Where Section 11(6) bars depreciation, capital expenditure applies

Where Section 11(6) bars depreciation, capital expenditure applies as income, but pre-operative expenses cannot be deferred.

Issue

Whether an assessee-trust disallowed from claiming depreciation under Section 11(6) is entitled to claim the actual capital expenditure incurred during the year as application of income under Section 11.
Whether charitable organizations can defer pre-operative expenditure to be claimed as application of income in future years, or if expenses must strictly be claimed in the year they are incurred out of that year’s income under Sections 11 and 12.

Facts

Background: The assessee-trust filed its return of income for Assessment Year 2017-18 declaring NIL income after claiming exemption under Section 11.
Depreciation Claim Disallowance: During scrutiny assessment, the Assessing Officer (AO) noted that the assessee had claimed depreciation. Citing the provisions of Section 11(6) and the lack of supporting documentary evidence in line with the amendment, the AO disallowed the depreciation claim.
Pre-operative Expenditure Claim Disallowance: The assessee-trust also claimed a deduction for pre-operative expenditure, contending that these expenses were incurred prior to the commencement of its charitable activities and were accumulated in its books of account as deferred revenue expenditure to be written off over future years. The AO disallowed this claim.

Decision

On Depreciation vs. Capital Expenditure Application (Section 11(6)): The Tribunal/Court held that while the assessee-trust was not entitled to claim depreciation due to the bar under Section 11(6), the actual capital expenditure incurred during the relevant year should be allowed as application of income under Section 11, subject to factual verification by the AO. The matter was remanded to the AO for this verification.
On Pre-operative & Deferred Revenue Expenditure: The Tribunal/Court held that the concept of “pre-operative expenditure” or “deferred revenue expenditure” is alien to charitable trusts under Sections 11 and 12. The statutory scheme mandatorily requires the application of 85% of income in the year of earn or accumulation as per prescribed rules. Trusts cannot defer current expenditure to future years.
On Current Year Application: However, the Tribunal/Court clarified that the eligible expenditure incurred during the year under consideration out of that year’s income is allowable as application of income to that extent. This specific issue was restored to the AO for factual verification and allowance as per law.

Key Takeaways

Capital Outlay as Application under Section 11(6): If depreciation is disallowed on capital assets whose cost was claimed or is not claimable as application, the actual capital expenditure incurred to acquire assets during the year remains eligible for deduction as application of income under Section 11.
No Deferred Revenue Expenditure for Trusts: The tax framework for charitable entities under Sections 11 and 12 operates on a strict yearly cash-flow/application mechanism. Commercial accounting concepts like carrying forward “pre-operative” or “deferred revenue” expenses to claim against future income are legally impermissible.
Strict Matching of Income and Application: Revenue expenses incurred by a charitable trust must be claimed as application of income in the specific year they are incurred out of the income generated during that year.

IN THE ITAT MUMBAI BENCH ‘D’

Dignity Lifestyle Trust

Income-tax Officer

Amit Shukla, Judicial Member
and ARUN KHODPIA, Accountant Member

IT Appeal Nos.1554 and 1741 (Mum) of 2026
[Assessment year 2017-18]

JULY 15, 2026

Pramod Prabhudesai for the Appellant. Sandeep Lakra, CIT DR for the Respondent.

ORDER

Arun Khodpia, Accountant Member.-The captioned two appeals are filed by the assessee to challenge the impugned orders passed by Commissioner of Income Tax Appeals, National Faceless Appeal Centre (NFAC), Delhi [in short,”the Ld. CIT(A)”], both dated 01.08.2025 for the Assessment Year (AY) 2017-18,by disposing of the appeal filed by the assessee to challenge the order u/s 143(3) of the Income Tax Act, 1961 [in short, “the Act”] dated 16.12.2019, passed by Income Tax Officer (Exemption) Ward 1(2), Mumbai [in short,”the Ld.AO”] and the second appeal pertains to the penalty u/s 270A of the Act, vide order dated 17.03.2022.

2. The grounds of appeal raised by the assessee in quantum appeal are as under:

“ITA 1554/Mum/2026AY2017-18

1. The learned Commissioner of Income Tax (CIT) Appeals erred in law and in facts in confirming the disallowance of depreciation made by the Assessing Officer of Rs.37,95,579-despite disallowing claim for capital expenditure.

