Application of Income and Accumulation by Trusts: 85% Rule

Understand Application of Income and Accumulation by Trusts

Key rules to remember

85% benchmark

Benchmark application = 85% × regular income of the tax year

Section 341(5). 85% is the benchmark below which the shortfall, or any part of it, may be treated as deemed application at the trust's option. It is not a mandatory minimum.

Donation to another registered non-profit organisation

Allowed application = 85% × sum paid as donation

Section 341(1)(b). A corpus donation to another organisation is not allowed at all (section 341(3)(c)).

Deemed application

Shortfall = (85% × regular income) − application allowed under section 341(1) to (4)

Option exercised on or before the section 263(1) due date. It must be applied in India by the year set in section 341(6).

Capital gain treated as application, whole property held for charity

If net consideration is fully reinvested: whole gain. If partly: amount utilised − cost of transferred asset (if positive)

Section 341(9)(a). Net consideration is sale value less transfer expenses. Cost includes cost of acquisition and improvement.

Capital gain, property held in part for charity

Same tests applied to the appropriate fraction of gain, amount utilised and cost

Section 341(9)(b) and (10)(a). Appropriate fraction is the extent to which the income was applicable to charitable or religious purposes before transfer.

Re-investment of corpus or loan repayment

Counts as application if made within 5 years from the end of the tax year of the original application

Section 341(2). The original application must be after 31 March 2021 and free of violation.

Anonymous donation exclusion

Exempt limit = higher of ₹1,00,000 or 5% of total donations received in the tax year

Section 337, item 1. Anonymous donations above this limit are specified income. Organisations created wholly for religious purposes, or wholly for charitable and religious purposes, are outside this item. The Act's bracketed carve-out deals with anonymous donations made with a specific direction for a university or other educational institution, or a hospital or other medical institution, run by the organisation.

How to solve Application of Income and Accumulation by Trusts questions

1. 1Separate the receipts. Take out corpus donations received under section 339, as they are not part of regular income (section 338(b)). Treat anonymous donations and other specified income separately.
2. 2Work out the regular income of the tax year as the question defines it.
3. 3List every payment for the registered objects in India. Allow it in full, except donations to other registered non-profit organisations, which count at 85%.
4. 4Remove disallowed items: application from corpus, loan, accumulated or specified income, depreciation on assets already claimed as application, set-off of earlier excess, and corpus donations given to others.
5. 5Add capital gain treated as application if the net consideration was reinvested under section 341(9), and any loan repayment or corpus re-investment qualifying under section 341(2).
6. 6Compare the allowed application with 85% of regular income. If it falls short, state the option of deemed application, the form, the due date and the year by which the amount must be applied in India.
7. 7Check section 337 for violations such as application outside India, related-person benefit, wrong investments and misapplied accumulated income. Add each to specified income in the year given in column C.
8. 8State the conclusion in rupees: application achieved, shortfall, deemed application available, and specified income.

Quickest way: Four-line check for 85% questions

Common mistakes in Application of Income and Accumulation by Trusts

• Counting a donation to another registered organisation at 100%.

  Students think any charitable payment is full application.

  Fix: Take 85% of the sum paid under section 341(1)(b). Corpus donations to other organisations get nothing under section 341(3)(c).

• Including corpus donations received in regular income when testing the 85%.

  All donations look like income.

  Fix: Corpus donations received under section 339 are excluded from regular income by section 338(b). Remove them before taking 85%.

• Treating deemed application as automatic.

  Students see that the shortfall can be carried and forget the conditions.

  Fix: It is at the trust's option, exercised on or before the section 263(1) due date. The amount must also be applied in India within the section 341(6) time limit, or it becomes specified income under item 13 of section 337.

• Allowing application made out of accumulated income, loan or corpus as fresh application.

  Money was spent on charity, so it feels allowed.

  Fix: Section 341(4) says such application is not considered for sub-sections (1) and (2). Only the specific cases in section 341(2) are exceptions.

• Allowing application outside India as a normal charitable spend.

  The objects are charitable, so location is ignored.

  Fix: Application must be in India. Outside India, it is excluded from regular income only if the Board directs under section 338(a). Otherwise it is specified income under section 337 item 3.

• Taxing specified income in the wrong year.

  Students tax every violation in the year of receipt.

  Fix: Use column C of section 337. For example, unapplied accumulated income (item 8) falls in the last of the years for which it was set apart.

Worked examples