Analysis of Section 10(23C)(iiiab) of the Income Tax Act, 1961

An Exposition of Section 10(23C)(iiiab) of the Income Tax Act, 1961: Conditions for Exemption of Educational Institutions

Introduction

Section 10 of the Income Tax Act, 1961 (hereinafter "the Act") enumerates various incomes that are not included in the total income of an assessee for the purpose of taxation. Among these, clause (23C) provides for exemptions to certain educational and medical institutions. Specifically, sub-clause (iiiab) of Section 10(23C) grants exemption to the income of any university or other educational institution that exists solely for educational purposes and not for profit, and which is wholly or substantially financed by the Government. This article undertakes a comprehensive analysis of the provisions of Section 10(23C)(iiiab), examining its constituent elements, judicial interpretations, and the evolving legal landscape governing such exemptions in India. The analysis draws significantly upon landmark judgments and statutory amendments that have shaped the understanding and application of this sub-clause.

The Statutory Framework of Section 10(23C)(iiiab)

Section 10(23C)(iiiab) of the Act stipulates that in computing the total income of a previous year of any person, any income falling within the following shall not be included:

"(iiiab) any university or other educational institution existing solely for educational purposes and not for purposes of profit, and which is wholly or substantially financed by the Government;" (As per M/S NEW NOBLE EDUCATIONAL SOCIETY v. THE CHIEF COMMISSIONER OF INCOME TAX 1, Supreme Court Of India, 2022, Reference Material 6; Director Of Income Tax (Exemption) v. All India Personality Enhancement & Cultural Centre For Scholars Aipeccs Society, Delhi High Court, 2015, Reference Material 4)

Crucially, an Explanation was added to Section 10(23C) by the Finance (No. 2) Act, 2014, with effect from 1st April 2015, to clarify the term "substantially financed". The Explanation, relevant for sub-clauses (iiiab) and (iiiac), reads:

"Explanation.—For the purposes of sub-clauses (iiiab) and (iiiac), any university or other educational institution, hospital or other institution referred therein, shall be considered as being substantially financed by the Government for any previous year, if the Government grant to such university or other educational institution, hospital or other institution exceeds such percentage of the total receipts including any voluntary contributions, as may be prescribed, of such university or other educational institution, hospital or other institution, as the case may be, during the relevant previous year;" (As per M/S NEW NOBLE EDUCATIONAL SOCIETY v. THE CHIEF COMMISSIONER OF INCOME TAX 1, Supreme Court Of India, 2022, Reference Material 6; Director Of Income Tax (Exemptions) v. Tata Institute Of Social Science, Bombay High Court, 2019, Reference Material 19 & 20)

The "prescribed percentage" mentioned in the Explanation has been set by Rule 2BBB of the Income Tax Rules, 1962, which states that an institution is considered substantially financed if Government grants exceed fifty per cent of its total receipts (including voluntary contributions) during the relevant previous year.

Thus, for an educational institution to claim exemption under Section 10(23C)(iiiab), it must satisfy two cumulative conditions:

  • It must exist "solely for educational purposes and not for purposes of profit."
  • It must be "wholly or substantially financed by the Government."

Analysis of the Condition: "Existing Solely for Educational Purposes and Not for Purposes of Profit"

This condition requires an institution's activities to be exclusively educational and devoid of any profit motive. The interpretation of "solely" has been a subject of considerable judicial scrutiny.

The Meaning of "Solely"

The Supreme Court in M/S NEW NOBLE EDUCATIONAL SOCIETY v. THE CHIEF COMMISSIONER OF INCOME TAX 1 (2022 SCC ONLINE SC 1458) (Reference Material 3), while dealing with Section 10(23C)(vi) which contains identical phrasing ("solely for educational purposes and not for purposes of profit"), advocated for a strict and literal interpretation of the term "solely." The Court held that "solely" must be understood as "only" or "exclusively," thereby moving away from the "predominant object" test that had been previously applied in cases like Queen'S Educational Society v. Commissioner Of Income Tax (2015) (Reference Material 8, cited in Chief Commissioner Of Income Tax, Chandigarh (S) v. St. Peter'S Educational Society, Chandigarh (S), 2016) and American Hotel And Lodging Association Educational Institute v. Central Board Of Direct Taxes And Others (2008 SCC 10 509) (Reference Material 1). The New Noble judgment emphasized that the main provision requiring exclusive dedication to education cannot be diluted by provisos or ancillary activities. While this ruling was in the context of sub-clause (vi), its reasoning regarding the interpretation of "solely" is highly persuasive for sub-clause (iiiab) due to the identical statutory language. The Chhattisgarh High Court in M/S SHAHEED NAND KUMAR PATEL VISHWAVIDYALAYA v. COMMISSIONER OF INCOME TAX (E) (2024) (Reference Material 9) also underscored the necessity for authorities to record a specific finding on whether an institution exists "solely for educational purposes" and not for profit, in light of the New Noble decision.