2. The learned Commissioner of Income Tax (CIT) Appeals erred in law and in facts in not allowing the claim of capital expenditure of Rs. 31,90,774/- as application of income as claimed in the income tax return which should have been considered in the alternative to Ground No 1.

3. The learned Commissioner of Income Tax (CIT) Appeals erred in law and in facts in confirming the disallowance of pre-operative expenses made by the Assessing Officer of Rs.17,10,746/treating same as Prior Period expenses which is incorrect-.

4. The learned Commissioner of Income Tax (CIT) Appeals erred in law and in facts in providing directions to the JAO to allow the claim of deduction of the assessee only if it has applied 85% of its income, excluding depreciation and pre-operative expenses and thus ignoring the provisions of the Act.

5. Each of the above grounds of appeal are independent and without prejudice to each other.

6. The assessee craves to amend/delete/alter any of the above grounds.

ITA 1741/Mum/2026 A Y 2017-18

1. The learned Commissioner of Income Tax (CIT) Appeals erred in law and in facts in confirming the disallowance of depreciation made by the Assessing Officer of Rs.37,95,579/

2. The learned Commissioner of Income Tax (CTT) Appeals erred in law and in facts in not allowing the claim of capital expenditure of Rs. 31.90,774/- as application of income as claimed in the income tax return.

3. The learned Commissioner of Income Tax (CIT) Appeals erred in law and in facts in confirming the disallowance of pre-operative expenses made by the Assessing Officer of Rs.17.10,746/-.

4. The learned Commissioner of Income Tax (CIT) Appeals erred in law and in facts in providing directions to the JAD to allow the claim of deduction of the assessee only if it has applied 85% of its income, ignoring the provisions of the law.

5. The above adjustments resulted in erroneous calculation of tax demand and penalty thereon.

6. The assessee craves to amend delete/alter any of the above grounds.”

3. Brief facts of the case are that the assessee-trust has filed its return of income belatedly on 06.02.2018 for the AY 2017-18, declaring total income at Rs. Nil. The case, thereafter, was selected for scrutiny through CASS under limited category and accordingly notices u/s 143(2) and 142(1) were issued. The assessee-trust has claimed exemption u/s 11 of the Act, which was examined by the Ld. AO during the scrutiny proceedings. The Ld. AO observed certain discrepancies in the computation of total income by the assessee on following issues: –

(i)

Depreciation – It is observed by the Ld. AO that during the year under consideration, the assessee has claimed a depreciation of Rs.37,95,579. A question was raised as to why depreciation claimed by the assessee should not be disallowed as per amended provisions of section 11(6) of the Act. In response, assessee placed its reliance on the decision of Hon’ble Bombay High Court in the case of PCIT v. Mandke Foundation [2019] ITL 1821 and in the case of CIT v. Institute of Banking Personnel Selection (IBPS) 264 ITR 110 (Bom). The assessee also relied on the decision of Hon’ble Supreme Court in the case of CIT v. Rajasthan & Gujarati Charitable Foundation Poona 402 ITR 441 (SC) and submitted that the claim of depreciation is allowable. Ld. AO was not convinced with the aforesaid submissions by the assessee, he observed that the contention of assessee is not acceptable as the assessee failed to prove any documentary evidence, which could support the claim in accordance with the amended provisions of section 11 of the Act. Accordingly, he disallowed the depreciation claimed by the assessee.

(ii)

The second issue raised by the Ld. AO was relating to pre-operative expenses claimed by the assessee for Rs.17,10,746/-. The assessee was asked to explain as to how such expenditure is allowable. In response, assessee submitted that the expenditure incurred by the assessee having the nature of enduring benefit over a period of time, therefore such expenses incurred prior to commencement of its operations.The nature of these expenses are of deferred revenue expenditure. Therefore, as per settled principle, the assessee is eligible to claim such deferred expenditure. The reply of assessee was not found tenable by the Ld. AO, he noted that the case laws cited by the assessee are differed on facts as the assessee is a charitable organization and accordingly its income needs to be specifically spent for object of charity benefitting public at large. If such practice of claiming prior period expenses is allowed as application, it will surely lead to deviation of the charitable purpose of the organization and subsequently the purpose for which it receives its income from donors and other various sources shall be defeated. The Ld. AO has also doubted the genuineness of expenditure and the nature. The Ld. AO accordingly disallowed the pre-operative expenditure of Rs.17,10,746/-.

