Charitable trusts play a crucial role in supporting social, educational, medical, and religious causes across India. The Indian Income-tax Act, 1961 offers several tax exemptions to such trusts, primarily under sections 11 to 13. However, these exemptions are conditional. One of the most fundamental requirements is the proper application of income toward the trust’s approved objectives. We explored the concept of application of income, the percentage thresholds, the treatment of various types of expenditures, and compliance nuances under section 11 of the Income-tax Act.
Understanding the Concept of Application of Income
The term “application of income” refers to the manner in which a charitable or religious trust uses its income to carry out its purposes. Unlike private entities that are taxed on income earned, charitable trusts are assessed based on how much of their income has been spent or “applied” toward charitable or religious goals.
Income includes voluntary contributions, donations, interest earned, rental income, and any other receipts attributable to the property held under trust. To qualify for exemptions under section 11, the trust must apply at least 85 percent of its income to charitable or religious purposes in India during the financial year.
What Qualifies as Charitable Purpose?
The Income-tax Act defines charitable purpose under section 2(15), which includes:
- Relief of the poor
- Education
- Medical relief
- Preservation of the environment
- Preservation of monuments or places of artistic or historic interest
- Advancement of any other object of general public utility
As long as the trust’s income is directed toward these objectives, it may qualify for exemption.
The 85 Percent Rule: Core Requirement
A trust must apply at least 85 percent of its income for charitable or religious purposes in India during the financial year to claim full exemption. If the trust is unable to apply the requisite percentage for valid reasons, it can carry forward the unspent income and apply it in subsequent years, provided it complies with specific procedural requirements.
Income is considered “applied” when it is actually spent or irreversibly earmarked for charitable purposes. Merely setting aside funds or making internal appropriations without actual expenditure will not qualify.
Accumulation of 15 Percent of Income
The law allows charitable trusts to accumulate up to 15 percent of their income without any special permission or requirement. This accumulated income can be retained for future use and still be exempt from tax. The remaining 85 percent must be applied during the same year unless the trust opts to carry it forward under permitted exceptions.
Capital vs Revenue Expenditure
Application of income includes both revenue and capital expenditure. This means that if a trust spends money on acquiring capital assets like land, buildings, or medical equipment for its charitable activities, such expenditures are also considered as valid application of income.
For example, if a trust purchases an ambulance for a charitable hospital, the full cost of the vehicle would be treated as application of income in the year of purchase, even though the benefit of the asset spans multiple years.
Depreciation Not Allowed as Application
It’s important to note that once capital expenditure is claimed as application of income, depreciation on the same asset in subsequent years is not allowed as additional application. This prevents trusts from claiming double benefits on the same outlay.
Treatment of Loans and Advances
If a trust gives an interest-free loan or advance to another charitable organization for similar purposes, it may still qualify as application of income, provided the intent and documentation clearly show that the fund is being used toward charitable objectives. However, if the funds are not utilized or are returned, it will be deemed that income was not applied in the year of giving the loan.
On the other hand, if a trust borrows money and applies it for charitable purposes, it is not considered as application of income at the time of spending. Instead, repayment of the loan (principal amount) will be considered as an application when it is actually paid back, provided it can be linked to the earlier application.
Corpus Donations and Their Exclusion
Corpus donations are voluntary contributions received by the trust with a specific direction from the donor that they form part of the corpus of the trust. These are fully exempt under section 11(1)(d) and are not treated as income. Therefore, any application of corpus funds is not considered as application of income for the purpose of the 85 percent rule.
However, if a trust chooses to apply corpus funds for charitable purposes, such expenditure must be replenished within five years by transferring equivalent amounts from non-corpus income, if the trust wants the expenditure to be treated as application in the year of utilization.
Inter-Charity Donations and Application Issues
Charitable trusts often donate to other charitable trusts. Donations made out of current year income to another registered charitable trust may be treated as application of income. However, donations made out of accumulated income or corpus funds do not qualify unless certain conditions are met.
From assessment year 2024-25 onwards, only 85 percent of the donation given to another trust will be considered as application of income. For example, if Trust A donates ₹10 lakh to Trust B, only ₹8.5 lakh will be treated as applied income in the hands of Trust A.
Conditions for Carry Forward of Unspent Income
When a trust is unable to apply 85 percent of its income due to:
- Non-receipt of income (e.g., donation pledged but not yet received)
- Any other valid reason (e.g., ongoing construction delays, project approvals pending)
It can opt to apply such unspent income in the following year or up to five years by submitting Form 9A within the prescribed due date. If this option is exercised correctly, the unspent amount will still be treated as applied in the year of income accrual. Failure to comply with timelines or filing requirements will lead to denial of the exemption.