Surplus Generation and Application

The phrase "not for purposes of profit" does not mean that an educational institution cannot generate surplus. The critical factor is the application of such surplus. The Supreme Court in Visvesvaraya Technological University v. Assistant Commissioner Of Income Tax (2016 SCC ONLINE SC 351) (Reference Material 2) acknowledged that VTU met the first criterion (solely for educational purposes and not for profit) because it reinvested its surplus for educational purposes. This aligns with earlier pronouncements, such as in Aditanar Educational Institution v. Additional Commissioner Of Income Tax (1997) 3 SCC 346 (Reference Material 1, cited in American Hotel and New Noble), which reinforced that surplus income does not necessarily indicate profit-making intent if it is reinvested into educational activities. The Rajasthan High Court in JHUNJHUNU ACADEMY SAMMITTEE v. INCOME TAX OFFICER JHUNJHUNU (2017) (Reference Material 10) also reiterated that when a surplus is ploughed back for educational purposes, the institution exists solely for educational purposes.

However, the Assessing Officer in Adit (Exemption) v. Vivek Education Society (2012 SCC ONLINE ITAT 14432) (Reference Material 16) had initially noted that the assessee earning surplus showed activities were for profit, a view that often gets contested if the surplus is applied back to education.

Analysis of the Condition: "Wholly or Substantially Financed by the Government"

This second limb requires that the institution's funding must predominantly come from governmental sources.

Judicial Interpretation Pre-Explanation

Prior to the insertion of the Explanation in 2014, the term "substantially financed" was not defined in the Act, leading to varied interpretations and litigation. The Supreme Court in Visvesvaraya Technological University (2016) (Reference Material 2) clarified that "substantially financed by the Government" implies direct government grants and cannot be interpreted to include fees collected under statutory provisions, even if regulated by an Act establishing the university. In that case, government grants constituted merely 1% of VTU's total receipts, which was held insufficient.

Courts had differing views on what percentage constituted "substantial." For instance, the Assessing Officer in Adit (Exemption) v. Vivek Education Society (2012) (Reference Material 16) attempted to apply the 75% threshold from the Comptroller and Auditor General's (Duties, Powers and Conditions of Service) Act, 1971 (CAG Act) to deny exemption where grants were 61%. However, the Bombay High Court in Director Of Income Tax (Exemptions) v. Tata Institute Of Social Science (2019) (Reference Material 19) explicitly rejected the importation of the CAG Act's definition, stating that the scope and purpose of the two Acts are entirely different and not in pari materia. The Karnataka High Court in Commissioner Of Income-Tax v. Indian Institute of Management (2014) (Reference Material 17) had upheld exemption for IIM Bangalore even when direct government grants were around 14.85% and 6.84% in certain years, possibly considering the initial land grant and corpus contributions by the government. In another case, Director Of Income-Tax v. Dhamapakasha Rajakarya Prasakta (2015) (Reference Material 18), the Karnataka High Court observed that finance to the extent of more than 10% could constitute substantial finance. The Punjab & Haryana High Court in Commissioner Of Income-Tax v. Jat Education Society (2015) (Reference Material 14) noted a revenue appeal where the ITAT had allowed exemption under (iiiab) with a 45.95% government grant, relying on a Karnataka High Court judgment that considered 34.33% substantial.

The Role of the Explanation and Rule 2BBB

The insertion of the Explanation to Section 10(23C) by the Finance (No. 2) Act, 2014 (effective AY 2015-16) brought much-needed clarity. As noted by the Bombay High Court in Tata Institute of Social Science (2019) (Reference Material 20), the Explanation was introduced to clarify the meaning of "substantially financed" due to litigation and varying judicial decisions. The Circular No. 1 of 2015, explaining the Finance (No.2) Act, 2014, also confirmed this legislative intent.

Rule 2BBB of the Income Tax Rules, 1962, operationalizes this Explanation by prescribing that an institution shall be considered "substantially financed by the Government" if Government grants exceed fifty per cent of its total receipts (including voluntary contributions) during the relevant previous year. This provides a clear, arithmetical benchmark. In the Tata Institute of Social Science (2019) case, the Bombay High Court noted that the institution received government grants that were 56% of total receipts and also exceeded 50% of total expenditure, thus satisfying the requirement introduced by the Explanation (even before a specific percentage might have been formally prescribed or during the transition).

Meaning of "Government Grant" and "Total Receipts"

As established in Visvesvaraya Technological University (2016) (Reference Material 2), "Government grant" refers to direct financial assistance from the Government. "Total receipts," as per Rule 2BBB, include all receipts of the institution, including any voluntary contributions. The Income Tax Appellate Tribunal in Dr.C.T.Eapen Trust, Kollam v. The ITO, Kollam (2014) (Reference Material 11 & 12) heard arguments that for computing aggregate receipts, government aid should be excluded, though the final determination on this specific point in that case is not detailed in the provided material; however, Rule 2BBB explicitly includes government grants as part of total receipts against which the percentage of said grants is measured.

