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Assessment of Trusts, Institutions & Political Parties: CA Final Tax MCQs

18 min read18 July 20260 viewsConferenza Conferenza

Assessment of trusts, institutions and special entities is a high-frequency CA Final examination topic. Unlike regular individuals, these entities operate under distinct tax regimes with stringent compliance conditions. Understanding when and how exemption is granted—and when it is forfeited—is critical for both computation and theory questions.

Why This Topic Matters in CA Final

The ICAI weightage on charitable trusts and special entities typically ranges from 8–12 marks in the Direct Tax paper. Questions test:

  • Eligibility criteria and registration requirements (First Regime vs. Second Regime)
  • Commercial receipt limits and when exemption is lost
  • Application of income and accumulation rules
  • Corpus donations and specified modes
  • Anonymous donations and diversion rules
  • Political parties, electoral trusts, and business trusts (REITs)

A single error in determining whether an entity retains charitable status can flip an entire computation from exempt to fully taxable. This article embeds the 18 real MCQs from Conferenza's question bank so you can test your understanding immediately.

The Two Regimes: First and Second

First Regime (Automatic Exemption): An educational institution with total annual receipts not exceeding ₹5 crore is automatically exempt from taxation without registration, provided it exists solely for educational purposes and is not for profit.

Second Regime (Section 11 & 12AB): Charitable trusts and institutions with receipts exceeding ₹5 crore (or electing to register voluntarily) must register under Section 12AB and comply with detailed conditions: application of income at 85%, accumulation limits, corpus investment rules, and filing of annual returns in specified forms.

The distinction determines both eligibility and ongoing compliance burden.

Commercial Receipts Limit: The 20% Rule

A charity may undertake activity in the nature of trade provided the receipts do not exceed 20% of total receipts (or 25% for 'relief of the poor'). Critical point: Once this limit is breached, the entire trust loses charitable status for that year—not just the trading income.

Relief of Poor (permitted) 25%
Other charitable objects (permitted) 20%
Breach → entire status lost Exceeds limit

The law does not allow partial exemption or tax on only the excess. This is a frequent exam trap.

Application of Income: 85% Rule

Under Section 11(1)(a), a charitable trust claiming exemption must apply at least 85% of its income for charitable purposes. This is the cornerstone of the Second Regime.

Key nuances:

  • Payment vs. Accrual: Application is measured on a cash/payment basis, not accrual. An expenditure accrued in March but paid in April applies to the latter financial year.
  • Capital purchases: A capital asset (e.g., a bus for students) is treated as application in the year of purchase. Depreciation on that asset cannot be separately claimed in subsequent years.
  • Diversion to non-charitable use: If the trust spends any amount for the benefit of a trustee or any other non-charitable purpose, that sum is denied exemption and taxed as "specified income" at 30% (not at the entity's marginal rate).

Accumulation of Income

A trust may accumulate (not spend) part of its income in a given year, provided it:

  1. Files Form 10 declaring the accumulation
  2. Specifies the charitable purpose for which funds are being set aside
  3. States the period (max 5 years) within which the amount will be applied
  4. Invests the accumulated amount only in specified modes: Government securities, scheduled bank deposits, investment-grade bonds, or land/building for charitable use

If the trust breaches condition (4)—e.g., diverts accumulated funds to a non-specified investment—the entire accumulated amount is brought to tax in the year of diversion.

Permitted accumulation quantum: A trust with income of ₹10 lakhs that spends ₹7 lakhs may accumulate only ₹1 lakh (10% of income); the maximum allowed is the higher of ₹1 lakh or 15% of income applied.

Corpus Donations

A corpus donation is a principal sum received with a specific direction that it form part of the endowment fund and never be spent. For such donation to be exempt, it must be invested in specified modes: Government securities, National Savings Certificates, scheduled bank fixed deposits, or bonds issued by a public sector undertaking or a company on the RBI's approved list.

A corpus placed in a non-specified mode (e.g., ordinary savings account, unregulated investment) will not qualify for exemption.

Anonymous Donations and the 5% Rule

A charitable trust receiving anonymous cash donations (or donations without identifying the donor) must pay tax at 30% on any anonymous donation that exceeds the higher of ₹1 lakh or 5% of total donations received in the year.

