KARNATAKA WATER SUPPLY & DRAINAGE BOARD vs. CIT, BANGALORE

It can be seen from the proviso to Sec.2(15) which came into effect from 01-04-2009 that advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business.

According to the AO, the Assessee was carrying on any other object of general public utility and therefore the proviso to Sec.2(15) of the Act would apply to the case of the Assessee. The AO further noticed that the Assessee was a statutory corporation created to implement its public utility schemes in relation to water supply and underground drainage services. The establishment, administration and supervision charges and water charges are collected by the Assessee for the services provided by it. The Assessee receives ETP & supervision charges from the State Government, Central Government and Urban Local Bodies (ULBS) on the works executed by it.

For the AY 2011-12 the following activities constituted major portion of receipts:-

The AO noted that that the assessee has shown a total income of Rs. 99,34,54,570 for the current assessment year from Collection of establishment, administration and supervision charges, water charges, interest etc. The assessee has also shown income exclusively collected from the ULB’s and consumers in the form of establishment, supervision and water charges to the tune of Rs. 79 crores for AY 2011-2012. The assessee has shown an excess income over expenditure of Rs. 25,00,62,435 in the income and expenditure A/c after making all the adjustments.

The details of ‘other income’ earned by the assessee were as follows:-

The submissions of the assessee were not accepted by the AO. He noted that the assessee is directly involved in rendering services in the form of maintenance and supply of potable water as well as the sanitation system for various facilities like the urban local bodies or the customers themselves on payment of certain ETP , Supervision charges and water charges. As such, the assessee is hit by the newly introduced proviso to section 2(15) as it is directly engaged in the activities of trade, commerce or business, and is also rendering service of maintenance of various facilities on payment of certain charges. According to the AO, it is evident that the assessee has earned substantial amount of its Income by way of fees from the administrative, supervision and water charges. The assessee has generated receipts in excess of Rs.25 lakhs for the current assessment year out of its commercial activities and hence the proviso to sec.2(15) is attracted in its case. Therefore the AO was of the view that that the income generated from the activities of assessee company clearly attracts the amended proviso to section 2(15) of the I.T. Act as amended by the Finance Act, 2008. He held that the assessee is providing services on payment of certain amount of fees and therefore its income is liable to be taxed, independent of cancellation of registration by the DIT(Exemption), Bangalore and assessee will not be entitled for exemption u/s 11.

As a consequence, the AO denied exemption u/s.11 of the Act. The taxable income of the Assessee was arrived at an amount of Rs.34,82,50,137 and total demand of Rs.14,52,80,690 was raised inclusive of interest u/s 234B and 234D.

Aggrieved by the order of the AO, the Assessee filed appeal before CIT(A). Before CIT(A), the Assessee contended that under clause 3 of Article 246 of the Constitution of India the State is empowered to make laws in respect of any matters enumerated in List II of Seventh Schedule to the Constitution of India [“herein after referred to the “State List”]. Item no 17 of the State List, reads thus:-

The assessee at the instance of the State Government or the Urban Local Bodies carries out the activities of investigation, preparation of schemes for regulation and development of drinking water and drainage facilities. These activities are carried out strictly in accordance with directions rules and regulations framed by Government.

While the assessee’s major task is to take up capital works (98.60% of expenditure for Assessment year is on capital works as against 1.40% on maintenance works). The assessee is engaged in bulk water supply to the Urban Local Bodies (ULBs) in 4 local areas under State Government.

The Government of Karnataka authorizes the assessee to debit as a percentage of the capital project costs from the funds released by Government of Karnataka as ETP (Establishment Tools & Plant) charges to meet the establishment, salaries and pension liabilities of the Board. Thus, the assessee has to act in strict adherence with the Government directions and regulations while executing the projects as also while recovering its cost as ETP charges, water charges etc.

The Assessee explained that its main source of income was from ETP charges and Water Charges.

