M/S. SARAKKI EDUCATIONAL SOCIETY,BANGALORE vs. INCOME TAX OFFICER, WARD-3(EXEMTIONS), BANGALORE

The order of the learned Commissioner of Income Tax (Appeals), NFAC, Delhi is opposed to the facts of the case and law applicable to it.

The learned Commissioner of Income Tax (Appeals), NFAC, Delhi erred in confirming disallowance to the extent of Rs.37,66,086/- out of the total disallowance of Rs.3,18,00,092/- made by the Assessing Officer holding that, out of the total professional charges paid to M/s. Edufice Education Services (P) Ltd being a specified person U/s. 13 of the act, as excessive and disallowable while computing the income under the provisions of section 11 of the act.

The learned Commissioner of Income Tax (Appeals), NFAC, Delhi erred in confirming disallowance to the extent of Rs.37,66,086/- as excessive ignoring the facts of the appellant that, there is no such excessive payment made to M/s. Edufice Education Services (P) Ltd and hence no disallowance was warranted

The learned Commissioner of Income Tax (Appeals), NFAC, Delhi, erred in holding that, the disallowance to the extent of •Rs.37,66,086/- confirmed will be charged at maximum marginal rate.

Brief facts of the case are that the assessee society is a charitable trust registered u/s. 12AA (1)(b)(i) of the Act vide order no. DIT (E)-12A/Vol.III/V-405/W-2/2005-06 dated 28/11/2005. The assessee society is in the activity of imparting education and runs a school named EKYA School, JP Nagar, Bangalore. The assessee filed its return of income for the AY 2017-18 on 08/10/2017 declaring total income of Rs. Nil. The computation of income was made in accordance with the provision of section 11 of the Act. For the year under consideration, the income was declared at Rs. 6,03,67,389/- and application of income excluding depreciation was declared at ITA Nos.1973, 1974, 1991 & 1992/Bang/2024 M/s. Sarakki Educational Society, Bangalore Page 4 of 19 Rs.6,75,81,997/-. The said return of income was thereafter selected for scrutiny with a limited purpose to examine the entitlement to the benefit of section 11 in the light of the transactions under taken with specified persons u/s. 13(3) of the Act. Accordingly, the notices u/s. 143(2) as well as 142(1) of the Act were issued. The AO after examination of materials gathered found that the assessee had entered into a memorandum of understanding (MOU) with M/s. Edufice Educational Services Pvt. Ltd. (EESPL). The AO further found that the managing trustee of the trust Sri. K.C. Ramamurthy is also the director of the said company. Further, the secretary of the assessee’s society Mrs. K.R. Tristha is the director of the company. The family members being Sri K.C. Ramamurthy his wife Smt. Savitha Ramamurthy and Sri K.R. Jayadeep son of Sri K.C. Ramamurthy and Mrs. K.R. Trishta holds 25% stake in the company. In short, the entire stake in the company is held by the family of the managing trustee of the assessee society. In view of the above M/s. Edufice Educational Services Pvt. Ltd. (EESPL) gets categorized as a specified person defined u/s.13(3)(e) of the Act and therefore the AO held that the transaction with M/s. EESPL has to be at arm’s length and any undue benefit in terms of section 13(2) of the Act would automatically result in disentitlement of exemption u/s. 11 of the Act.

1 Further, the AO noted that as per the terms and conditions of MOU, M/s. EESPL had been permitted to appoint teachers and to guide them about teaching techniques for the benefits of students who are admitted in EKYA School. The assessee society will reimburse the entire expenditure relating to maintenance, electricity, water, salaries, rates and taxes and other government levies to the company. In effect, the assessee’s society is only name lander and the entire scheme of education is corporatized indirectly motivated by profit. This contention on the profiteering is accentuated by the ITA Nos.1973, 1974, 1991 & 1992/Bang/2024 M/s. Sarakki Educational Society, Bangalore Page 5 of 19 condition that while the company effectively manages the affairs of the schools administratively and academically, the assessee trust is bound to pay an additional sum computed @ of 35% of the gross collections to the company.

2 The main contention of the AO is that the company has been employed with sole purpose to divert the income of the society. Secondly M/s. EESPL does not possess any extraordinary qualification or an intangible asset so as to demand such a huge payment. Further, nearly 62% of the gross receipts of the society were diverted to the company and therefore it was essential to verify as to whether an equivalent value of services had been rendered by the company to the assessee’s society or not. Further, the AO noted that the income credited to the profit and loss account of the company comprises receipts from two enterprises, viz. the assessee’s society and other being M/s. CMR Janardhana Trust which is again the group of institution. The related parties/ specified persons drew huge sum of money as salaries and in effect, the charitable society is funding the same. These facts are clearly elucidated in summary of related party transactions incorporated in the audit report of the company M/s. EESPL for the AY 2017-18. Thus, the AO is of the opinion that when the profit margins of the company, who’s gross receipts are predominantly from the related enterprises only, before payment of salaries to the specified persons u/s. 13(3) and after payment of the same are in order of 85.18% and 75.37% respectively, it substantiates that transaction between the assessee society and M/s. EESPL is not at arm’s length in terms of section 13(2)(c) and 13(2)(g) of the Act.