Mandatory Filing of Return and Audit
To avail of the exemption under section 11, the trust must:
- Get its accounts audited if the total income (before claiming exemption) exceeds the basic exemption limit
- File Form 10B (audit report) along with the return of income in Form ITR-7
- Maintain books of account, donation receipts, and utilization records
- Furnish Form 10 when income is accumulated beyond the 15 percent allowance for specific future purposes
Non-compliance with filing requirements may result in loss of exemption for that year.
Registration Requirements Under Sections 12AB and 80G
Exemption under section 11 is available only to trusts that are registered under section 12AB. Additionally, to allow donors to claim tax benefits under section 80G, the trust must have a valid 80G registration.
Both registrations are time-bound and subject to renewal. Trusts must also file statements of donations (Form 10BD) and issue donation certificates (Form 10BE) to donors. These procedural requirements are closely tied to application rules.
Income From Business and Its Impact
Charitable trusts are generally not allowed to carry on business unless:
- The business is incidental to the attainment of its objects
- Separate books of account are maintained
Even then, the income from such business must be applied toward charitable purposes to qualify for exemption. Income earned from a business that is not incidental will be treated as taxable, regardless of its application.
Use of Income Outside India
Application of income outside India is allowed only if:
- The trust is established for promoting international welfare in which India is interested
- The Central Board of Direct Taxes (CBDT) has specifically approved such application
Otherwise, expenditures incurred outside India do not qualify as application for the purpose of exemption under section 11.
Anonymous Donations and Their Treatment
Anonymous donations are subject to tax under section 115BBC. While such donations are still considered part of income, any portion exceeding the higher of ₹1 lakh or 5 percent of total donations is taxable at a flat rate of 30 percent.
The trust may still apply the remaining income to charitable purposes, but anonymous contributions create additional compliance burdens.
Penalties for Non-Compliance
Failure to comply with the provisions of section 11, whether related to application thresholds, return filing, or misuse of income, can result in denial of exemption and full taxation of income at maximum marginal rate. Penalties may also be levied under other sections for inaccurate filings or misreporting.
Clarifying the Term “Application” in Practice
In legal and tax contexts, the term “application of income” has a very specific meaning. For charitable trusts, it involves not only incurring expenses but also ensuring those expenses align with the organization’s stated objectives. It is not sufficient for funds to simply leave the trust’s bank account; they must be directed toward the defined charitable or religious purposes within India. This definition is essential for compliance under Section 11.
The income is said to be applied when it is irretrievably spent on charitable purposes, regardless of whether the payment was in cash or accrual. Even advance payments, where services are yet to be rendered, may qualify as application if they fulfill the trust’s mission.
Corpus Donations and Their Exclusion from Application
Corpus donations are contributions made with a specific direction from the donor that the amount shall form part of the trust’s corpus or capital. These donations are not treated as income for the purposes of application. Since they are capital receipts, trusts are not expected to apply these amounts to charitable purposes in the year of receipt.
However, if a corpus donation is misclassified or not supported by donor instructions, the authorities may include it in the income subject to application. Therefore, proper documentation and clarity in donor communications are vital.
Voluntary Contributions and Their Treatment
Voluntary contributions that are not corpus in nature are treated as income and must be applied to charitable purposes. These include donations from the general public or specific donors without any instructions to form part of the corpus.
The trust must utilize at least 85% of these voluntary contributions for charitable activities within the same financial year or carry forward the shortfall in application under prescribed conditions.
Revenue vs. Capital Expenditure: Eligible Application
One critical question for charitable trusts is whether capital expenditure qualifies as application of income. Under prevailing jurisprudence, capital expenditures made towards achieving the objects of the trust are treated as valid application.
For instance, building a school or hospital is considered application, even though the asset’s benefits extend over multiple years. However, the asset must be used for charitable purposes and not for generating commercial profits. On the other hand, capital expenditures that benefit the trust’s management (like administrative buildings) must be scrutinized carefully to ensure they support charitable functions.
Depreciation on Capital Assets and Double Deduction
Once capital expenditure is allowed as application, claiming depreciation on the same asset in subsequent years could lead to a double deduction. Judicial opinions have varied on this issue, but current interpretations generally disallow depreciation where the full capital cost has already been claimed as application of income.