Example: Total donations = ₹5 lakhs. 5% = ₹25,000. A single anonymous donation of ₹1,10,000 triggers tax at 30% on the entire ₹1,10,000 (because it exceeds both ₹1 lakh and 5% of total donations).

This rule applies regardless of whether the trust is registered or the amount is legitimately used for charitable purposes.

Educational Institutions: Receipts Threshold

An educational institution existing solely for educational purposes and not for profit:

  • Up to ₹5 crore annual receipts: Automatic exemption; no registration required.
  • Exceeding ₹5 crore: Must register under Section 12AB; must maintain separate books for any incidental business activity; business activity must be subsidiary to the main educational object.

Institutions with receipts over ₹5 crore that have not applied for registration cannot claim exemption even if they otherwise meet the criteria.

Political Parties and Electoral Trusts

Political parties: Exempt from tax on income from voluntary contributions, provided the party is registered with the Election Commission. However, a single breach—receiving even a small cash contribution when the law permits only cheques/digital—forfeits the entire income exemption for that year. This is a severe penalty and reflects the strict compliance expected.

Electoral Trusts: An electoral trust must distribute at least 95% of aggregate contributions it receives to registered political parties during the previous year (or earlier years) for its own income to remain exempt.

Business Trusts (REITs)

A Real Estate Investment Trust (REIT) or Infrastructure Investment Trust (InvIT)—termed a "Business Trust"—receives income from real estate rentals and from interest earned by Special Purpose Vehicles. Both streams are exempt in the hands of the trust itself. Distributions to unit holders are subject to TDS at 5% (or treaty rates if lower).

This is the rare case where a trust's business income is exempt; charitable trusts do not enjoy such privilege.

Practice Questions

Q1. A trust's object includes 'relief of the poor' and 'advancement of any other object of general public utility'. If the receipts from an activity in the nature of trade exceed 25% of its total receipts in the previous year, what is the consequence?

  1. The trust loses its charitable status only for the 'advancement of any other object of general public utility' component.
  2. The trust retains its charitable status because 'relief of the poor' is an independent object and is not subject to the commercial receipt limit.
  3. The trust loses its entire charitable status because the limit for commercial receipts is exceeded.
  4. The income from the trading activity is taxable at the maximum marginal rate, but the rest of the income remains exempt.
Show answer & explanation

Correct answer: C. The threshold for 'relief of the poor' is 25%, but once breached, the entire trust loses exemption. The law does not permit partial exemption or carving out one object from another when a commercial receipt limit is exceeded. This is a strict-compliance rule.

Q2. A charitable trust registered under the Second Regime (Sections 11 to 13) has an annual income of ₹10,00,000. It spends ₹7,00,000 on charitable purposes during the year. What is the maximum additional amount it can accumulate for future use without any conditions?

  1. ₹1,50,000
  2. ₹1,00,000
  3. ₹3,00,000
  4. ₹2,50,000
Show answer & explanation

Correct answer: B. The maximum accumulation is the higher of ₹1 lakh or 15% of income applied for charitable purposes. Here, 15% of ₹7,00,000 (income applied) = ₹1,05,000. The higher limit is ₹1,05,000, but ₹1,00,000 is the standard safe harbour. Accumulation must comply with Form 10 filing and investment in specified modes.

Q3. A trust receives a corpus donation of ₹5,00,000 with a specific direction that it shall form part of the corpus. The trust must adhere to a specific requirement for this donation to be exempt from tax. What is this primary requirement?

  1. The amount must be spent on the charitable objects within the same financial year.
  2. The amount must be invested or deposited in one or more of the specified forms or modes.
  3. The entire amount must be accumulated for a maximum period of 5 years by filing Form 10.
  4. The trust must apply 85% of this amount to charitable purposes in India in the same year.
Show answer & explanation

Correct answer: B. Corpus donations are principal sums that must never be spent, only the interest earned is used. The corpus itself must be invested in Government securities, National Savings Certificates, scheduled bank deposits, or prescribed bonds. Investment in non-specified modes disqualifies the donation from exemption.

Q4. An educational institution existing solely for educational purposes and not for profit has aggregate annual receipts of ₹4.50 crore. Which statement regarding its claim for income exemption is correct?

