ITAT Clarifies Taxability of Long-Pending Student Caution Money Under Section 41(1)

Background of the Dispute

The case of Sh. Chander Chinar Bada Akhara Udaseen Society Vs ITO, (Exemption) came up before the ITAT Amritsar in I.T.A. No.314/Asr/2025, arising from an assessment framed under Section 143(3) of the Income Tax Act 1961 for Assessment Year 2017-18.

The assessee, a charitable trust registered under Section 12AA, was engaged in managing a hospital, medical college and nursing college. For AY 2017-18, it filed a return of income declaring nil income, claiming exemption under Sections 11 and 12.

During scrutiny assessment, the Assessing Officer (AO) took three primary actions:

  1. Denied exemption under Sections 11 and 12, invoking alleged violations of Section 13(1)(c) and Section 13(1)(d).
  2. Added ₹56,95,846 under Section 41(1) on account of unrefunded student caution money reflected as liability in the balance sheet.
  3. Disallowed interest of ₹11,65,504 paid to specified persons, treating it as excessive under Section 40A(2) read with Section 13(3).

The assessee challenged these actions in appeal.

Findings of the Commissioner (Appeals)

The CIT(A), NFAC, Delhi, partly accepted the assessee’s contentions:

  • On exemption under Section 11, the CIT(A) held that the denial could only extend to income hit by Section 13(1)(d) and restricted the disallowance accordingly.
  • On interest disallowance under Section 40A(2), substantial relief was given, reducing the disallowance from ₹11,65,504 to ₹1,59,744.

However, the CIT(A) upheld:

  1. The addition of ₹56,95,846 under Section 41(1) towards caution money collected from students prior to FY 2011-12.
  2. The reduced disallowance of ₹1,59,744 on account of interest paid at 18% to specified persons.

CIT(A)’s Reasoning on Caution Money

The CIT(A) viewed the outstanding caution money pertaining to periods prior to 2011-12 as a “static liability”, reasoning that:

  • Caution deposits had been collected year after year and shown as a liability.
  • In respect of batches where sufficient time had elapsed for course completion and claim of refund, no refund had actually been made.
  • The assessee had, in effect, enjoyed the benefit of such deposits for several years without refunding them.
  • This, according to the CIT(A), amounted to cessation of liability within the scope of Section 41(1).

The CIT(A) further stated that if any caution money were refunded in a subsequent year, the assessee could claim a deduction in that year.

CIT(A)’s View on Interest to Specified Persons

In relation to interest paid at 18% on unsecured loans from specified persons, the CIT(A):

  • Noted that interest at 18% was also paid to unrelated parties.
  • Nevertheless, considered 18% as an excessive rate when paid to specified persons.
  • Restricted the disallowance to ₹1,59,744, treating this portion as excessive interest under Section 40A(2).

Grounds Raised Before ITAT

The assessee took the matter to the Tribunal, challenging, among others, the following issues:

  • Addition of ₹56,95,846 under Section 41(1) on account of student caution money.
  • Confirmation of disallowance of ₹1,59,744 representing excess interest to specified persons.

Ground No. 3 regarding a separate aspect of interest disallowance (₹11,65,504) was specifically withdrawn during the hearing before the Tribunal.

Nature and Treatment of Caution Money – Assessee’s Stand

The assessee’s Authorised Representative (AR) submitted a detailed explanation regarding the character of the student caution money:

Character of Caution Money

  • Caution money was described as security deposits received from students pursuing:
    • MBBS (5 years + 1 year internship),
    • PG/MD (3 years), and
    • Nursing (3 years).
  • These amounts were taken at the time of admission and kept as a refundable deposit.
  • Refund became due only after:
    1. Completion of the course (and internship where applicable),
    2. Issue of No Objection Certificate (NOC) from all concerned departments,
    3. Submission of a formal refund request by the student.

The AR clarified that:

The caution money was never recognized as income but consistently shown as a liability in the balance sheet.