3 The AO relying on the decision of the Hyderabad ITAT in the case of M/s. NTR Memorial Trust in ITA NO: 461 & 462/HYD/2010 dated 18/03/2011 held that the benefit conferred is unduly

4 Further, Since the assessee society provided undue benefit in terms of section 13(2)(c) and 13(2)(g) r.w.s. 13(3) and 13(1)(c) of the Act, the surplus generated in the hands of the society was brought to tax but denial of exemption u/s. 11 of the Act and accordingly the AO re-drawn the taxable income as detailed below:-

Aggrieved by the order of AO passed u/s. 143(3) of the Act dated 18/12/2019 the assessee preferred an appeal before the ld. CIT (A)/NFAC.

The ld. CIT (A)/NFAC partly allowed the appeal of the assessee by observing that the audit report in Form No.10B for the AY 2017- 18 mentioned that the rent of Rs.12 lakhs was received from a property at Bangalore owned Mrs. K.R. Tristha, secretary. Further the professional charges of Rs.3,76,60,868/- was paid to M/s. Edufice Educational Services Pvt. Ltd. (EESPL) were K.R. Trishta, secretary is also a director of the said company. Thus, the fact that the assessee had made payment to the interested party is beyond doubt. In principle, it is accepted that the AO as acted within his authority to determine the reasonable payment and to disallowed the payment found unreasonable and excessive. Further, the ld. CIT(A)/NFAC found the action of AO to restrict net profit to arrive at a reasonable profit is logical however, held that the profit percentage of 8% and 5% might have been used as a benchmark/ yardstick and ITA Nos.1973, 1974, 1991 & 1992/Bang/2024 M/s. Sarakki Educational Society, Bangalore Page 8 of 19 it does not require to be guided by section 44AD OR 44ADA of the Act in all respects and accordingly partly allowed this ground of appeal.

1 The ld. CIT (A)/NFAC also held that to view the two distinct entities as one is incorrect. Further, in case of a charitable trust, it is only the income from a investment or deposit which has been made in violation of section 11(5) of the Act i.e. liable to be tax and violation u/s 13(1)(d) does not tantamount to denial of exemption u/s. 11 of total income of assessee-trust and thus in the present case exemption u/s. 11 of the Act is held to be allowable to the assessee to the extent admissible under the act. However, the amount so disallowed (out of Rs.2,50,36,908/-) by the AO suffers from the taxation at maximum marginal rate. Further, the ld. CIT (A)/NFAC held that income utilized for the purchase of capital assets, repayment of a loan for the purchase of capital assets, revenue expenditure, (subject to disallowance made), shall also be treated as application towards charitable purposes and hence exempted from tax to the extent of 85%, if registered u/s.12AA of the Act.

2 In view of the above discussion the ld. CIT (A)/NFAC directed the AO to recalculate the exemption u/s. 11 of the Act after restricting the disallowance to the 10% of amount actually paid to M/s. Edufice Educational Services Pvt. Ltd. (EESPL) (restricted to Rs.37,66,086/- only). Further, the amount not falling under the application of income (out of disallowance) will be taxes at maximum marginal rate and accordingly partly allowed the appeal of the assessee.

Aggrieved by the order of ld. CIT (A)/NFAC dated 23/08/2024, the assessee is in appeal before us by challenging the disallowance confirmed to the extent of Rs.37,66,086/- (10% of the amount

Before us, the ld. A.R. of the assessee vehemently submitted that fees for professional services paid as per memorandum of understanding (MOU) with M/s. Edufice Educational Services Pvt. Ltd. (EESPL) is justifiable & are in accordance with the object of the Trust and there is no undue benefit passed on to the person as specified u/s. 13(3) of the Act. Further, ld. A.R. submitted that the activity of M/s. Edufice Educational Services Pvt. Ltd. (EESPL) are in the nature of activity carried by KPO and services rendered by the entity are specialized in nature and required specific skill-based analysis and research. Further, the payment towards the professional fee were at arm’s length and hence no disallowance was warranted at all and further submitted that the disallowance u/s. 13(1)(c) of the Act does not lead to denial of exemption u/s. 11 of the Act as contended by the revenue. Further, the directions of the ld. CIT(A)/NFAC that amount not falling under application of income be taxed at maximum marginal rate is highly illegal and bad in law especially when Circular No.320 dated 11/01/1982 stated that in respect of charitable trust the taxes are to be levied that regular rates and not at maximum marginal rate.

We have heard the rival submission and perused the material available on record. The assessee society named “M/s. Sarakki Educational Society” is in the activity of imparting education and runs a school name EKAY School, JP Nagar, Bangalore. The assessee’s society is registered before The