Still, if the asset was acquired in a year where the trust did not claim full application (for instance, if it did not claim exemption under Section 11), depreciation may be permitted for that asset in subsequent years.
Carry Forward and Set-Off of Deficit
A trust may sometimes incur expenses exceeding its income for a given year, resulting in a deficit. The question then arises whether this deficit can be carried forward to future years and set off against future income to calculate the application requirement.
Recent amendments and judicial interpretations have leaned toward disallowing such set-offs, emphasizing that each year’s income must be applied independently to qualify for exemption. However, some High Court rulings have allowed set-off where the deficit arose from genuine over-application in prior years.
Inter-Charity Donations and Their Limitations
Charitable trusts may transfer funds to other registered charitable institutions as part of their charitable strategy. Such inter-charity donations are generally considered valid applications of income, provided the recipient is registered under Section 12AB and uses the funds for similar purposes.
However, recent legal changes have introduced restrictions. For example, only 85% of a donation made to another charitable organization is considered as an application. This measure is designed to avoid repeated cycles of donations and to ensure that most of the money is spent on end-use activities.
Further, donations to trusts with similar objectives must not be used as a tool to merely transfer surplus funds to avoid application requirements. The purpose and execution of the donation must align with the originating trust’s core mission.
Advances and Prepayments as Application
Charitable trusts often make advance payments for future services, such as construction of school buildings or upfront grants for multi-year programs. Whether these qualify as applications depends on the terms and usage.
If the advance is given in furtherance of a charitable object and is non-recoverable (or recoverable only under breach), it is usually treated as application in the year of payment. However, purely refundable advances or those not earmarked clearly may not qualify. Proper agreements, documentation, and accounting treatment can help validate such advances as application of income.
Repayment of Loans as Application
Charitable trusts may sometimes borrow funds in one year and repay the loan in a subsequent year. The question arises whether such repayment can be considered as application of income.
If the loan was originally used for charitable purposes and the repayment is made from the current year’s income, courts have held that such repayment constitutes application of income in the year of repayment. This is especially true where the original borrowing helped the trust meet urgent charitable needs, and the subsequent income is used to discharge that financial obligation.
Foreign Contributions and Their Implications
Many charitable trusts in India receive foreign contributions for their programs. These are regulated by the Foreign Contribution (Regulation) Act (FCRA). From an income application perspective, foreign contributions that qualify as income under Section 11 must also be applied toward charitable purposes in India.
The trust must ensure that FCRA funds are not used for prohibited activities or administrative expenses beyond permissible limits. Proper record-keeping, bank segregation, and reporting to the Ministry of Home Affairs are essential for trusts receiving such contributions.
Treatment of Grants and Subsidies
Government grants, institutional subsidies, or project-specific funding received by trusts must also be applied in line with their charitable objectives. These funds are generally considered income and must meet the 85% application rule.
However, if the grant comes with restrictions (such as utilization over multiple years or earmarked for capital expenditure), the trust must apply and report accordingly. Utilization certificates and grant compliance documentation are crucial.
Role of Accounting Methods in Determining Application
Whether a trust uses cash or mercantile accounting can significantly influence how it reports applications. Under the cash system, income is accounted for when received, and expenditure when paid. Under the mercantile system, income and expenses are recorded when accrued.
For trusts following the accrual system, a genuine liability incurred in one year—even if paid later—can be considered application in that year. But merely booking an expense without intent or ability to pay may invite scrutiny. The trust must follow a consistent accounting policy and reflect the actual flow of funds to meet compliance standards.
Monitoring Administrative Expenses
Application of income must primarily be toward the trust’s core objectives. Excessive spending on administration, staff, or unrelated functions may be disallowed or raise compliance concerns. Authorities may look at ratios like program vs. admin expenses.
While some administration is inevitable and permissible, it must be reasonable and proportionate. Charitable institutions are expected to optimize their use of public donations and grants. To manage this, a clear segregation of expenses in financial statements is helpful. Categorizing programmatic vs. administrative expenses allows stakeholders to assess the trust’s operational efficiency.
Donations in Kind and Non-Monetary Application
Trusts often receive or distribute donations in kind, such as food, clothes, books, or medicine. These are valid forms of application if the donation is accounted at fair market value and used for charitable objectives.
Accurate documentation, valuation, and beneficiary records support the classification of such distributions as application of income. Moreover, barters or exchanges with other organizations for goods and services—if aligned with charitable work—may also qualify, though care must be taken to avoid crossing into commercial territory.