  1. It must get its registration/approval before it can claim any exemption under the First Regime.
  2. It is mandatorily required to be registered under the Second Regime (Section 12AB) to claim exemption.
  3. It can claim exemption without making any application to the prescribed authority, as its receipts do not exceed ₹5 crore.
  4. It must have been substantially financed by the Government to claim the exemption.
Show answer & explanation

Correct answer: C. The ₹5 crore threshold is the dividing line. Below ₹5 crore, educational institutions operating not-for-profit enjoy automatic exemption under the First Regime without any application or registration. This is one of the most student-friendly provisions in the tax code.

Q5. An educational trust operating under the Second Regime (Section 11) accrues a revenue expenditure liability of ₹80,000 in March 2026. However, the payment for this liability is made in April 2026. For which Financial Year will this ₹80,000 be treated as 'application of income'?

  1. Financial Year 2025-26, based on the accrual method of accounting.
  2. Financial Year 2026-27, as application is allowed only on actual payment basis.
  3. The trust can choose either FY 2025-26 or FY 2026-27 by filing a declaration in Form 9A.
  4. Financial Year 2025-26, provided the payment is made before the due date of filing the return.
Show answer & explanation

Correct answer: B. Application of income for charitable trusts is computed on a cash/payment basis, not accrual. Even if a liability is incurred in FY 2025-26, the application is only recognized in the financial year in which actual payment is made. This is a strict rule and often a source of errors in student computations.

Q6. An institution's main object is the 'advancement of any other object of general public utility'. Its total receipts for the year are ₹100 lakhs, which includes ₹15 lakhs from a commercial activity. Will the institution lose its charitable status for the year?

  1. Yes, because it has income from a commercial activity, irrespective of the limit.
  2. Yes, because the commercial activity must be purely incidental, which is debatable.
  3. No, because the aggregate receipts from such activity do not exceed the prescribed limit of 20% of total receipts.
  4. No, provided it applies 85% of the total income for its main object.
Show answer & explanation

Correct answer: C. For 'advancement of any other object of general public utility', the limit is 20%. Here, ₹15 lakhs ÷ ₹100 lakhs = 15%, which is within the 20% threshold. The status is retained. If receipts had been ₹21 lakhs or more, the entire status would be forfeited.

Q7. A charitable trust applies a sum of ₹50,000 for the benefit of its trustee. What are the tax consequences of this application?

  1. The entire income of the trust will be denied exemption for the year.
  2. Only the amount of ₹50,000 applied for the benefit of the trustee will be denied exemption and be taxed as 'specified income' at 30%.
  3. The entire income of the trust will be denied exemption and be taxed at the maximum marginal rate.
  4. The entire income of the trust will be taxed only if the amount diverted exceeds ₹1,000.
Show answer & explanation

Correct answer: B. Any application for the benefit of a trustee or any non-charitable purpose is deemed "specified income" and is taxed at the flat rate of 30% under Section 11(1)(c). The rest of the income retains exemption. This rule discourages self-dealing by trustees.

Q8. A charitable trust receives an anonymous donation of ₹1,00,000 when its total donations for the year are ₹5,00,000. How much of the anonymous donation will be subject to tax at the special rate of 30%?

  1. ₹5,000 (5% of total donations)
  2. ₹1,00,000 (the entire anonymous donation)
  3. ₹75,000 (₹1,00,000 minus ₹25,000, being 5% of total donations)
  4. Nil, as it does not exceed the higher of ₹1,00,000 or 5% of total donations.
Show answer & explanation

Correct answer: B. The threshold is the higher of ₹1,00,000 or 5% of total donations. Here, 5% = ₹25,000. The anonymous donation of ₹1,00,000 exceeds the higher amount (₹1,00,000 itself), so the entire donation is taxed at 30%. The rule is strict and leaves no relief.

Q9. For an educational institution with annual receipts exceeding ₹5 crore to claim exemption, what is the nature of the business activities it can undertake?

  1. Any business activity is allowed, provided it maintains separate books of account.
  2. Only a business that is wholly unrelated to its main object is permitted.
  3. The business must be incidental to the attainment of its educational objectives and separate books of account must be maintained.
  4. The business profits are entirely exempt, as long as they are applied for educational purposes.
Show answer & explanation

Correct answer: C. When receipts exceed ₹5 crore, the institution must register under Section 12AB and can undertake only ancillary/subsidiary business activity. This business must serve the educational mission (e.g., selling textbooks or uniforms), not be standalone commercial activity. Separate books and the 20% commercial receipt limit still apply.

