Reasonable Remuneration to Prohibited Persons Does Not Attract Section 13(1)(c): Delhi HC in CIT (Exemption) v. IILM Foundation

1. Introduction

This commentary examines the Delhi High Court’s decision in Commissioner of Income Tax (Exemption) Delhi v. IILM Foundation (2025 DHC 2745-DB), delivered on April 21, 2025. The Revenue appealed under Section 260A of the Income Tax Act, 1961 against an ITAT order which had upheld the trust’s claim to exemption under Sections 11/12 of the Act despite payment of salary to a “prohibited person” under Section 13(3). The key issues were:

Whether payment of salary to a related party (the trust’s chairperson) automatically attracts the bar under Section 13(1)(c) and nullifies exemption under Sections 11/12.
Whether the salary paid was “excessive” or “unreasonable” so as to be deemed an application of the trust’s income for the benefit of a prohibited person under Section 13(2)(c).

Parties:

Appellant: Commissioner of Income Tax (Exemption) Delhi
Respondent: IILM Foundation (formerly Ram Krishna Kulwant Rai Charitable Trust)

2. Summary of the Judgment

The Delhi High Court dismissed the appeals of the Revenue and held:

Section 13(1)(c) disqualifies exemption only to the extent that a trust’s income is “used or applied… for the benefit of” a prohibited person.
Section 13(2)(c) deems any salary or allowance paid to such a person as “application” of income only if it is “in excess of what may be reasonably paid for such services.”
Since the salary of ₹16,20,000 paid to Ms Malvika Rai (chairperson and a Section 13(3) person) was found to be reasonable and commensurate with her services and experience, the exemption under Sections 11/12 remained intact.

3. Analysis

3.1 Precedents Cited

The principal precedent was Director Of Income Tax (Exemption) v. Charanjiv Charitable Trust (2014 SCC OnLine Del 7776), where the court observed that any application of income to a prohibited person eliminates exemption. The High Court in IILM Foundation clarified that the Charanjiv decision must be read with Section 13(2)(c), which reserves disqualification only for excessive payments.

3.2 Legal Reasoning

The Court’s reasoning unfolded in three stages:

Statutory Text of Section 13(1)(c): Exempts from relief under Sections 11/12 any income “used or applied… for the benefit of” persons in Section 13(3).
Role of Section 13(2)(c): Clarifies that payment by way of salary to a Section 13(3) person is deemed an “application” only if it exceeds what is “reasonably paid for such services.”
Assessment of Reasonableness: The ITAT had admitted additional evidence—brochures, event photographs and testimonials—demonstrating Ms Rai’s two-decades of academic leadership. Her ₹16.2 lakhs salary was on par with market benchmarks and past CIT(A) approvals. No evidence was produced by the Revenue to show any unreasonableness.

Therefore, the salary did not fall within the disqualifying clause of Section 13(1)(c) and the trust retained its registration under Section 12A.

3.3 Impact on Future Cases

This ruling:

Confirms that trusts may remunerate trustees or founders who are “prohibited persons” under Section 13(3), provided payments are reasonable and well‐documented.
Places the onus on Revenue authorities to demonstrate excessiveness, not merely the existence of a related‐party transaction.
Encourages trusts to maintain robust service records, comparative salary benchmarks and consistent internal approvals to withstand scrutiny.

4. Complex Concepts Simplified

Section 12A Registration: Grants tax benefits to charitable trusts; withdrawal turns assessable income taxable.
Section 11/12 Exemptions: Exclude application of certain incomes of a charitable trust from taxable income.
Section 13(1)(c): Disqualifies exemption if any income is used for benefit of certain persons (e.g., trustees, founders).
Section 13(2)(c): Treats salary/allowance to those persons as “application” only where it is in excess of what is reasonably payable.
Section 40A(2)(a): Disallows unreasonable payments to related parties in business/trade assessments.
Section 260A Appeal: Special leave to appeal from ITAT orders directly to High Court on questions of law.

5. Conclusion

The Delhi High Court’s decision in CIT (Exemption) v. IILM Foundation crystallizes the interplay between Sections 13(1)(c) and 13(2)(c). It establishes that a charitable trust does not forfeit its exemption merely by paying a salary to a related or “prohibited” person, so long as the payment does not exceed a reasonable market rate for services rendered. This precedent provides much‐needed clarity and safeguards legitimate charitable operations from mechanical disqualifications, subject to careful documentation of roles, qualifications and remuneration policies.