In a ruling that will have a significant implication on local authorities set up under state legislations, the Supreme Court has held that they are not eligible for income tax exemption, overruling a Rajasthan High Court order. 

A top court bench gave its ruling on October 12, 2018 in respect of the Urban Improvement Trust constituted under Rajasthan Urban Improvement Act, 1959. 

The Supreme Court, while reviewing the scheme of Rajasthan Urban Improvement Act and the Rajasthan Municipalities Act, observed that though the assessee undertakes development in the urban area included in municipality or municipal board, it is not constituted in place of the municipality or municipal board. 

It noted that deletion of “authorities” listed in erstwhile Section 10(20A) of the Income Tax Act through an amendment in 2002 was a clear indicator that such authorities, which were hitherto enjoying exemption, shall no longer be entitled to enjoy it. 

Vikas Vasal, national leader tax at Grant Thornton India LLP, said the ruling provides clarity on taxation of local authorities. Although they perform activities similar to those performed by municipalities, local authorities are not to be treated as ‘municipalities’ per-se for tax benefit purposes, he said. 

“Many such authorities constituted under various state legislations would be impacted by the decision,” Vasal told ET. As a corollary, taxpayers making rent and other payments to such authorities will have to review their tax withholding obligations on payments made by them, he said. 

The Income Tax Act exempts income of a local authority under the various heads within its own jurisdictional area or from the supply of water or electricity within or outside its own jurisdictional area. 

The income could include that from house property, capital gains and income from other sources, from a trade or business carried on by it, which arises from supply of a commodity or service other than water or electricity. 

Local authority for this purpose is defined as panchayat as referred to in Article 243D of the Constitution or municipality as referred to in Article 243P of the Constitution or municipal committee and district board, legally entitled to or entrusted by the government with the control or management of a municipal or local fund or cantonment board. 

The Income-Tax Act defined ‘local authority’ under Section 10 (20A) and the income earned by such authorities was exempt from tax. However, this section was deleted by Finance Act 2002 and the tax exemption was covered under Section 10(20). The Finance Act 2002 also amended the definition of ‘local authority’, making it much narrower. 

The tax department held that the assessee is no longer covered by this definition and accordingly its income shall be liable to tax. 

The Rajasthan High Court had ruled in the assessee’s favour, taking the view that since the assessee is carrying on various municipal functions for the benefit of the state government relating to urban development, it was covered by the definition of municipal committee. 

The I-T department challenged this decision relying on a recent Supreme Court decision in case of Noida that was in context of the provisions of Uttar Pradesh Industrial Area Development Act, 1976 and also on the SC’s ruling in a case of Agricultural Produce Market Committee, Narela. 

The top court has now rejected the view held by the high court to rule in the department’s favour. #casansaar (Source - Economic Times)