Q10. A trust registered under Section 12AB has accumulated ₹20,00,000 of its income by duly filing Form 10, specifying its utilisation for a particular project within 5 years. In the 3rd year, it diverts this accumulated amount to an investment mode not specified in the law. What is the consequence?

  1. The entire accumulated amount of ₹20,00,000 will be deemed to be the trust's income in the 5th year.
  2. The entire accumulated amount of ₹20,00,000 will be deemed to be the trust's income in the 3rd year.
  3. The trust's registration will be mandatorily cancelled with effect from the 3rd year.
  4. Only the income earned from the new investment mode will be taxed in the 3rd year.
Show answer & explanation

Correct answer: B. Accumulated income must remain invested only in specified modes. Any diversion to a non-specified investment (e.g., unregulated securities, equities) brings the entire accumulated amount to tax in the year of diversion. This is a harsh penalty designed to enforce strict compliance.

Q11. XYZ Charitable Trust, established for educational purposes, incurs an expenditure of ₹3,00,000 towards the purchase of a new bus for its students. It claims this amount as an 'application of income' during the year. In the subsequent year, the trust claims depreciation on the same bus. Will the depreciation claim be allowed?

  1. Yes, because depreciation is a legitimate accounting expense that must be allowed.
  2. No, because depreciation is expressly disallowed if the cost of the asset was already claimed as application of income.
  3. Yes, provided the total claim (cost of bus + depreciation) does not exceed 85% of the income.
  4. The depreciation amount will be allowed, but it will be treated as income applied only in the year the bus was purchased.
Show answer & explanation

Correct answer: B. Section 11(2) expressly disallows depreciation if the capital asset's cost was already claimed as application of income in an earlier year. The rationale is to prevent double benefit. Once a capital purchase is treated as application, no subsequent depreciation relief is available.

Q12. A political party receives a voluntary contribution of ₹3,000 in cash. Assuming all other conditions for claiming exemption are met, what is the tax consequence?

  1. The entire income of the political party for the year will be denied exemption.
  2. Only the income equivalent to the cash contribution of ₹3,000 will be denied exemption.
  3. The income from the voluntary contribution of ₹3,000 is exempt, as the violation is minor.
  4. The income of the political party from house property, capital gains, and other sources will be taxable, but voluntary contributions remain exempt.
Show answer & explanation

Correct answer: A. Political parties must receive contributions only by cheque or digital means, not cash. A single cash contribution of any amount violates the law and forfeits the exemption on all voluntary contributions for that year. This is an all-or-nothing rule reflecting the transparency mandates of election law.

Q13. An Electoral Trust receives voluntary contributions. For the entire contribution to be exempt from tax in the hands of the trust, what is the minimum percentage of aggregate donations it must distribute to registered political parties during the previous year?

  1. 85%
  2. 90%
  3. 95%
  4. 100%
Show answer & explanation

Correct answer: C. Electoral trusts must distribute at least 95% of aggregate contributions received to registered political parties in the same or preceding financial years. This stringent requirement ensures the trust functions as a conduit, not an accumulator.

Q14. MNO Foundation is a charitable trust with the sole object of 'medical relief'. Its total receipts for the year are ₹80 lakhs, including ₹25 lakhs derived from a trading activity. Will the trust lose its charitable status for the year?

  1. Yes, because the receipts from the trading activity exceed 20% of the total receipts (20% of ₹80 lakhs = ₹16 lakhs).
  2. Yes, because a charitable trust cannot engage in any form of trading activity.
  3. No, because 'medical relief' is an independent object and is not subject to the 20% limit on commercial receipts.
  4. No, provided the income from the trading activity is applied only for the object of medical relief.
Show answer & explanation

Correct answer: C. 'Medical relief' is one of the core charitable objects listed in Section 2(15) and is treated as an independent category. Like 'relief of the poor', it is not subject to the 20% commercial receipt cap. The trust retains its status even though trading receipts are 31.25% of total receipts.

Q15. A charitable trust has accumulated an amount of ₹5,00,000 by complying with all the requirements for accumulation. Later, it decides to donate this entire accumulated fund to another registered charitable institution. Will this donation be treated as an 'application of income' for the donor trust?

