Comparative analysis between Social Sector Entities- Section 8 companies and Trusts

– Team Corplaw | corplaw@vinodkothari.com

Social sector entities can be of various types like a section 8 company, trust, societies, etc. The common idea behind these entities is the promotion of social welfare activities. Even with the common objective in place, there are various differentiating features between them. This write up is a comparative analysis between two types of social sector entities – Section 8 company and a trust.

A.  Companies with Charitable objects (Sec 8 under the Companies Act, 2013)

The concept of non-profit making organizations or companies with charitable objects in India is quite old as it traces its history to the early 20th century. This concept was first introduced under the Companies Act 1913, then under the Companies Act, 1956. Now, under the Companies Act, 2013 (hereinafter “the Act”), the provision for setting up of non-profit making organizations are enumerated under section 8 of the Act read with Rule 19 and 20 of Companies (Incorporation) Rules, 2014.

Nature of the entity:

As per section 2(20) of the Act, any company incorporated under the Companies Act 2013 or under any previous law shall be considered as “company” for the purpose of the Act. Further, as per section 2(11) of the Act, body corporate includes all companies which are incorporated in India as well as those incorporated outside India. Thus, a section 8 company registered and incorporated under the Act in India will be considered as a body corporate and ultimately a company.

As per Rule 20(1) of the Companies (Incorporation) Rules, 2014, only a limited company registered under this Act or under any previous company law shall make an application to the Registrar for issue of license. Therefore, a company with unlimited liabilities cannot be registered as a Section 8 Company. However, it may be incorporated as a company limited by shares or by Guarantee.

Governing laws:

Section 8 companies are regulated through the Act, accordingly the registration and administration of these companies is regulated only by the Central Government. Earlier a non-profit earning organization was governed under section 25 of the Companies Act 1956. At present, section 8 of the Companies Act, 2013 provides for registration of non-profit earning organizations. They are also regulated by their charter documents i.e. Memorandum of Association and Article of Association.

Number of members:

A section 8 company may be incorporated either as a ‘Private company’ or a ‘Public company’. Having said that as per section 3(1) of the Act, a public company may be formed with seven or more persons and a private company may be formed with two or more persons. If it is incorporated as a private company, then the limitation on maximum number of members (i.e., 200 members) as provided under section 2(68) of the Act shall apply.

A person may become a member of the company by subscribing to its memorandum or by purchasing its shares. Unlike other companies, a section 8 company is prohibited from distributing its profit by way of dividend to its members. Moreover, it also prohibits returning the surplus assets to its members in the event of winding up. Therefore, the entire reasoning behind the issue of redeemable preference shares become futile and therefore, section 8 companies cannot issue such securities. Thus, a section 8 company only has equity shareholders as its members. Our detailed writeup on the same is available on the following link: https://vinodkothari.com/2022/05/utilisation-of-accumulated-surplus-by-section-8-companies/

Before admitting any person as its member, the following restriction/ prohibition must be adhered to:

• Rule 3(6) of the Incorporation Rules prohibits “one person company” to invest in securities of any body corporate, thus a one person company cannot become a member in a section 8 company.
• A Partnership firm or an LLP can become a member of Section 8 Company. The provisions of respective Acts need to be complied with by the partnership firm or LLP as the case may be.^[1]
• As per section 8, any person or association of person may apply for registration of limited company as section 8 company subject to the conditions as specified under the law. A registered co-operative society being an association of person and legal entity may become a member of section 8 company.

Governing body:

In any corporate enterprise, though shareholders are the owners of the entity they rarely exercise the ownership right. The affairs of a company are taken care of by its directors, who are appointed by the members of the company. Like any other company, functions of a section 8 are managed by the board of directors of the company.

Number of members in governing body:

Section 149(1) lays down limitations on appointment of minimum and maximum number of directors in a company. However, as per the exemption notification of the Ministry of Corporate Affairs, dated 05th June, 2015, the said limitation of appointment of minimum and maximum number of directors shall not apply to a section 8 company.

In addition to above except for the appointment of Independent directors, provisions related to appointment of women directors, residential directors shall apply.

