Violation of Section 13 Taxes Only Non-Conforming Investment Income at MMR, Not Entire Trust Income

By | October 2, 2026
Violation of Section 13 Taxes Only Non-Conforming Investment Income at MMR, Not Entire Trust Income

Issue

Whether a violation of Section 13 of the Income-tax Act, 1961 results in the total forfeiture of Section 11 exemption for the entire income of a charitable trust, or if the denial and application of the maximum marginal rate (MMR) under the proviso to Section 164(2) is confined strictly to the income relatable to the non-conforming investment.

Facts

  • Assessee Profile: The assessee is a charitable trust claiming tax exemption under Section 11 of the Income-tax Act, 1961 for the Assessment Year 2007-08.
  • Non-Conforming Investment: During the relevant assessment year, the trust incurred a violation under Section 13 due to investments or holdings made in a mode or manner not permitted under the specified statutory guidelines.
  • Revenue’s Position: The Assessing Officer denied the Section 11 tax exemption to the total income of the trust, treating the entire income as liable to tax at the maximum marginal rate due to the Section 13 breach.
  • Assessee’s Contention: The trust maintained that any forfeiture of exemption must be restricted solely to the income generated from or attributable to the prohibited/non-conforming investment rather than penalizing the entire qualifying charitable income.

Decision

  • Partial Forfeiture Principle: The Tribunal/Court held that a violation attracting Section 13 does not lead to a total denial of Section 11 exemption on the trust’s entire income.
  • Taxability at MMR: Only the specific portion of the trust’s income relatable to the non-conforming investment is disentitled from exemption and subject to tax at the Maximum Marginal Rate (MMR) as per the proviso to Section 164(2).
  • Verdict: Decided in favor of the assessee [Para 3].

Key Takeaways

  • Proportional Disallowance: Infractions under Section 13 do not blanket-cancel the charitable status or total exemption under Section 11 for qualifying income.
  • Application of Section 164(2) Proviso: The statutory mechanism under the proviso to Section 164(2) operates to ring-fence and tax only the tainted/non-conforming income stream at the Maximum Marginal Rate.
  • Protection of Generic Charitable Exemption: Income derived from compliant modes and applied towards genuine charitable activities remains fully protected and eligible for Section 11 benefits.
  • Harmonized Provisions: The decision preserves parity between the Income-tax Act, 1961 (Sections 11, 13, 164) and corresponding provisions under the Income-tax Act, 2025 (Sections 341, 351, 307).
HIGH COURT OF MADRAS
Kathir Foundation
v.
Director of Income-tax
Dr. Anita Sumanth and S. Raveekumar, JJ.
TCA Nos. 339 & 340 of 2012 †
SEPTEMBER  8, 2026
Ms. S. Karishma and R. Janakiraman for the Appellant. J. Narayanaswamy, Senior Standing Counsel for the Respondent.
JUDGMENT
Dr. Anita Sumanth, J.- These are appeals at the instance of the assessee trust challenging an order of the Income Tax Appellate Tribunal (Tribunal) for assessment year (AY) 2007-2008. The order dated 19.05.2012 disposes an appeal of the revenue in the case of this assessee and a cross objection filed by one M/s.KAS Foundation relating to AY 2007-2008.
2. The issue that arose for consideration before the Tribunal is one and the same. In the case of Kas Foundation v. DIT [TCA. Nos. 337 and 338 of 2012, dated 1-12-2025], allowed the appeals on identical questions of law as arising in these matters. The questions of law that had been admitted in these appeals are as follows:-
“1.Whether on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the entire income of the trust is to be taxed at maximum marginal rate, even though undisputedly, violation of Section 11(5) was limited only to the amount borrowed from the Bank? 1 249 ITR 533 (Bom)
2. Whether on the facts and in the circumstances of the case, the finding and conclusion of the Tribunal is perverse, especially in the context of all other investments and application of income by the trust being in conformity with the objects of the trust and the provisions of the Act?
3. Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in reversing the order of the CIT (A) and denying exemption under Section 11 on the entire income without adverting to the contentions placed before it?
4. Whether the Tribunal was right in law in holding that the entire income of the trust is liable to be taxed in spite of the provisions of Section 11(2)(b) and proviso to Section 164(2), as also the Board Circular No. 387 dated 6.7.84, which mandates only the non-conforming portion of income as liable for taxation at the maximum marginal rate of tax?
5. Whether the Tribunal was correct in law in merely holding that there was violation of Section 13(2)(h) and deny exemption under Section 11, without any material and also assigning any reason for the same?
6. Whether the Appellate Tribunal was justified in rejecting the claim to tax only the alleged violative portion of investment, even though the High Court decisions in 249 ITR 253 – Director of I.T v SMG Foundation Trust and 311 ITR 425 – CIT v Narinder Mohan Foundation and also the Board Circular No. 387 dated 6.7.84 squarely apply on all fours to the facts of assessee’s case?”
3. In light of the identity of the present matter with order dated 01.12.2025, we extract the operative portion of that order and allow the present Tax Case (Appeals) as well.
“2. For assessment year, 2007 – 08, a return of income had been filed and an order of assessment passed on 24.12.2009, wherein, the assessing authority, denies the benefit of exemption claimed under Section 11 of the Income-Tax Act, 1961 (in short, ‘the Act’) on the ground that there is a violation under Section 13(1)(d) thereof.
3. In appeal, the Commissioner of Income-Tax (Appeals), intervenes to the effect of holding that where the trust contravenes the provisions of Sections 13(1)(c) or 13(1)(d), maximum marginal rate would be applicable only in respect of that part of the income which is a violation and the entirety of the income, would not lose the benefit of exemption under Section 11.
4. The Commissioner of Income-Tax (Appeals) refers to Circular No. 387 dated 06.07.1984 issued by the Central Board of Direct Taxes applied by the Bombay High Court in the case of DIT (E) v Seth Mafatlal Gagalbhai Foundation [249 ITR 533 (Bom)]. The Tribunal, at the instance of Revenue, reverses the order of the Commissioner of Income-Tax (Appeals), and rejects the cross objection filed by the appellant, aggrieved by which, the present appeals has been filed by the assessee/appellant.
5. The following substantial questions of law have been admitted for consideration on 17.10.2012:-