The actual water charges received is only Rs. 5, 27, 32,721. The sum of Rs.21,63, 78,723/-, represents interest accrued on the amounts receivable from urban local bodies is Rs. 18,11,72,905. This interest charged has not been received from urban local bodies for more than a decade. However, the assessee has no option, but to charge interest as per Water Supply Regulations, 1985 approved in the Government Order No. HUD 16 UMS 83 Bangalore dated 14.06.1985.

The assessee is operating on no profit basis. This is substantiated by the actual income received on operations of the Assessee and the expenditure incurred. The Assessee pointed out that the following table would show that the Assessee has actually incurred a loss on its operations and is operating on a no profit basis:-

Accordingly, even in complying with the constitutional obligations, the assessee has been carrying on its activities in a real charitable manner and by no stretch of imagination could it be considered as carrying on activity in the nature of trade, commerce or business or providing services in relation thereto. The assessee is engaged only in those activities that are authorized or approved by the Government. It is pertinent to note here that the assessee does not deal with any private individuals/organisations at all. It deals only with State Government and Urban Local Bodies. Thus it can be seen that the State Government, the assessee and Urban local bodies are all acting under an obligation prescribed by the Constitution of India.

The assessee, in serving either the state Government or urban local bodies, cannot also be said to be involved in rendering services in relation to trade, commerce or business. Accordingly, proviso to section 2(15) of the Act does not apply to the assessee’s case. Consequently, the exemption under section 11 cannot be denied to the assessee.

Further, the Assessee drew attention to the speech of Finance Minister dated 29-2-2008 which clarifies that the proviso is not intended to be applicable to genuine charitable organizations which do not carry regular trade, commerce or business or rendering services in relation to such trade commerce or business. The memorandum explaining Finance Bill of 2008 reported in 298 ITR (Statue) 190, clarifies that only the entities operating in commercial lines and which are claiming exemption of their income either U/s 10(23) or sec. 11 of the Income-tax Act have been sought to be excluded from the definition of ‘charitable purpose’ and not ‘genuine charitable institution’ like the assessee. Since the term “trade, commerce and business” have been mentioned together in section 2(15) of the Act, it has to mean that the activity has to be systematic and organized activity carried out with the said purpose and objective of making profit. For this purpose, reliance was placed on the decisions of the Hon’ble Supreme Court in the case of Loka Shikshana Trust Vs. CIT reported in 101 ITR 234 (SC) and CIT (Addl) Vs. Surat Art Silk Cloth Manufacturers Association reported in 121 ITR 1 (SC). It was submitted that having regard to the fact that the Assessee serves only the State Government and local area bodies only to comply with the obligations thrust on it by the Constitution of India; further, the assessee is actually incurring losses on its operations. It was also submitted that the assessee has to follow the directions, rules and regulations formulated by the State Government without any discretion of its own. Accordingly, it was argued that the assessee is a genuine charitable institution, to which the legislature does not intend to deny exemption. Thus, the proviso to section 2(15) of the Act does not apply to the assessee.

The Assessee also explained as to how the rates for supply of water are fixed. The estimates for Water Supply and Underground Drainage projects are prepared adopting the current schedule of rates approved by the Assessee and Public Works Department. After estimates are sanctioned, the recognized systems to carry the work is by contract work. The contractor is selected by inviting tenders in accordance with procedures prescribed in Karnataka Transparency Act in Public Procurement Act, 1999 [KTPP Act]. The tenders received are compared with the estimated rates. The tenderer whose tender is lowest and fulfils all the prescribed financial and technical eligibility criteria is selected. Thus, rates are fixed by following the procedures prescribed in KTPP Act.

In view of the above, it was prayed that the assessee has to be granted exemption u/s. 11 of the Act.

The CIT(A) did not agree with the submission made on behalf of the Assessee for the following reasons:-

The preamble to THE KARNATAKA URBAN WATER SUPPLY AND DRAINAGE BOARD ACT, 1973, (KUWSDB Act) under which the Assessee was created, did not specify that the Assessee’s activities have to be carried out without any profit motive. There is also no prohibition through any government order that prevents the Assessee from making profits or generating surplus.