As per section 174 of the Act read with exemption notification dated 5th June, 2015, the minimum quorum requirement for conducting a valid Board meeting is minimum 8 members or 25% of its total strength whichever is less. Thus, a section 8 company shall have a minimum of two directors on its Board for holding a Board meeting.

Voting Rights of members:

Section 47 of the Act provides every member shall have a right to vote on every resolution placed before the company. Such voting rights are given to every member of the company limited by shares and holding equity shares. This section will be applicable to a section 8 company in light of section 8(2) of the Act, which provides that a section 8 company shall enjoy all the privileges and be subject to all the obligations of the limited company.

Corpus/capital formation and nature of economic/non-economic activity

1. Economic activity: as per section 8 of the Act, a person or association of person may apply for registration of company under this section if he intends to carry out objects such as promotion of commerce, art, science, sports, education, research, social welfare, religion, charity, protection of environment or any such other object. This type of company is prohibited from carrying out other business activities.

As per Rule 19(2) of the Companies (Incorporation) Rules, 2014, memorandum of association of the Section 8 company shall be in Form no. INC 13. Upon review of the said form, it provides for carrying out such other incidental activities for the furtherance of the main objects of the company.^[2]

Since section 8 companies are incorporated with the intention of promotion of art, science and social welfare etc. the Act places express prohibition on distribution of dividend to its members in any form. Further in light of Rule 22(4), a declaration is required form the Board of Directors of the company that no portion of income or property of the company shall be paid directly or indirectly by way of dividend or bonus or otherwise to the persons who are or have been members of the company.

2. Mode of acquisition of Capital:

Apart from subscribing to the memorandum of the company, a person or association of persons may become a member of the company by way of making an application for allotment or by transfer/transmission of equity share capital of the company or by becoming beneficial owner of the shares or by providing guarantee (if limited by guarantee).

The MCA exemption notification does not provide for exemption from applicability of section 56 of the Act. Thus, shares of a section 8 company are transferable subject to compliance with section 56 of the Act.

Contractual rights:

Like any other company, a section 8 company is a separate legal entity distinct from its members. It is an artificial juristic person and is separate from its owner. Hence, it is capable of enjoying rights. A section 8 company being a company has following characteristics:

1. Ownership of the property: InBacha F. Guzdar v. CIT, Bombay (supra) The Hon’ble Supreme Court held that the company is a juristic person and is distinct from the shareholders. It is the company which owns the property and not the shareholders. A shareholder has got no interest in the property of the company though he has undoubtedly a right to participate in the profits if and when the company decides to divide them.
2. Ability to sue and be sued: A company having a corporate personality has its own name, acts under its name, can own a property, incur a debt, make borrowing and investment, can sue and be sued for the acts done like a living person. A member cannot be held liable for the acts done by the Company, even if he holds the entire share capital.
3. Perpetual succession: A company is an artificial person existing in the eyes of laws. It never dies except when it is wound up. Even if all the members of the company cease to exist, it does not affect its continuity and is unaffected by the death of its members or directors.
4. Borrowing rights: For the purpose of carrying out its objectives, a section 8 company is entitled to borrow funds under section 179 of the Act. There is no restriction on a section 8 company from borrowing funds for its business. However, due to their restrictive nature owing to which they can invest funds only towards the furtherance of their foundational objectives, such companies are often kept out of the lending portfolios of commercial financial institutions. As a result, these companies look for other methods of raising funds. Section 8 companies may look to its own members for the purpose of borrowing funds and pay interest thereupon and such a transaction is not prohibited by law. Such companies may even issue debentures to the public, including its own members. However, any interest or redemption of such debentures must be purely compensatory in nature and done on an arms’ length basis. Redemption of debentures on a premium to its members might be seen as being in contravention to Rule 22 (4) of the Companies (Incorporation) Rules, 2014.^[3]

Regulatory Requirements:

Ease of formation:

Filing requirement: Every company incorporated in India is required to file annual returns specifically under the Companies Act, 2013 and Income Tax Act, 1961. Applicable e-forms must be submitted to the MCA/IT authority within the period prescribed under the law.

