India: Corporate Social Responsibility

"A good company delivers great products and services but a great company does that and makes the world a better place". This statement by William Ford Junior, Chairman of the Ford Motor Company seems very apt to introduce the topic of corporate social responsibility not just for the statement but because of the person making it. Ford Motor Company is said to have increased wages for its own employees so that it could create a market for cars to be purchased. So while it did social good, it benefitted the company too enormously. If all companies believe they can achieve this, corporate social responsibility would be a far bigger success than what the lawmakers could have dreamed of achieving with this new legislation.

While there is indeed a philosophical and policy debate about whether the concept of corporate social responsibility is something that can be mandated, the purpose of this article is not to debate that point but to examine what exactly has been now mandated by the law. Section 135 of the new Companies Act, 1913 (Act) mandates that all companies which satisfy anyone one of the following criteria; (i) a turnover of 1000 crores, (ii) a net worth of 500 crores or (iii) a profit of 5 crore and above need to spend 2% of their profit on its corporate social responsibility policy. Profit means net profits before tax with the average calculated over a block of 3 years. What activities constitutes corporate social responsibility (CSR) activities is indicated in Schedule VII of the Act and includes among others, eradication of hunger and poverty, education, gender equality, women empowerment, environmental sustainability and enhancing vocational skills. The law is not very clear whether the list in Schedule VII is exhaustive or illustrative. There is a contradiction in a couple of provisions which makes the issue hazy. Several companies are therefore taking a conservative view and currently sticking with only Schedule VII identified matters. This is unfortunate for some needy sections such as senior citizens care, care for differently abled which are not specifically covered in Schedule VII. It would be good to get early clarity on this. It is important to note that activities undertaken exclusively for the benefit of employees or their families will not be considered as CSR.

Now that we know which companies have this obligation and what the financial obligations are, let us examine what exactly these companies are required to do. Before these companies actually get down to spending that money, they need to do a few things. They need set up a corporate social responsibility committee consisting of 3 directors including one independent director. This corporate social responsibility committee is required to create a social responsibility policy. The Board of the company must then ensure that the policy is followed and activities specified in such policy are undertaken by spending the 2% profits. If it does not spend it, it has to explain with reasons, why it was not spent. The draft rules framed under this go on to provide some additional clarity on various aspects of this law including the dos and don'ts for a company. A company can implement the activities through charitable organisations provided they satisfy certain criteria. A company cannot spend solely on its own employees' welfare and claim that such expense is part of the corporate social responsibility. Only activities undertaken in India qualify as CSR activities for the purpose of compliance of this law. Companies may pool resources with other companies and undertake CSR activities.

All this seems simple enough but the law and the draft rules still leave a lot of questions unanswered and need more clarity or some changes.

Take for instance, the need to have 3 directors including one independent director. If you are a small private company (and in today's world, just because you have 5 crores in profit does not make you large), you are unlikely to have an independent director; you are not even required under law to have an independent director. In fact you need not even have 3 directors and can have only 2 directors. So it seems a little harsh to insist on such a third director and that too an independent one just to ensure corporate social responsibility whilst that additional money could have itself been spent on a socially responsible cause.

Can any portion of this 2% be spent on administrative expenses which will be inevitable (such as hiring people to do or monitor the activities) or is such administrative expense over and above the 2%? There is no clear answer to this. However since the wordings of Section 135 states that this 2% should be spent 'in pursuance of the CSR Policy', one may be able to take the view that administrative expenditure related to CSR would also be considered as part of the 2% spend.

It is also not quite clear as to the precise obligations of a Company in execution of the CSR. The rules permit companies to work through NGOs but mandates that the Company must ensure that the policy is complied with. Does this mean that a company cannot pass on all the money to an umbrella NGO which ensures that the money is then passed on to various other NGOs working on the ground in the required activities and such umbrella NGO provides suitable reports to the Company? Is the Company required to personally supervise and ensure compliance by itself or by giving it to NGOs that are themselves doing the actual ground work. In view of the lack of clarity, most companies would hesitate to give money to NGOs which will only perform the role of supervisor and administrator to other NGOs and organisations doing the actual work.

Another glaring issue is the consequence of non-compliance. There are clear penal consequences if you fail to even set up the CSR committee, fail to create a policy etc. However if you fail to spend the money, you only have to report this along with reasons. Failure to so report has a clear penal consequence with fine etc. However once you report, there is no penalty for actually not spending the money. This seems at first glance acceptable as the new law is meant more to push companies to do more for social good and hence not something to be treated as demanding a harsh non-compliance provision. However it seems that the law would have been better served if certain penal consequence for non-compliance with spending for a continuous or prolonged period of time had been provided. The good part is that if the report does not really give good and bona fide reasons, the directors can be hauled up for failing in their duty to take reasonable care, skill and diligence under Section 166 of the Companies Act. Proper use of Section 166 can then compel genuine compliance with this Section.

The CSR policy also needs tax clarity. The fundamental question whether CSR spend can be considered as tax deductible is yet to be clarified. One hopes that this clarity comes soon.

These issues surely can and will be quickly ironed out. The fact is that there is a definite policy now in place and now that there is a law, time for companies or anyone else to crib and criticise are over. Companies are better off strategizing on how best to implement this and maximise benefits to themselves while maximising social good. A good CSR policy well implemented can clearly have immense benefits to the brand value of the Company, can result in an inspired and motivated work force and attract more customers and investors. In the end, it may be that Companies end up actually welcoming the law as a boon that opened their eyes to new possibilities and take the company to a different level. If this happens, the law would have more than served its purpose.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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