The regulated formal education sector in India is broadly made up of schools (often classified as K-12 – kindergarten to 12) and higher education institutions. Although India has been proactive in liberalization, the education sector has remained largely unaffected by the reform process. Archaic legislations require all formal educational institutions in India to be run as “non-profit” centers by non-profit entities viz. a partnership, trust, or section 25 company. All surplus funds generated in the process of operating K-12 schools or institutions of higher education must be reinvested in the same school or educational institutions under the same trust and may not be distributed dividends to members of non-profit entities. . In addition, the constitution of the trust/company must be such that it does not give control to a single individual or members of a family, that is, the trust/company must not have the character of owner and the educational institutions must operate on a “not for “benefit” mode.
The ‘non-profit’ mandate is the biggest discovery that has kept serious corporate activity at bay in the attractive K-12 segment. Most of the schools in India are independent and until recently the chains used to be established by private charitable, political and/or religious groups, including the Vidya Bharti schools (affiliated with the right-wing political organization RSS) with over 18,000 schools. , Dayan and Anglo Vedic (DAV) schools with approximately 600 schools and Chinmaya Vidyalaya with approximately 75 schools, among others.
Lately, corporate houses seeking to transform K-12 schools into a ‘profit’ proposition have been using indirect means such as lease rentals, administration fees, fees to provide ancillary services and support, etc. extract the surplus locked up in the trust. Following the lead of these schools, the Indian education sector has seen some corporate activity in the K-12 space along similar lines, but in a formal version of these old structures. The strict regulations are being handled through an innovative two-tier structure, which complies with ‘trustee’ regulations and allows promoters (at the corporate level) to generate profit from the company. In this way, the ‘surplus’ profit flows to the service entity in the form of rent/fees for providing the land and services and is available to the company to distribute as a dividend or use to finance another company.
However, it is important that the relationship between the trust and associated services company and the infrastructure and management company be carefully structured to conform to educational and fiscal rules and regulations.
A charitable institution such as a trust is entitled to exemptions from income tax under section 11 of the Income Tax Act 1961 (“IT Act”) subject to meeting the requirements listed therein. Trust income that is exempt from tax includes income derived from property held in trust wholly for charitable or religious purposes to the extent that the income is applied in India.
The terms ‘property held under trust’ include a business enterprise whose business is incidental to the achievement of the trust’s objectives and separate books of account are maintained by such trust in respect of such business. For purposes of claiming the exemption, it is required that 85% of the total income of the trust be applied to the object of the trust itself and the trust must not accumulate more than 15% of the income since excess accumulation, if any. , will be subject to income tax.
To take advantage of tax breaks on income generated by the trust from the management and operation of schools, the trust should ensure that the trust’s predominant activity is to fulfill a charitable purpose of promoting education and not to make a profit. The trust may charge a reasonable fee to the students since the earning of profit per se does not vitiate the exemption granted by the tax authorities. The Supreme Court of India confirms this view by holding that “the decision as to the fee to be charged must necessarily be left to the private educational institution which does not seek or is not dependent on any government funds.”
However, corporate structuring must assess the implications of section 13(1)(c) of the IT Act. In the event that part of the income or any property of the trust in question has been used or applied during the previous year, directly or indirectly, for the benefit of certain persons, such as the author/founder of the trust; any trustee or trust administrator; any relative of any author/founder; or any business in which either person has a substantial interest (“Interested Persons”), then such income so used or applied shall not be excluded from the total income of the trust for the prior year.
It will be considered that the income or assets in trust have been used or applied for the benefit of the Subject Persons, among others, if –
(i) any part of the income or assets of the trust is or continues to be slow for any of the Persons Involved without any security or adequate interest or both;
(ii) any land, building or other property of the trust is made or continues to be made available to any of the Involved Persons without charging adequate rent or other compensation;
(iii) any amount is paid in salary, allowance or otherwise to any of the Involved Persons for services rendered and the amount so paid exceeds what can reasonably be paid for such services;
(iv) the trust services are made available to the Subjects without adequate remuneration or compensation;
(v) any property is sold by or on behalf of the trust to any of the Involved Persons for less than adequate consideration;
(vi) any property is purchased by the Interested Persons’ trust that is more than adequate; etc.
In view of the above, the expenses incurred by the trust to pay rents and service fees to associated service companies should be compared with the service fees paid by other trusts for services of a similar nature so that they are not perceived as unjustified and inconsistent . in excess of what is reasonably paid for such services to ensure continued tax exemptions. If it is determined that the expenses incurred by the trust are in excess of what can reasonably be paid for such services, the tax authority may reject such expenses incurred for the benefit of the Persons Involved or even deny tax exemption under Article 11 of the IT Law and subject to tax the net income of the trust less the expenses justified under the heading of “income from other sources”.
The structure, discussed above, no doubt risks being challenged by regulatory authorities as education is a ‘socially sensitive’ sector in India, especially at the K-12 level. However, the structure (which differs from the spirit of the ‘non-profit’ concept) has been around for a long time in the K-12 segment and the model has been adopted by various players in the education sector. .
