Spending your income: the 85% rule and accumulation

A registered NGO’s income stays tax-free only if it spends most of it on its charitable purposes in the same year. Under the Income-tax Act, 2025 the rule is in Section 336 (formerly section 11(1)(a)): if at least 85% of the organisation’s regular income is applied to its purposes in India, or accumulated for a stated purpose, in the tax year, its taxable regular income is nil.

The rule sounds simple, but “applying” income has precise limits, and money set aside needs the right form by the right date. This guide explains how the 85% rule works, what counts and what doesn’t, deemed application, accumulation for up to five years, investments and benefits to insiders, with worked examples. It is for NGO finance teams, trustees and their chartered accountants (CAs).

How a registered NGO’s income is taxed

Section 334 sorts a registered non-profit organisation’s income into three kinds:

• Regular income (Section 335): income from its registered charitable or religious activities, income from property, deposits or investments held for those purposes, voluntary contributions such as donations and grants, and gains from permitted commercial activity. The 85% rule applies to this.
• Specified income (Section 337): income that has broken one of the rules, listed in a table in the Act. It is taxed at a flat 30%.
• Residual income: anything else, taxed at normal rates.

Some receipts are left out of regular income altogether (Section 338): corpus donations, which have their own rules (see corpus and anonymous donations), and income applied outside India, but only where the CBDT has permitted it. Without that permission, income applied outside India is specified income.

The 85% rule, worked through

What counts as applying income

Money paid for the registered purposes in India during the tax year counts (Section 341(1)). It is a payment test: a bill still unpaid on 31 March counts in the year you pay it, and money promised to a partner counts only when it leaves your account. Spending on equipment or a building for the objects counts when paid.

Two rules borrowed from the business deductions also apply (Section 341(1), applying Sections 35(b)(i) and 36(4) to (7)):

• TDS defaults. If tax should have been deducted at source from a payment and wasn’t, or wasn’t paid to the government by the deadline in Section 35(b)(i), 30% of that payment doesn’t count until the tax is paid. See TDS for NGOs.
• Cash payments. A payment of more than ₹10,000 to one person in a day, made otherwise than through a bank or the prescribed online modes, doesn’t count.

Also counted:

• 85% of a donation to another registered non-profit organisation (Section 341(1)(b)). If you give a partner NGO ₹10 lakh from this year’s income, ₹8.5 lakh counts.
• Putting money back into the corpus, or repaying a loan, within five years of spending it, where that spending from the corpus or the loan happened after 31 March 2021 (Section 341(2)).

What doesn’t count

Deemed application: when money hasn’t arrived

Sometimes income is earned but not received by 31 March, or something else stops an organisation reaching 85%. Section 341(5) to (7) lets it opt to treat the shortfall as applied in the year, and then spend it later:

• where the income wasn’t received during the year, in the year it is received or the year after;
• for any other reason, in the next tax year.

The option is exercised in Form 108 (formerly Form 9A) by the due date of the return.

Accumulating income for a purpose

When an organisation is saving for something specific, such as a building, a new centre or a multi-year programme, it can accumulate or set apart part of its regular income for up to five years (Section 342). The conditions:

• File Form 109 (formerly Form 10) by the due date of the return under Section 263(1), stating the purpose and the period. Miss it and the accumulation isn’t allowed.
• Invest the money in the permitted modes, or apply it to the stated purpose.
• Use it for the stated purpose within the period. Time lost to a court order or injunction doesn’t count.
• Don’t pass it on. Accumulated income can’t be paid to another registered non-profit organisation (Section 342(2)).
• Ask before changing the purpose. A change of purpose needs the Assessing Officer’s permission (Sections 342(5) and (6), with new Forms 110 and 111). On dissolution, the Assessing Officer may let accumulated income go to another registered non-profit organisation (Section 342(7)).

Accumulated income that is misapplied, not applied in time or paid to another registered NGO becomes specified income, taxed at 30%.

The 15%, investments and related persons

The 15%. An organisation that applies at least 85% may keep the rest, up to 15% of regular income. The Act calls it deemed accumulated income, and if it is invested, the investment must be in a permitted mode (Section 343).

Permitted investments. Money held as accumulated income, deemed accumulated income or corpus can be invested only in the modes listed in Schedule XVI, such as bank deposits and government securities, or others the Central Government notifies (Section 350). Investments outside them, and assets not held in a permitted form a year after they are acquired, produce specified income.

Related persons. Income applied, directly or indirectly, for the benefit of a related person is specified income, taxed at 30% (Section 337), and using income other than for the objects can also lead to cancellation (Section 351(1)(a)). Related persons (Section 355(h)) include the founder; anyone who has given more than ₹1 lakh in the tax year, or more than ₹10 lakh in total; trustees and managers; relatives of the founder, trustees and managers; and businesses in which these people hold 20% or more of the voting power or profits. A fair salary for real work can be paid, but take advice before any payment to an insider. See the NGO board.

Common mistakes

• Counting money that hasn’t been paid, such as grants approved but not released, or bills not yet settled.
• Paying suppliers in cash above ₹10,000 a day, or forgetting to deduct TDS, so part of the spending doesn’t count.
• Counting the full value of grants to partner NGOs, when only 85% counts.
• Giving accumulated money to another NGO, which turns it into specified income.
• Missing the Form 108 or Form 109 deadline, which falls on the return’s due date.
• Treating spending from corpus or loans as application in the year it is spent.

The rules interact in ways that are easy to get wrong in a busy year, so ask your CA to check the year’s application and any accumulation before the return is filed. The audit report (Form 112) asks the auditor to report on all of it: see filing the return and audit report.