Apart from event-based filing, section 8 company is required to file following periodic forms:

S.no	Form	Applicable provision
1.	MGT-7A/7	Sec 92 of the Companies Act, 2013
2.	AOC-4	Sec 129, 137 of the Companies Act, 2013
3.	DIR-8	Sec 164(2) of the Companies Act, 2013
4.	MBP-1	Sec 184(1) of the Companies Act, 2013
5.	DIR-3KYC	Sec 153 of the Companies Act, 2013
6.	ADT-1	Sec 139 of the Companies Act, 2013
7.	ITR-6	Exempted for companies with charitable object

Accounts and audit regulations: The provision of section 129 pertaining to financial statements and section 139 for appointment of the auditor of the company are applicable to the section 8 company. Hence, a section 8 company is required to prepare its financial statement as per schedule prescribed under section 129 and shall also appoint a statutory auditor under section 139.

Treatment on dissolution: Existence of a section 8 company may be discontinued under following provision:

Voluntary Liquidation u/s 59 of IBC 2016:

The Company being a ‘corporate person’ as defined u/s 3(7) of the Insolvency and Bankruptcy Code, 2016 (IBC 2016) is entitled to initiate liquidation voluntarily u/s 59 of IBC 2016.

As per section 8(9) of the Act, in the event of winding up or dissolution of a company registered under this section, there remains, any asset remaining after paying of and settling all the debts and liabilities, may be either transferred to another company registered under this section and having similar objects, subject to such conditions as the Tribunal may impose, or may be sold and proceeds thereof credited to Insolvency and Bankruptcy Fund formed under section 224 of the Insolvency and Bankruptcy Code, 2016.

Strike off under section 248 of the Act:

The provisions relating to strike off provide an opportunity to the dormant companies to get their names struck off from the records of the ROC.^[4] A company can be struck off by two modes as given:

1. Removal of name by Registrar on suo moto basis under section 248(1) of the Act; or
2. Application by the company for removal of its name under section 248(2) of the Act.

The Act clearly mentions that a company registered under section 8 cannot apply suo moto for strike off under section 248(2). Further, first proviso to Rule 3(1) of Companies (Removal of names of companies from the register of companies) Rules, 2016 specifically exclude companies registered under section 25 of the Companies Act, 1956 or section 8 of the Act. Therefore, a section 8 company cannot be struck off from register either by Registrar on suo moto basis or by making an application itself.

Revocation of license u/s 8(6) of the Act:

If the company:

1. contravenes provision of section 8 or
2. Violates conditions subject to which license was granted or
3. Conducts its affairs in fraudulently

The Central Government may revoke the license granted to a company registered under this section or may pass such other order as provided under said section. However, an opportunity of being heard to be given before passing such an order.

As per Rule 23 of Company (Incorporation) Rules, 2014, an intimation of such revocation or surrender of license u/s 8(6) shall be filed with the Registrar by the company in eForm INC-­20.

Corporate Restructuring:

Section 8(10) provides that a company registered under section 8 shall amalgamate only with another section 8 company which have similar objects. In view of this, it cannot amalgamate with a non-section 8 company. As per the FAQs released by ICSI on section 8 company, it was mentioned therein that so long as the main objects of two section 8 companies are within the objects specified under section 8 (1) (a) the objects will be considered similar because the similarity between the objects are established by the fact that with either of such objects the said companies can be registered as section 8 companies. It is not necessary that the objects of the two section 8 companies be identical. The words “having similar objects” should not be read in a limited sense.

In case of demerger, there seems to be no restriction. A section 8 company may demerge and transfer any of its division or undertaking to another company. However, considering the restriction placed under section 8(10) for the purpose of amalgamation, an inference may be drawn that the resulting company should also be registered under section 8 and having similar objects.

Restriction on payout to Managers/Contributors:

As discussed above, section 8 company is prohibited from distribution of its income in any manner to its members whether directly or indirectly. Having said that, if a member also happens to be a director of said Company, he will not be entitled to any remuneration or other benefit from the company except for reimbursement of out-of-pocket expenses. In all other cases, a non-member director or manager may be paid remuneration.

Moreover, sub-section 9 of section 8 provides for transfer of net assets to another section 8 company in case of winding up or dissolution. Thus, there exists strict prohibition upon distribution of its Income or profit to members during its life and even after its winding up or dissolution.

Income Tax Treatment:

According to Section 2(15) of Income Tax Act, 1961, “charitable purpose” includes relief of the poor, education, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest, and the advancement of any other object of general public utility.

