Application of Income and Accumulation by Trusts

Understand Application of Income and Accumulation by Trusts

Key rules to remember

Minimum application

Required application = 85% × Income of the year (computed without deduction for application)

Corpus donations with a specific direction are left out of the income used here.

Shortfall

Shortfall = 85% of income − Amount actually applied

If the shortfall is positive, it is taxable unless validly accumulated. Income applied and the free 15% retention stay exempt; only the shortfall is taxable.

Free retention

Income that can be retained without conditions = up to 15% of income

No notice or investment is needed for this part.

Accumulation conditions

Notice in prescribed form + investment in specified modes + application within 5 years

Failure on any condition makes the amount taxable. The notice must be filed within the allowed time.

Capital gain on asset held for the trust

Capital gain treated as applied = Amount reinvested − Cost of the transferred asset (limited to the capital gain); Taxable gain = Capital gain − gain treated as applied

Applies where the net consideration is used to acquire a new capital asset. If the full net consideration is reinvested, the whole gain is treated as applied and no gain is taxable. The gain is not applied in proportion to the amount reinvested. If the amount reinvested does not exceed the cost, no gain is treated as applied.

Donation to another registered trust

Application = 85% × Sum donated (not a corpus donation)

A corpus donation to another trust is not application.

Corpus donation

Voluntary contribution + specific direction as corpus = not income

A general donation with no such direction is income and enters the 85% base.

How to solve Application of Income and Accumulation by Trusts questions

1. 1Check that the trust is registered or approved. Without that, the exemption does not apply at all.
2. 2List all receipts. Remove corpus donations that carry a specific direction. Put every other receipt into income.
3. 3Compute income under the normal rules, without deducting the application for the year. Take care with depreciation on assets whose cost was already treated as application.
4. 4Calculate 85% of that income to find the required application.
5. 5Add up the actual application in India: revenue spending, capital expenditure on objects, and eligible deemed application. Count a donation to another registered trust at 85% of the sum donated. Exclude spending outside India and any double claims.
6. 6Find the shortfall. If it is nil or negative, nothing is taxable on this ground.
7. 7If there is a shortfall, check for a valid notice, specified-mode investment and the 5-year period. Without these, the shortfall is taxable.
8. 8Write the conclusion: exempt income, accumulated income, and taxable amount, each with its reason.

Quickest way: Three-line trust test

Common mistakes in Application of Income and Accumulation by Trusts

• Including a corpus donation in income when applying the 85% test.

  Students treat every donation received as income.

  Fix: Check for a specific direction that the sum is corpus. If it is there, exclude it from the base. If the direction is missing, treat it as income.

• Calculating 85% on income after deducting the amount applied.

  Students compute income the way they compute business profit for a company.

  Fix: Take income before any deduction for application, then compare 85% of it with the actual application.

• Treating the 15% free retention as accumulation that needs a notice.

  Students mix up the two ideas.

  Fix: Up to 15% can be kept without any condition. A notice and investment are needed only for the shortfall below 85%.

• Counting investment of corpus funds or of accumulated funds as application.

  Both involve putting money into an asset.

  Fix: Investing in specified modes is only parking. Application happens when the money is spent on the objects.

• Counting spending outside India as application.

  The purpose looks charitable, so students allow it.

  Fix: Application must generally be in India. Use an exception only if the question clearly states one.

• Claiming the same amount twice, once as capital application and again as depreciation.

  Students apply the depreciation rules by habit.

  Fix: If the cost of an asset has already been treated as application, do not allow depreciation on it again.

• Counting the full sum donated to another trust as application.

  Students assume money given to charity is fully applied.

  Fix: A donation to another registered trust (not corpus) counts only at 85% of the sum donated. A corpus donation does not count.

Worked examples