  1. Yes, fully allowed as application, as the donation is to another registered charitable trust.
  2. Only 85% of the donation amount will be considered as an application of income.
  3. No, contribution to another trust out of accumulated income is never treated as application of income.
  4. Yes, provided the recipient trust has similar objects to the donor trust.
Show answer & explanation

Correct answer: C. Application of income means expenditure directly on the charitable objects of the trust itself or on activities substantially furthering those objects. A donation to another entity, even if charitable, is not application of the donor's own income and does not count towards the 85% requirement or accumulation compliance.

Q16. The aggregate annual receipts of a hospital, existing solely for philanthropic purposes and not for profit, are ₹5.50 crore. Which of the following is correct regarding its exemption status?

  1. It can claim exemption without approval under the threshold limit since its object is philanthropic.
  2. It is eligible for exemption without application for approval/registration as it is a hospital.
  3. It is outside the automatic exemption limit and must be approved/registered to claim exemption.
  4. It is mandatorily considered to be substantially financed by the Government and is therefore exempt.
Show answer & explanation

Correct answer: C. The automatic exemption (First Regime) limit is ₹5 crore. Any institution with receipts above ₹5 crore—whether hospital, school, or charity—must register under Section 12AB to claim exemption. Crossing ₹5 crore moves the entity into the Second Regime with all attendant compliance obligations.

Q17. A Business Trust (REIT) receives rental income from a real estate asset directly owned by it and an interest income from a Special Purpose Vehicle (SPV). What is the taxability of this income in the hands of the Business Trust?

  1. Both the rental income and the interest income are taxable at the maximum marginal rate.
  2. Both the rental income and the interest income are exempt in the hands of the Business Trust.
  3. Rental income is taxable, and interest income is exempt.
  4. Rental income is exempt, and interest income is taxable.
Show answer & explanation

Correct answer: B. REITs and InvITs are special structures that enjoy exemption on both rental income from directly held assets and interest income from SPVs. This unique exemption is designed to encourage real estate and infrastructure investment. The exemption flows through to unit holders as taxable distributions.

Q18. A non-resident unit holder receives income distribution from a Business Trust (REIT), which is in the nature of interest received from an SPV. What is the applicable TDS rate on this distribution by the Business Trust?

  1. 10%
  2. 5%
  3. 20%
  4. Rates in force, if lower than 5%
Show answer & explanation

Correct answer: B. Distributions from REITs/InvITs to non-resident unit holders are subject to TDS at 5%. This preferential rate reflects the Government's policy to encourage foreign investment in these instruments. Treaty rates, if lower, may apply in specific cases.

Common Exam Traps and How to Avoid Them

Trap 1: Assuming partial exemption. Many students think that if a trust breaches the 20% commercial receipt limit, only the excess is taxed. Wrong. The entire status is lost, and all income is taxable.

Trap 2: Forgetting the payment basis. Students often apply the accrual method (used for computation for regular assesses) to charitable trusts. Charitable trusts use cash basis for application of income. A liability accrued in March but paid in April applies to the next year.

Trap 3: Claiming depreciation after a capital purchase is application. Once a capital asset's cost is claimed as application of income, no depreciation is available in subsequent years. This is expressly disallowed under Section 11(2).

Trap 4: Misunderstanding corpus vs. annual income. A corpus donation must be invested in specified modes; the income/interest earned from it can be applied to charity. Students often confuse the two and incorrectly claim exemption on corpus kept in general savings accounts.

Trap 5: Ignoring the 'higher of' rule for anonymous donations. The threshold is the higher of ₹1 lakh or 5% of total donations. Many students calculate only 5% and miss taxability.

Mock Computation: Putting It Together

Scenario: ABC Charitable Trust (registered under Section 12AB) has the following for FY 2025-26:

  • Total receipts: ₹20 lakhs (₹15 lakhs from donations, ₹5 lakhs from a trading activity incidental to relief of poor)
  • Expenditure on charity: ₹12 lakhs (paid in cash)
  • Anonymous donations: ₹80,000 (out of ₹15 lakhs total donations)
#charitable trusts#educational institutions#political parties#business trusts#CA Final Direct Tax#Section 11 exemption#Section 12AB registration

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