Section 8 companies get exemption from income tax under section 80G and section 12A provided, it is registered.

Under the Income Tax Act, 1961, the donors of Section 8 Company may claim a 50% rebate against the donations they made. Under Section 80G, it shall be valid for a period of one to three years. If Section 8 Company got registered under section 12AA (tax exemption) of the Income Tax Act, then its profits shall be entirely exempted, and no tax will be levied on the company.

B.  Trust 

A Trust is a relationship in which a person or entity holds a valid legal title to a certain property which is known as the Trust property. The Trust is bound by a fiduciary duty to exercise that legal title for the benefit of any one or more individuals or group of individuals or organizations, who are known as the Beneficiaries. The Trust shall be governed by the terms of the Written Trust agreement.^[5]

Section 3 of Indian Trust Act, 1882, defines the term “Trust” as an obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner.

A trust may be created for any lawful purpose. If the purpose is such that it is forbidden by law, or it is of such that it would defeat the provision of law, or is fraudulent or causes injury to the person or property of another, or the court regards it as immoral or opposed to public policy.

Trusts can also be used as a vehicle for investments, such as mutual funds and venture capital funds. These trusts are governed by the Securities and Exchange Board of India (SEBI).

Nature of entity:

The term ‘body corporate’ has been defined under section 2(11) of the Companies Act, 2013. The said section provides an inclusive definition. In this regard one may refer to Daman Singh and Ors. V. State of Punjab and Ors AIR 1985 SC 973 in which reference was made to the definition of a ‘corporation’ in Halsbury’s Laws of England, 4th Edition, Volume 9, Paragraph 1201, it is said, “A corporation may be defined as a body of persons (in the case of a corporation aggregate) or in office (in the case of a corporation sole) which is recognised by the law as having a personality which is distinct from the separate personalities of the members of the body or the personality of the individual holder for the time being of the office in question.”^[6]

Further, in paragraph 1204 a corporation aggregate has been defined as “A corporation of individuals united into one body under a special domination having perpetual succession under an artificial form, and vested by the policy of law with the capacity of acting in several respects as an individual, particularly of taking and granting property, of contracting obligations and of suing and being sued, of enjoying privileges and immunities in common and of exercising a variety of political rights, more or less extensive, according to the design of its institution, or the powers conferred upon it, either at the time of its creation or at any subsequent period of its existence.”

Based on the above definition, a body corporate has following characteristics:

1. Distinct from its members
2. Perpetual succession
3. Own a property
4. Can sue and be sued

In Duli Chand v Mahabir Prasad Trilok Chand Charitable Trust AIR 1984 Del 144 the court observed that “It is well-known that a Trust is not a legal entity as such… Thus all Trustees in law are owners of the property but they are obliged to use the same in a particular manner….. It is not like a Corporation which has a legal existence of its own and therefore can appoint an agent. A Trust is not in this sense a legal entity. It is the trustees who are the legal entities.” 

Governing laws:

Private trusts are regulated by the Indian Trusts Act, 1882, whereas public trusts are classified as Charitable and religious trusts. The Charitable and Religious Trust Act, 1920, the Religious Endowments Act, 1863, the Charitable Endowments Act, 1890, the Societies Registration Act, 1860, and the Bombay Public Trust Act, 1950 are the relevant legislations for the recognition and enforceability of public trusts.

The Indian Trusts Act, 1882 for Private Trusts and general law for Public Trusts except states like Gujarat, Maharashtra where they have separate public trust acts.

Number of members:

There is no limit on the maximum number of trustees. But a minimum of two trustees are necessary to form a Trust and there is no upper limit. Also, the author generally cannot be the trustee.

Governing body:

The trustee(s) are supposed to manage the trust property for the beneficiaries. Section 10 of the Indian Trusts Act, 1882, states about who may be a trustee. It states that “Every person capable of holding property may be a trustee; but, where the trust involves the exercise of discretion, he cannot execute it unless he is competent to contract.”

Contractual Rights:

In the case of M.C. Chacko v. State Bank of Travancore, 1970 AIR 500, the Supreme Court states that “It has however been recognised that where a trust is created by a contract, a beneficiary “may enforce the rights which the trust so created has given him. The basis of that rule is that though he is not a party to the contract his rights are equitable and not contractual.”