“1.Whether on the facts and in the circumstances of the case, the Appellate Tribunal was correct in law in holding that the entire income of the trust is to be taxed at maximum marginal rate, even though undisputedly, violation of Section 11(5) was limited only to the amount borrowed from the Bank?

2. Whether on the facts and in the circumstances of the case, the finding and conclusion of the Tribunal is perverse, especially in the context of all other investments and application of income by the trust being in conformity with the objects of the trust and the provisions of the Act?

3. Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in reversing the order of the CIT (A) and denying exemption under Section 11 on the entire income without adverting to the contentions placed before it?

4. Whether the Tribunal was right in law in holding that the entire income of the trust is liable to be taxed in spite of the provisions of Section 11(2)(b) and proviso to Section 164(2), as also the Board Circular No. 387 dated 6.7.84, which mandates only the nonconforming portion of income as liable for taxation at the maximum marginal rate of tax?

5. Whether the Tribunal was correct in law in merely holding that there was violation of Section 13(2)(h) and deny exemption under Section 11, without any material and also assigning any reason for the same?

6. Whether the Appellate Tribunal was justified in rejecting the claim to tax only the alleged violative portion of investment, even though the High Court decisions in 249 ITR 253 – Director of I.T v SMG Foundation Trust and 311 ITR 425 – CIT v Narinder Mohan Foundation and also the Board Circular No. 387 dated 6.7.84 squarely apply on all fours to the facts of assessee’s case?”

6. Both Mr.Vasudevan, for the appellant/assessee and Mr.Narayanaswamy, appearing for the Department, are consensus ad idem on the position that the issue raised in these appeals stand covered by a decision of this Court in Commissioner of Income-Tax v Working Women’s Forum [365 ITR 353 (Madras)]. The question in that case as well, related to whether the denial of exemption under Section 11 should be only to the extent of income which is violation of Section 13(1)(d) of the Act.
7. In the case of Working Women’s Forum [365 ITR 353 (Madras)], this Court has also noted the decision of the Bombay High Court in Seth Mafatlal Gagalbhai Foundation [249 ITR 533 (Bom)] and, extracting the following paragraph and its agreement with the statement of the Bombay High Court therein, has rejected the revenue’s appeal. We may usefully extract the same paragraph below:-

“Under section 161(1A), which begins with a non obstante clause, it is provided that where any income in respect of which a person is liable as a representative assessee consists of profits of business, then tax shall be charged on the whole of the income in respect of which such person is so liable at the maximum marginal rate. Therefore, reading the above two phrases show that the Legislature has clearly indicated its mind in the proviso to section 164(2) when it categorically refers to forfeiture of exemption for breach of section 13(1)(d), resulting in levy of maximum marginal rate of tax only to that part of the income which has forfeited exemption. It does not refer to the entire income being subjected to maximum marginal rate of tax. This interpretation of ours is also supported by Circular No. 387, dated July 6, 1984 (see [1985] 152 ITR (St.) 1). Vide the said circular, it has been laid down in para. 28.6 that, where a trust contravenes section 13(1)(d) of the Act, the maximum marginal rate of income-tax will apply only to that part of the income which has forfeited exemption under the said provision and not to the entire income. We may also add that in law, there is a vital difference between eligibility for exemption and withdrawal of exemption/forfeiture of exemption for contravention of the provisions of law. These two concepts are different. They have different consequences. It is interesting to note that although the Legislature withdrew section 164(2) by the Direct Tax Laws (Amendment) Act, 1987, which provision was reintroduced by the Direct Tax Laws (Amendment) Act, 1989, the Legislature did not touch the proviso to section 164(2) which has been on the statute book right from April 1, 1985. The said proviso was inserted by the Finance Act, 1984. The proviso specifically refers to violation of section 13(1)(d) and its consequences.”

8. In light of the decision in Working Women’s Forum [365 ITR 353 (Madras)] with which we respectfully concur, the questions of law are answered in favour of the assessee / appellant and adverse to the revenue.
9. These Tax Case (Appeals) are allowed in terms of this order. No costs. Connected miscellaneous petition is closed.”