Taxation Norms for Social Enterprises and Donors on the Social Stock Exchange

Taxation plays a pivotal role in the Social Stock Exchange (SSE) ecosystem by incentivising investors and ensuring the financial sustainability of Social Enterprises (SEs). To foster a deep and liquid market for social investments, the regulatory framework provides specific tax benefits and exemptions for both Not-for-Profit Organisations (NPOs) and their contributors.

10.1 Overview of Taxation in the Social Sector

The SSE serves as a regulated mechanism for both For-Profit Social Enterprises (FPEs) and Not-for-Profit Organisations (NPOs) to raise funds while maintaining high standards of transparency and accountability.

• Legal Forms of NPOs: NPOs typically operate as societies, trusts, or Section 8 companies.
• Mandatory Registration: To qualify for tax-exempt status, all NPOs must be registered under Section 12AB of the Income Tax Act.
• Primary Funding Sources: NPOs rely on individual donations, Foreign Contribution (Regulation) Act (FCRA) contributions, CSR grants, and government schemes.
• SSE Incentives: To kickstart market activity, tax incentives are provided to donors making investments through the SSE platform, such as through Zero Coupon Zero Principal (ZCZP) instruments.

10.2 Deductions under Section 80G of the Income Tax Act

Section 80G allows taxpayers—including individuals, partnership firms, HUFs, and companies—to claim deductions for donations made to specified relief funds and charitable institutions.

10.2.1 Key Rules for 80G Deductions

• Eligibility: Deductions are available irrespective of the type of income earned by the taxpayer.
• Validation: Donors must ensure the NPO possesses a valid registration number on the date of the donation, which must be clearly stated on the donation receipt.
• Cash Limit: No tax deduction is permitted for cash donations exceeding Rs. 2,000.
• SSE Facility: The NSE SSE has introduced a facility for bidding on ZCZP instruments where donors can contribute starting from Rs. 10,000 via registered brokers to avail 80G benefits.

10.2.2 Categories of Section 80G Donations

10.3 Tax Exemptions for Social Enterprises (NPOs)

NPOs can enjoy income tax exemptions provided they adhere to the registration and compliance requirements under Section 11 and Section 12AB.

10.3.1 Registration under Section 12AB

• New Norms: All charitable institutions (including those previously under 12AA) must apply for fresh registration under Section 12AB.
• Validity: Provisional registration is valid for a maximum of 3 years, while subsequent full registration is valid for 5 years.

10.3.2 Mandatory Compliance for Registered NPOs

To maintain tax-exempt status, NPOs must:

1. Maintain proper books of accounts and documents as prescribed by law.
2. File Income Tax returns within the prescribed timeline and undergo a mandatory audit by a Chartered Accountant.
3. Furnish details as per Rule 18AB for every financial year.
4. Issue a Form 10BE certificate to donors to validate their contributions.

10.3.3 The 85% Application Rule

Under Section 11, an NPO is exempt from tax on income derived from property held for charitable purposes if it applies at least 85% of its income towards its stated objectives during the year.

• Accumulation: If an NPO cannot apply 85% of its income, it may accumulate the balance for application within a maximum period of 5 years, provided it files the specific forms and invests the funds in specified instruments.
• Corpus Donations: Donations received with a specific direction to form part of the corpus fund are exempt but must be invested in specified assets.

10.4 Special Provisions and Risks to Exemption

10.4.1 Business Income and GPU

• Incidental Business: Exemptions apply only if the business activity is incidental to the NPO’s objectives and separate books of accounts are maintained.
• General Public Utility (GPU): For NPOs involved in trade or commerce related to GPU, aggregate receipts from such activities must not exceed 20% of the total receipts of the NPO in that financial year.

10.4.2 Capital Gains and Anonymous Donations

• Capital Gains: Gains from the transfer of capital assets are exempt if the proceeds are reinvested in other capital assets.
• Anonymous Donations: Donations where the identity of the donor is unavailable are taxable at a flat rate of 30% (unless the institution is purely religious).

10.4.3 Grounds for Losing Tax Exemption

An NPO may lose its exempt status if:

• Income or property is applied for the benefit of specified persons (e.g., founders, trustees, or substantial contributors who have given more than Rs. 50,000).
• The NPO is converted into an ineligible form or its registration is cancelled for non-compliance.
• It merges with an entity that does not have similar objectives.
• Upon dissolution, it fails to transfer assets to another registered NPO within 12 months.

Important Terms

• Adjusted Gross Total Income: The total income reduced by tax-exempt portions and other eligible deductions under the IT Act.
• Section 12AB: The current section under which NPOs must register to obtain tax benefits.
• Form 10BE: The certificate issued by NPOs to donors to enable them to claim 80G deductions.
• Charitable Purpose: Defined under Section 2(15), covering relief of poor, education, medical relief, and environment preservation.

Key Takeaways

• Registration is Key: NPOs must be registered under Section 12AB to be tax-exempt and provide 80G benefits to donors.
• Donation Limits: Cash donations above Rs. 2,000 are ineligible for tax deductions; donors should use digital modes or the SSE bidding facility.
• Expenditure Requirement: NPOs must spend 85% of their income annually to remain exempt, with limited provisions for accumulation.
• Strict Neutrality: Applying funds for the personal benefit of trustees or founders will lead to immediate loss of tax-exempt status.