4. Being aggrieved with the aforesaid additions made by the Ld. AO, assessee preferred an appeal before the Ld. CIT(A). The Ld. CIT(A) has deliberated on the aforesaid two issues at length and had held that as per amended provisions of section 11(6), which mandates that depreciation or any other allowance shall not be allowed in respect of a capital asset, acquisition of which has been claimed as application of income in the same or any other previous year with effect from 1^st April 2015, therefore, the order of AO, in which depreciation claimed by the assessee was disallowed, has been upheld.

5. On the second ground of appeal regarding pre-operative expenses, the Ld. CIT(A) had held that the contention raised by assessee is not found tenable on the ground that such expenses were incurred prior to commencing the operation by trust and are thus prior period expenses. The fact has also been admitted by the assessee itself, further the case laws cited by the assessee differed on facts as the assessee is a charitable organization and accordingly its income needs to be specifically spent for the object of charity benefitting public at large. If such practice of claiming prior period is allowed as application, it will surely lead to deviation of the charitable purpose of the organization and subsequently the purpose for which it had received its income from donors and other various sources shall be defeated. The Ld. CIT(A) also directed the Jurisdictional Assessing Officer (JAO) to relook into computation of the income of the assessee-trust while giving effect to the appellate order that if without giving benefit of expenses application for amount claimed as depreciation and prior period expenses, the assessee can prove that it has applied 85% of its aggregate income referred to in section 11 and 12 for the relevant assessment year then, deduction claimed by the assessee being a registered charitable institution is required to be allowed. The appeal of assessee has been partly allowed by the Ld. CIT(A).

6. Being dissatisfied with the aforesaid decision of Ld. CIT(A), the assessee has preferred the present appeal before us.

7. The first ground of appeal of the assessee is that the Ld. CIT(A) had erred in dismissing the ground of appeal of assessee for claiming depreciation despite disallowing the claim of capital expenditure. On this aspect, it is submitted by the Ld. AR that the capital expenditure of Rs.31,90,774/- was claimed in schedule EC of ITR for AY 2017-18 (referred page no.15 of ITR, Sl. No.3 of Schedule EC and Sl. No.8 of Schedule EC). The said amount is appearing in part B of the total income at page 5 of the ITR at Sl No.4 II (relevant page of ITR duly marked as appendix III). It is submitted that this amount should be treated as application of income and Ld. AO should consider it as application of income.

8. Per contra, Ld. DR supported the order of Revenue Authorities.

9. On a careful consideration of aforesaid facts, we find substance in the submission of assessee that if the assessee is not entitled for depreciation in terms of amended provision of section 11(6) of the Act, the actual capital expenditure incurred by the assessee should be allowed as application of income which are furnished by the assessee in its ITR as mentioned (supra). Under such circumstance, we deem it fit to restore this issue to the file of Ld. AO with the direction to allow actual capital expenditure incurred during the year by the assessee after factual verification in terms of provisions of section 11 and 12 of the Act and allow the same in accordance with the provisions of law. Ground Nos. 1 and 2 of the assessee’s appeal, therefore, are allowed for statistical purposes.

10. Ground No.3 pertains to disallowance of pre-operative expenses made by the Assessing Officer treating the same as prior period expenses. On this issue, Ld. AR of assessee submitted that it has incurred various expenses prior to commencement of its charitable activities, therefore, such expenses are accumulated by the assessee and treated as deferred revenue expenditure to be claimed as prior period expenses in the following years and such expenditure should be allowed, whereas the Ld. AO has denied to allow such expenditure and the Ld. CIT(A) also confirmed the findings of Ld. AO. It was the prayer that the approach of Ld. AO and CIT(A) was incorrect and the assessee should be allowed to claim such prior period expenses.