Use of Interest and Other Income
Income from fixed deposits, savings accounts, or investments must also be applied for charitable purposes. This income forms part of the total receipts and is subject to the 85% application rule.
If such income is reinvested, it must be shown how the reinvestment serves charitable objectives. Passive investment strategies without clear linkage to programs may be questioned. Proper linking of interest income to programmatic needs—such as scholarships, maintenance of charitable institutions, or healthcare services—strengthens the case for effective application.
Capital Gains and Their Special Treatment
When a charitable trust sells a capital asset, the resultant capital gain is also considered income. However, there is a specific provision under Section 11(1A) that allows exemption of such capital gains if the net consideration is reinvested in acquiring a new capital asset for charitable purposes.
This reinvestment must be made within the same year or as per timelines allowed. The exemption is proportionate—if only part of the net sale proceeds is reinvested, then only a part of the capital gain is exempted. Hence, the capital gains exemption operates as an extension of the application principle, encouraging trusts to retain capital assets for charitable ends.
Compliance and Record-Keeping
Accurate bookkeeping, audited financial statements, and compliance with the Income-tax Act are essential to defend claims of application. Every rupee claimed as applied must be traceable, documented, and purposeful.
Maintaining resolutions of the managing committee, contracts, vouchers, invoices, and utilization certificates are essential for transparency. Trusts must also file the required tax forms, audit reports, and annual returns to ensure their exempt status remains intact and to demonstrate their adherence to the rules surrounding application of income.
Limitations on Mode of Application
To prevent diversion or misuse of charitable funds, laws prescribe that income must be applied through banking channels or traceable modes. Cash payments beyond a certain threshold may be disallowed as valid applications.
Further, donations or grants to entities that are not registered or compliant with regulatory frameworks can also result in disallowance. Trusts must verify the credentials of recipient organizations before disbursing funds. These limitations ensure transparency and prevent the abuse of exemptions granted under Section 11.
Importance of Accurate Monitoring and Documentation
One of the core responsibilities of a charitable trust claiming exemption under section 11 is to maintain clear, verifiable records of how its income is applied. Accurate documentation supports the trust’s claim that the income has indeed been used for charitable or religious purposes in accordance with the law. Such records may include invoices, payment receipts, agreements, project progress reports, and any other documentation substantiating expenditure.
Auditing standards necessitate that charitable trusts maintain books of accounts that reflect the inflow and application of funds. The Income-tax Act also provides that a trust must get its accounts audited if its total income before claiming the exemption exceeds the basic exemption limit. The audit report must be submitted along with the income tax return in Form 10B.
Timely Application of Income and Its Consequences
Under the Act, a trust is expected to apply at least 85% of its income during the financial year in which it is received. Failure to do so, unless the income is accumulated as per legal provisions, may lead to denial of exemption. Timely application reflects the ongoing commitment of the trust to its declared charitable or religious purpose.
Charitable trusts should plan their income utilization strategy in advance, ensuring that projects and programs are implemented in a phased and timely manner. Any surplus income not applied during the year must be either accumulated under Section 11(2) or it becomes taxable as income.
Audit Requirements and Form 10B
To validate the claim of income application, section 12A(b) of the Income-tax Act requires that if the total income of a trust exceeds the basic exemption limit (before exemption under sections 11 and 12), then its accounts must be audited by a qualified chartered accountant. The audit report must be prepared in Form 10B.
Form 10B includes details such as:
- Nature of activities carried on by the trust
- Income and expenditure statements
- Application and accumulation of income
- Mode of investments
- Compliance with provisions of sections 11 to 13
Filing Form 10B on time is critical. It must be submitted at least one month prior to the due date of furnishing the income tax return under section 139(1). Late submission or non-filing can result in denial of exemption.
Mode of Investment and Restrictions
Section 11(5) of the Income-tax Act specifies the modes in which a trust’s funds can be invested or deposited to retain eligibility for exemption. These permitted modes include:
- Savings certificates and other government securities
- Deposits in scheduled banks or co-operative banks
- Investment in units of mutual funds as specified
- Debentures issued by certain notified public companies
- Investment in immovable property
Any investments made outside the scope of section 11(5) would render the income from such investments taxable, and possibly jeopardize the overall exemption status.
Charitable trusts must consistently evaluate their investment portfolios to ensure alignment with the permitted avenues. Regular board meetings and financial reviews may help maintain transparency and compliance.
Treatment of Business Income
While the primary objective of a charitable trust is not to engage in commercial activities, it is possible for a trust to derive income from a business undertaking. However, Section 11(4A) makes it clear that exemption will be available on such business income only if:
- The business is incidental to the attainment of the objectives of the trust; and
- Separate books of account are maintained for such business.