Rights of Trustee under the Act are as follows:

1. Right to Title-deed: As per Section 31, A trustee is entitled to have in his possession the instrument of trust and all the documents of title (if any) relating solely to the trust-property.
2. Right to reimbursement of expenses: As per Section 32, Every trustee may reimburse himself, or pay or discharge out of the trust-property, all expenses properly incurred in or about the execution of the trust, or the realization, preservation or benefit of the trust-property, or the protection or support of the beneficiary.
3. Right to be recouped for erroneous over-payment: Where a trustee has by mistake made an over-payment to the beneficiary, he may reimburse the trust-property out of the beneficiary’s interest. If such interest fails, the trustee is entitled to recover from the beneficiary personally the amount of such over-payment.
4. Right to indemnity from gainer by breach of trust: As per Section 33 of the Act, a person other than a trustee who has gained an advantage from a breach of trust must indemnify the trustee to the extent of the amount actually received by such person under the breach; and where he is a beneficiary the trustee has a charge on his interest for such amount.
5. Right to settlement of accounts: As per Section 35 of the Act, a Trustee is entitled to have the accounts of his administration of the trust-property examined and settled; and, where nothing is due to the beneficiary under the trust, to an acknowledgment in writing to that effect.
6. General authority of trustee: As per Section 36 of the Act, a trustee may do all acts which are reasonable and proper for the realization, protection or benefit of the trust-property, and for the protection or support of a beneficiary who is not competent to contract.

Sources of Fund from outside India  

Section 11 of the FCRA, 2010 prescribes that no person, save as otherwise provided in the Act, shall accept foreign contribution unless such person obtains a certificate of registration or prior permission of the Central Government.

Periodic Form Filing of Trust

Income Tax Act has prescribed the following forms:

Two separate forms have been prescribed for a trust, institution, or NGO as per the new rules:

• Form No. 10A: For provisional registration.
• Form No. 10AB: For conversion from provisional registration to permanent registration.

Permissible Business Activity

Trusts formed for charitable or religious purposes which are not intended to do commercial activities are allowed various benefits under the Income-Tax Act, inter-alia, exemption under section 11.^[7]

Management and voting rights

The scheme of management of the Trust mainly by Trust members, who alone had the right to attend and vote at the Annual General Meeting of the Trust and to appoint Ordinary Trustees which comprise the Managing Committee of the Trust.

Income Tax Treatment:

Section 160(1) (iv) of the 1961 Act recognizes the trustee of a trust to be its representative for tax purposes. Section 161(1) of the 1961 Act provides for a situation where a trustee could be taxed in a representative capacity “in like manner and to the same extent the beneficiaries would have to pay tax.” Section 161(1A) provides for a situation where the trust could be taxed at maximum marginal rate, if the income of the trust includes business profits. Section 164 of the 1961 Act lays that in case the beneficiaries are not identifiable and their share of income is not ascertainable, the trust is to be taxed at maximum marginal rate.

In terms of Section 11 of the 1961 Act, income of public trusts for a religious or charitable purpose are exempted from payment of tax on their income given that such trusts are registered under the 1961 Act in Form 10A.

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^[1] FAQs on Section 8 Companies issued by Institute of Company Secretaries of India, accessible on: https://www.icsi.edu/media/webmodules/publications/FAQs_on_Section_8_Companies.pdf

^[2] FAQs on Section 8 Companies issued by Institute of Company Secretaries of India, accessible on: https://www.icsi.edu/media/webmodules/publications/FAQs_on_Section_8_Companies.pdf

^[3] Access our detailed write up on Section 8 company on : https://vinodkothari.com/2022/05/utilisation-of-accumulated-surplus-by-section-8-companies/

^[4] ICSI module on Setting up of business entities and closure: https://www.icsi.edu/media/webmodules/26112021_Setting_up_of_Busines_Entities_&_Closure.pdf

^[5] ICSI Setting up of Business Entities and Closure executive module.

^[6] Read the entire text of the ruling at: https://indiankanoon.org/doc/408851/

^[7] https://www.casemine.com/judgement/in/5608fabfe4b01497111482cd#22