11. Per contra, Ld. DR supported the orders of Revenue Authorities.

12. We have considered the rival submissions, perused the material available on record and case laws relied by the assessee at the assessment stage. Admittedly, in the present case, the assessee has incurred certain expenditure before commencement of its charitable activities. Such expenditures were accumulated by the assessee in its books of accounts and have deferred such expenditure to claim in the future years as prior period expenditure. As per provisions of section 11, a charitable organization is supposed to maintain its books of accounts on actual receipt and payment basis. According to provisions of section 11(1)(a), the assessee is required to apply its income derived from property held under the trust wholly for charitable purpose or religious purpose however, where any such income is accumulated or set apart for application to such purpose in India to the extent to which the income so accumulated or set apart is not in excess of 15% of the income from such property, such income shall not be included in the total income of previous year as taxable income of the assessee-trust. Accordingly, the assessee trust is required to apply its income for charitable purposes, according to its objects upto 85% during the year under consideration and remaining 15% can be carried forward for utilization in future years.

13. As per Explanation (i) to Section 11(1), if in the previous year, the income applied to charitable or religious purpose in India fall short of 85% of the income derived during the year from property held under trust or as the case may be then it can be accumulated or set apart either in whole or part for application to such purposes in India, such income so accumulated or set apart shall not be included in the total income of previous year of the assessee subject to certain conditions u/s 11(2) of the Act.

14. Since the income of trust has to be accounted for and the entitlement of exemption u/s 11 and 12 is subject to certain conditions, therefore, the accounting of trust and claim of expenditure to remain eligible and titled u/s 11 and 12 of the Act has to be in accordance with the provisions of the Act. The assessee cannot adopt the accounting standards which are applicable for commercial concerns other than non-profit organizations working for profit, while preparing the books of accounts and computing the income of an institution working for charitable purposes registered u/s 12A or 12AB of the Act. The concept of pre-operative expenditure is alien for charitable organizations, since it would impair and disrupt the sole scheme of section 11 and 12, under which the provisions of application of funds upto 85%, accumulations and set apart are mandatory.

15. We, thus, are of the view that the practice and exercise by the assessee to defer the expenditure and claim it as pre-operative expenses in the future years is not in accordance with the mandate of section 11 and 12, therefore such practice cannot be appreciated and approved. We thus dismiss this ground of appeal of assessee, however the eligible expenditure of assessee for the year under consideration, which are incurred out of the income earned during the year as application of income in terms of provisions of section 11 shall be allowable to that extent. The issue therefore is restored to the files of Ld. AO for verification and to allow the expenditure in terms of provisions of section 11 and 12, which are actually incurred during the year.

16. It is also submitted by the assessee that the assessee has applied for rectification application u/s 154 regarding capital expenditure claimed by the assessee as application on 28^th April, 2022, which is still not disposed by the Ld. AO therefore, the Ld. AO may be directed to decide the same. Since in ground no.1 and 2 of the present appeal are already restored back to the file of Ld. AO, the issue is covered by our directions and the Ld. AO is directed to give effect to the same accordingly.

17. Ground No.4 of the appeal is regarding directions of CIT(A) to Ld. AO to allow claim of deduction of assessee only if it has applied 85% of its income excluding depreciation and pre-operative expenses thus ignoring provisions of Act. On this issue, since we have already directed the Ld. AO to allow the capital expenditure for the year under consideration in ground no.1 and 2 of the present appeal and then recompute the income of assessee-trust in accordance with the provisions of section 11 and 12, this contention of assessee has become academic only and, therefore, no further adjudication is required.

18. Ground No.5 and 6 are general in nature thus are not adjudicated

19. In result, the appeal of assessee is partly allowed for statistical purposes in terms of our aforesaid observations.

ITA No. 1741/Mum/2025

20. Regarding penalty u/s 270A, the same is consequential in nature and depends upon the outcome of quantum appeal for which the effect to be given by the Ld. AO in terms of our directions in ITA No.1554/Mum/2026. The challenge to penalty appeal by the assessee, therefore, has been restored back to the file of Ld. AO for fresh adjudication.

21. In result, ITA No. 1741/Mum/2026 is allowed for statistical purposes.

22. In combined result, appeal of assessee in ITA No.1554/Mum/2026 is partly allowed for statistical purposes whereas ITA No.1741/Mum/2026 is allowed for statistical purposes.