For example, a charitable hospital running a pharmacy for its patients can claim business income as exempt if the pharmacy is ancillary to the medical services and separate books are maintained. Any business activity that becomes the dominant purpose of the trust, or is not incidental to the main objective, could attract scrutiny and result in disqualification from tax benefits.
Non-Compliance and Consequences
Failure to comply with the conditions under section 11 and related provisions may lead to significant consequences for charitable trusts, including:
- Loss of exemption on entire income
- Taxability under normal provisions of the Act
- Penalty for late filing or misreporting
- Disqualification from future exemption benefits
Some common reasons for non-compliance include:
- Non-application of 85% of income
- Investments made in modes not permitted under section 11(5)
- Not maintaining separate books for incidental business
- Filing returns or Form 10B after the deadline
The assessing officer may also disallow certain expenses or reclassify the income if documentation does not support the claim of charitable application.
Revocation of Registration under Section 12AB
Section 12AB provides for registration of trusts for the purpose of claiming exemption under sections 11 and 12. If the Commissioner of Income Tax finds that the trust is not applying its income for charitable purposes, or is violating provisions of the Act, then the registration can be cancelled after giving a reasonable opportunity to be heard.
Revocation of registration has serious consequences:
- The trust cannot claim exemption under sections 11 and 12
- Income will be taxed at maximum marginal rate
- Donors cannot claim deduction under section 80G for contributions
Hence, ongoing compliance with section 11 is crucial to maintain good standing under section 12AB.
Role of CBDT Circulars and Judicial Precedents
The Central Board of Direct Taxes (CBDT) from time to time issues circulars clarifying the interpretation and application of various provisions related to charitable trusts. For example, CBDT Circular No. 5/2021 provides guidelines on the application of income, accumulation provisions, and procedures for filing.
Judicial rulings also play a vital role in interpreting section 11. Courts have clarified issues such as whether depreciation can be claimed after capital expenditure has been treated as application, or whether corpus donations need to be spent to claim exemption. Charitable trusts must remain updated with judicial developments to align their practices accordingly.
Strategic Planning and Governance
Effective governance structures are key to ensuring compliance with section 11. Trustees must meet periodically to:
- Review budgets and expenditure
- Approve investments
- Oversee implementation of projects
- Ensure timely filings
Charitable trusts should prepare annual plans for income application and closely monitor the progress. A compliance calendar can help track deadlines related to income application, filing of Form 10B, income tax returns, and investment decisions. Transparent functioning and documented decision-making add to the credibility of the trust. This not only ensures compliance but also builds trust with donors and regulatory authorities.
Importance of Seeking Professional Advice
Given the complex tax and regulatory landscape, charitable trusts should consider consulting qualified professionals, including chartered accountants and legal advisors. These professionals can help in:
- Interpreting provisions of section 11
- Maintaining required records
- Preparing Form 10B and financial statements
- Representing the trust in case of scrutiny or appeal
Regular consultation can preempt errors and avoid potential penalties or disqualification from exemption.
The efficient and compliant application of income is central to the functioning of charitable trusts under Indian tax law. Adherence to section 11 and related provisions ensures not only exemption from taxation but also credibility in the eyes of stakeholders.
Conclusion
The application of income by charitable trusts is a cornerstone of their eligibility for exemption under Section 11 of the Income-tax Act. A trust must ensure that a substantial portion of its income at least 85% is effectively applied towards its charitable or religious purposes within India. This principle not only reflects the spirit of altruism behind the creation of such trusts but also aligns with the regulatory framework that governs them.
Proper understanding and implementation of rules related to deemed application, accumulation of income, treatment of corpus donations, and the handling of inter-charity donations are crucial for maintaining tax-exempt status. Trusts must also be vigilant about procedural compliance, including filing returns within prescribed timelines, adhering to audit requirements, and maintaining transparency in financial reporting.
The recent legal interpretations and administrative clarifications have further emphasized that mere intention to spend is not enough — actual deployment of funds for eligible purposes is necessary. Moreover, with the changes brought by the Finance Acts in recent years, particularly regarding fresh registration and revalidation, charitable institutions must stay updated and adapt their operational practices to meet evolving legal expectations.
In summary, applying income in the prescribed manner is not just a statutory requirement but also a reflection of the trust’s commitment to its objectives. Ensuring compliance builds public confidence and helps secure the long-term sustainability of charitable organizations.