The activities of the Assessee showed components of systematic business activity employing human and technical resources, and consciously conducted for healthy surplus generation. The Assessee had to support its expenditure through its own revenue inflows without any government grants or subsidy. The Assessee did generate surplus from operations during the previous year. 3. The Assessee provides service of project supervision against the receipt of Establishment, Supervision and Administration charges (ETP charges) from ULBS and sale of water against a fee/cess and these factors clearly indicate that the Assessee’s activities are in the nature of business/commerce. Though supply of water might be a constitutional duty of the Government, the fact that the Assessee facilitates performance of such duty will not render the Assessee’s activity as one without any profit motive. The fact that the water charges are levied are low does not mean that there was lack of profit motive. Rather it indicates inefficient operation of the Assessee. The fact that the Assessee executes project on behalf of the ULBS and not for private parties cannot be the basis to hold that the Assessee’s activities are not in the nature of trade or commerce.

Aggrieved by the order of the CIT(A), the Assessee is in appeal before the Tribunal.

We have heard the submissions of the learned counsel for the Assessee and the learned DR. The learned counsel for the Assessee reiterated submissions as were made before CIT(A) on the applicability of the proviso to Sec.2(15) of the Act. He also drew our attention to the various provisions of the KUWSDB Act and relied on certain judicial pronouncements, in this regard. The learned DR relied on the order of the CIT(A). We will first deal with the applicability of the proviso to Sec.2(15) of the Act to the Assessee.

The Assessee was established as a corporation under KARNATAKA ACT No. 25 OF 1974 (First published in the Karnataka Gazette Extraordinary on the Twenty-first day of August, 1974). THE KARNATAKA URBAN WATER SUPPLY AND DRAINAGE BOARD ACT, 1973. The preamble to the Act gives the objects and reasons which reads thus:

By Sec.3 of the KUWSDB Act, the Assessee was created as a body corporate. The said provision reads as follows:

The functions and powers of the Assessee are set out in Sec.16, 17 & 18 of the KUBWSDB Act, which reads as follows:

General powers of the Board.- The Board shall for the purpose of carrying out its functions under this Act. have the following powers, namely:- (i) to acquire and hold such movable and immovable property as it deems necessary and to lease, sell or otherwise transfer any such property subject to such conditions as may be prescribed; (ii) to acquire under the Land Acquisition Act, 1894 (Central Act I of 1894) any land or any interest therein required by the Board for implementing any schemes; (iii) to incur expenditure and undertake any work in any area in the State for the preparation and execution of such schemes as it may consider necessary for the purpose of carrying out the provisions of this Act, or as the case may be, the functions entrusted to it by the Government ; (iv) to enter into any contract; and (v) to do all things necessary for the purpose of carrying out the provisions of this Act.”

Chapter VI containing Secs.19 to 28 H of the KUWSDB Act provides as to how the Assessee has to investigate, prepare and execute, maintain Schemes by the Assessee. The cost of any scheme has to be borne only by the ULBs. It is clear from these provisions that any scheme has to be approved by the Government. Sec.28A of the KUWSDB Act provides that the operation and maintenance of scheme can be directed by the State Government to be carried out by the Assessee. Otherwise the schemes when completed are handed over to the Urban Local Bodies (ULBs). When a scheme is directed to be maintained and operated by the Assessee, the all reservoirs, tanks, cisterns, fountains, wells, pumps, conduits and other works and water scheme and the sewers etc., as the case may be, shall vest with the Assessee. It is only in respect of schemes which vest with the Assessee pursuant to direction of the Government that the Assessee has the power to levy rates, fees, rental and other charges in respect of water supply or sewerage. In this regard, the provisions of Sec.31A of the KUWSDB Act, which reads thus:

It can be seen from the powers of the Assessee to levy and collect water charges, fees etc., cannot have any element of profit and is based only on the requirements for fulfilment of the purposes set out in Sec.31A of KUWSB Act. In all other respects the Assessee only acts as a person who executes the scheme approved by the Government for ULBs. Prior to the introduction of the proviso to Section 2(15) of the Act, there was no dispute that the Assessee was established for charitable purposes. The income derived by the Assessee is in the form of collection of water and sewerage charges. The dominant and main object of the Assessee as we have already seen is to provide for the establishment of a Water Supply and Drainage Board and the regulation and development of drinking water and drainage facilities in the urban areas of the State of Karnataka. The source of income of the Assessee as can be seen from the income side of the Income and expenditure account is from (a) establishment, administration & supervision charges it receives from ULBs, water charges levied by it, interest on funds kept with the bank on deposits. The funds that are not immediately required for execution of schemes are parked in deposits. The Assessee also is in receipt of rental income. The other income of the Assessee is from fines, sale of tender forms, registration/renewal fees, sale of scrap, cost of SR book, other receipts, P & L contribution of board, Vendor assessment charges.

A look at the income stream of the Assessee clearly reveals that all the activities from which the Assessee derives income are an inherent part of the main object of the Assessee. It is clear from the facts of the case that profit making is not the driving force or objective of the Assessee. Rather the purpose for which the Assessee was created is to regulate and develop drinking water and drainage facilities in the urban areas of the State of Karnataka and for matters connected therewith. This makes it clear that any income generated by the Assessee does not find its way into the pockets of any individuals or entities. It is to be utilized fully for the purposes of the objects of the petitioner.

Keeping in mind the above factual aspects and the provisions of the KUWSDB Act, we shall now understand the approach to be adopted in coming to the conclusion as to whether the proviso to Sec.2(15) of the Act will be applicable to the Assessee in the light of the decision of the Hon’ble Delhi High Court in the case of India Trade Promotion Organization Vs. DGIT(Exemption) and others 371 ITR 333 (Delhi). The learned counsel for the Assessee has placed strong reliance on this decision to support his plea that the proviso to Sec.2(15) of the Act is not applicable to Assessee. The facts of the case before the Hon’ble Delhi High Court in the case of India Trade Promotion Organization (supra) was that the Assessee in that case enjoyed the benefit of exemption u/s.10(23C)(iv) of the Act.

The principle laid down in the aforesaid decision, in our view, if applied to the facts of the present case, will clearly show that the Assessee does not driven primarily by desire or motive to earn profits but to do charity through advancement of an object of general public utility. The assessee is operating on no profit basis. This is substantiated by the actual income received on operations of the Assessee and the expenditure incurred set out in para-14 of this order. The income of the Assessee is primarily consists of Establishment, Administration and Supervision Charges, Water charges, interest, rent and other income (comprising of hire charges, fines, sale of scrap, tender forms etc.). If interest, rent and other income are excluded and compared with the expenditure on operations incurred by the Assessee, it becomes clear that the Assessee does not have profit motive. The proviso to Sec.2(15) of the Act is therefore not applicable to the case of the Assessee. We therefore hold that the Assessee is entitled to the benefits of Sec.11 of the Act for the impugned assessment years. The AO has not disputed the conditions necessary for allowing exemption u/s.11 of the Act, except the applicability of proviso to Sec.2(15) of the Act. In view of our conclusions that the said proviso is not applicable to the case of the Assessee, we hold that the Assessee’s income is not includible in the total income and therefore the income returned by the Assessee is directed to be accepted.

Several other contentions regarding applicability of Sec.10(2) of the Act, Sec.10(46) of the Act and whether the levy of tax would be improper in view of Article 289(1) of the Constitution of India, were advanced before us. We have not dealt with those contentions, in view of our conclusion on the applicability of the proviso to Sec.2(15) of the Act to the Assessee.

In the result, the appeal by the Assessee is allowed.