keeping for Compliance
To substantiate claims of application, trusts must maintain detailed records. This includes:
- Vouchers and invoices for all payments
- Bank statements showing disbursements
- Resolutions or minutes of trustees approving significant expenditures
- Contracts and agreements for services or construction
- Separate ledgers for corpus funds, loans, and accumulated funds under Section 11(2)
Proper documentation is especially important for payments to other charitable institutions, where proof of the recipient’s eligibility and the intended purpose is essential. Inadequate documentation can lead to disallowance of application during assessment.
Payments to Other Charitable Institutions – Compliance Checklist
When making donations to other trusts or institutions, the donor trust must ensure:
- The recipient is registered under Section 12AB or approved under Section 10(23C)
- The donation is not from corpus funds unless replenished from current income
- The recipient’s objects align with the donor’s approved purposes
- The donation is made through banking channels to avoid disallowance under Section 40A(3)
- Proper acknowledgment and receipt are obtained from the recipient
From assessment year 2024–25, only 85 percent of the amount donated will be treated as application for the donor, adding another layer to the calculation.
Avoiding TDS and Cash Payment Disallowances
Sections 40(a)(ia), 40A(3), and 40A(3A) apply to trusts in the same way as to business entities. This means:
- Payments requiring tax deduction at source must have TDS deducted and deposited within the prescribed time
- Cash payments exceeding ten thousand rupees in a day to a single person are generally disallowed
- Exceptions exist for payments in areas without banking facilities or in other prescribed cases
Non-compliance not only leads to disallowance of expenditure for application purposes but can also result in penalties. Therefore, trusts must integrate TDS and payment mode compliance into their standard financial procedures.
Managing Corpus Funds
Corpus donations, when received with a specific direction, enjoy exemption under Section 11(1)(d) but must be invested in modes specified under Section 11(5). If corpus funds are used for application, the amount must be replenished from current year’s income to retain their capital nature.
The replenishment must also be invested in approved modes. This requirement prevents erosion of the trust’s capital base and ensures that corpus contributions continue to serve as a long-term resource for charitable activities.
Planning for the 85 Percent Application Requirement
The 85 percent application rule requires continuous monitoring throughout the year. Trusts should:
- Prepare a budget at the beginning of the year estimating income and planned expenditure
- Track actual income and expenditure monthly to identify gaps early
- Adjust spending schedules to ensure the threshold is met without last-minute rushes
- Use the accumulation provision under Section 11(2) for surplus income that cannot be spent immediately but is earmarked for a specific purpose
Large donations or unexpected income late in the year may require quick planning to either spend the amount or accumulate it in compliance with the law.
Common Pitfalls Leading to Non-Compliance
Several recurring issues lead to disallowance of application:
- Treating provisions for expenses as application without actual payment
- Making cash payments above the prescribed limit without valid exceptions
- Failing to deduct or deposit TDS on time
- Donating to ineligible institutions
- Using accumulated or corpus funds without proper replenishment or approval
- Spending on purposes outside the trust’s approved objects
Each of these can be avoided with proper internal controls, regular review of compliance, and trustee awareness of the rules.
Role of the Audit Report in Form 10B
Charitable trusts claiming exemption under Section 11 must file an audit report in Form 10B. This report, prepared by a chartered accountant, certifies compliance with various provisions, including application of income, investment in approved modes, and adherence to accumulation requirements.
Any qualification or adverse remark in the audit report can trigger scrutiny from the tax authorities. Therefore, trusts should work closely with their auditors to ensure all compliance issues are addressed before the report is finalised.
Interplay with Section 10(23C) Institutions
Institutions approved under Section 10(23C) are also subject to application requirements similar to those under Section 11. However, differences exist in procedural compliance, particularly regarding accumulation and reporting.
For trusts transitioning between these regimes or operating both types of approvals, careful attention must be given to the specific conditions applicable to each to avoid unintended violations.
International Activities and Application Rules
While the general rule is that application must be within India, trusts can apply income outside India if specifically permitted under Section 11(1)(c). This requires approval from the Central Board of Direct Taxes and is typically granted for international welfare projects in alignment with the trust’s objects.
Applications outside India without such approval are disregarded for exemption purposes, even if they are charitable in nature. Trusts engaged in cross-border activities must, therefore, obtain the necessary approvals in advance.
Impact of Judicial Trends on Practical Planning
Recent case law continues to influence how application rules are interpreted. Courts have shown willingness to accept a broad view of application when genuine charitable intent is demonstrated, but the legislative trend is towards tightening definitions and requiring actual payment.
Trusts must balance reliance on favourable judicial precedents with strict adherence to current statutory provisions, especially where amendments have overridden earlier rulings.
Building a Compliance-Oriented Culture
Ultimately, sustaining exemption under Section 11 requires a culture of compliance within the trust. This involves:
- Training staff and trustees on application rules and procedural requirements
- Establishing written policies for expenditure approval, payment methods, and documentation
- Conducting internal reviews of compliance status mid-year and at year-end
- Maintaining transparency in dealings with donors, beneficiaries, and regulatory authorities
Such a culture not only reduces the risk of disputes but also reinforces donor confidence and enhances the trust’s credibility.
Conclusion
The framework for application of income under Section 11 has evolved from a relatively flexible regime into a highly regulated system with clear emphasis on actual payment, strict timelines, and transparent utilisation for approved charitable or religious purposes. The combination of legislative amendments, detailed compliance conditions, and judicial interpretation has transformed how trusts must plan their finances and operations.
The shift from accrual to payment basis for recognising application has made cash flow management as important as the charitable activities themselves. The prohibition on carrying forward excess application, the reduced benefit for inter-trust donations, and the conditions attached to use of corpus and borrowings all point to a system designed to ensure that income is channeled promptly and directly into active charitable work.
At the same time, the provisions still recognise the need for long-term planning through mechanisms like the 15 percent retention allowance and accumulation under Section 11(2), provided they are supported by specific purpose declarations, approved investments, and timely utilisation. Judicial decisions continue to offer interpretative guidance, but statutory amendments increasingly define the boundaries within which trusts must operate.
The central theme that emerges is that compliance is no longer an end-of-year exercise but an ongoing process. Trustees and administrators must integrate the application rules into budgeting, project scheduling, donor communication, and governance practices. Adequate documentation, adherence to payment mode restrictions, proper handling of TDS, and ensuring alignment between objectives and expenditure are no longer optional best practices, they are essential for preserving exemption.
When these requirements are understood not as bureaucratic hurdles but as safeguards for the trust’s integrity and mission, they can reinforce the credibility and sustainability of charitable institutions. A trust that maintains disciplined financial management, aligns every rupee spent with its stated purposes, and anticipates compliance challenges will not only retain its tax-exempt status but also be better equipped to deliver enduring social impact.