Interplay with Other Sub-clauses and Provisos

It is important to distinguish Section 10(23C)(iiiab) from other sub-clauses, particularly (iiiad) and (vi).

  • Section 10(23C)(iiiad): This sub-clause exempts educational institutions whose annual receipts do not exceed a prescribed limit (currently Rs. 5 crore, previously Rs. 1 crore). The conditions regarding government financing are not applicable here. The ITAT in Dr.C.T.Eapen Trust (2014) (Reference Material 11 & 12) considered arguments that each institution run by a trust should be assessed individually for this monetary threshold.
  • Section 10(23C)(vi): This sub-clause provides exemption to universities and educational institutions existing solely for educational purposes and not for profit, which are approved by the prescribed authority. Unlike institutions qualifying under (iiiab) or (iiiad), those seeking exemption under (vi) must obtain specific approval.

A significant distinction, highlighted by the Delhi High Court in Director Of Income Tax (Exemption) v. All India Personality Enhancement & Cultural Centre For Scholars Aipeccs Society (2015) (Reference Material 4), is that the conditions stipulated in the various provisos to Section 10(23C) – such as those relating to the extent of income accumulation, investment patterns, and audit requirements – primarily apply to institutions seeking exemption under sub-clause (vi). These provisos do not apply to universities and educational institutions covered under sub-clauses (iiiab) and (iiiad). This means that if an institution squarely meets the criteria of (iiiab), it gains exemption without the need for separate approval or adherence to the complex conditions laid down in the provisos for (vi).

Judicial Precedents: A Deeper Dive

Several landmark cases have shaped the contours of Section 10(23C)(iiiab):

  • Visvesvaraya Technological University v. Assistant Commissioner Of Income Tax (2016 SCC ONLINE SC 351) (Reference Material 2): This Supreme Court judgment is pivotal for (iiiab). It established that:
    • Reinvestment of surplus for educational advancement satisfies the "solely for educational purposes and not for profit" condition.
    • "Substantially financed by the Government" necessitates direct government grants, not merely statutory power to collect fees. The university's 1% government funding was deemed insufficient.
    This case was an appeal from the Karnataka High Court's decision in Visvesvaraya Technological University v. Assistant Commissioner Of Income Tax (2013 SCC ONLINE KAR 10047) (Reference Material 13), which had similarly denied the exemption.
  • M/S NEW NOBLE EDUCATIONAL SOCIETY v. THE CHIEF COMMISSIONER OF INCOME TAX 1 (2022 SCC ONLINE SC 1458) (Reference Material 3): While primarily addressing Section 10(23C)(vi), this Supreme Court ruling's emphasis on a strict, literal interpretation of "solely" (as "only" or "exclusively") has profound implications for (iiiab) due to the identical statutory language. It challenged the applicability of the "predominant object" test in this context.
  • Director Of Income Tax (Exemptions) v. Tata Institute Of Social Science (Bombay High Court, 2019) (Reference Material 19 & 20): This case is crucial for understanding the "substantially financed" criterion post the 2014 Explanation. The Bombay High Court:
    • Affirmed that the Explanation was clarificatory.
    • Rejected the applicability of the CAG Act's definition of "substantially financed."
    • Found that government grants exceeding 50% of total receipts (and expenditure in that specific case) met the "substantially financed" test, aligning with the intent later codified in Rule 2BBB.
  • American Hotel And Lodging Association Educational Institute v. Central Board Of Direct Taxes And Others (2008 SCC 10 509) (Reference Material 1): Though dealing with Section 10(23C)(vi), this case discussed the scope of inquiry by the CBDT and the nature of educational institutions. It also referenced the "predominant object" test, which has since been refined by New Noble for the term "solely".

Conclusion

The exemption under Section 10(23C)(iiiab) of the Income Tax Act, 1961, is available to educational institutions that rigorously satisfy two fundamental conditions: they must exist "solely for educational purposes and not for purposes of profit," and they must be "wholly or substantially financed by the Government." The interpretation of "solely" has moved towards a stricter, literal meaning, demanding exclusive dedication to education, as strongly indicated by the Supreme Court in New Noble Educational Society. The generation of surplus, if ploughed back into educational activities, generally does not vitiate the non-profit character.

The ambiguity surrounding "substantially financed" has been significantly reduced by the insertion of the Explanation to Section 10(23C) and the prescription of a 50% threshold of government grants (in relation to total receipts) under Rule 2BBB. This provides a clearer, quantifiable metric for both taxpayers and revenue authorities. Institutions qualifying under Section 10(23C)(iiiab) benefit from a more straightforward exemption pathway compared to Section 10(23C)(vi), as they are not subjected to the approval process or the stringent conditions laid down in the provisos applicable to the latter. Educational institutions seeking to avail this exemption must meticulously ensure compliance with both these conditions, supported by robust documentation, in light of evolving judicial standards and statutory clarifications.

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