Corporate social responsibility (CSR) is a company's sense of responsibility towards the community and environment in which it operates. It basically refers to a business practice that involves participating in initiatives which benefit the society. Companies are not usually observed engaging into a lot of philanthropic activities. Therefore, as a positive step towards the society, this responsibility has been made mandatory on various companies by the enactment of the new companies act, 2013 (Companies Act) and the Companies (CSR Policy) Rules, 2014 (Rules).
Mr. Sachin Pilot, former minister of State for Corporate Affairs, was of the view that the aim of the CSR law was to encourage "firms to undertake social welfare voluntarily instead of imposing that through 'inspector raj' and [to] make India an attractive and safe investment destination."
The Companies Act provides for CSR on every company1 which has during any of the three preceding financial years2:
- net worth of INR 500 crores or more; or
- turnover of INR 1000 crores or more; or
- net profit of INR 5 crores or more.
The company has to spend, in every financial year, minimum 2% of the average net profits3 of the company made during the 3 immediately preceding financial years. The Companies Act and the Rules have not clarified that the average of net profits for the purpose of CSR would include any loss suffered by a company in a year. However, the logical interpretation is that only the "profits" would be averaged out and not the losses because of the usage of the words "net profits" and not "net earnings" or "net profits/losses".
This criteria would include a lot of companies in India incurring quite a bit of CSR expenditure. Ernst & Young, the audit and advisory company, had estimated that the CSR law would cover about 3,000 companies in India and about USD 2 billion of expenditures on CSR activities.
CSR has been criticised as a mandatory expenditure which is usually tax and that essentially CSR through Companies Act has imposed an additional 2% tax on companies. Companies have also criticised the mandatory clause in the Companies Act as it will decrease the profitability of firms.
However, expenditure on CSR increases firms' profitability by building their image in the eyes of consumers, suppliers and the government. Companies can also strategically differentiate their products from rivals' products in the market on the basis of CSR. As a part of CSR initiatives, two leading companies, Tata Consultancy services and Bharti Airtel had committed to build toilets for girls in schools in the wake of government's Swachha Bharat Abhiyan. Such efforts by the companies will surely be appreciated by the consumers and the society in which these companies operate.
For the convenience of companies, if an Indian subsidiary of a foreign holding company is required to engage into CSR activities as per the Companies Act, then the law permits that such expenditure can be incurred by the foreign holding company for CSR activities in India if, the CSR expenditures are routed through Indian subsidiaries.
On failure by a company to spend such amount, the Board has to specify the reasons for not spending such amount in its report in the general meeting. There is nothing mentioned as to what is a legally valid explanation which gives Boards of the companies scope to provide any sort of explanation which may or may not be reasonable. However, failure to specify the reasons in the report may be punishable with fine which can extend to INR 25,00,000 and every officer of the company who is in default may be punishable with imprisonment for a term which can extend to 3 years or with fine which can extend to INR 5,00,000, or with both.
The Company is required to give preference to the local area and areas around it where it operates for spending the before mentioned amount on CSR activities. However, projects or programs or activities only in India will amount to CSR expenditure.
The above mentioned companies are required to constitute a CSR Committee (Committee) of the Board comprising of at least 3 directors, out of which one director has to be an independent director. Requirement of an independent director is not applicable to an unlisted public company or a private company. Further, a private company having only 2 directors on Board will constitute a Committee with only 2 such directors. For a foreign company, the Committee will constitute of at least 2 persons of which one will be a person4 resident in India authorized to accept on behalf of company service of process and any notices or other documents required to be served on such company and another person will be nominated by the foreign company.
This Committee is required to formulate and recommend to the Board, a CSR Policy (Policy) to indicate the list of projects or programs to be undertaken by the company falling within the purview of the Schedule VII5 of the Companies Act, specifying the modalities of execution of such projects or programs and implementation schedules for those projects or programs. It has been clarified that the activities provided under the Schedule VII of the Companies Act should be interpreted liberally so as to capture the essence of the subjects enumerated in such Schedule. Further, CSR activities cannot include activities undertaken in pursuance of normal course of business of a company. Any project or program or activity benefitting only the employees of the company and their families will not be considered as CSR under the Companies Act. Also, contribution to any political party directly or indirectly will not be considered as CSR activity.
Along with the CSR policy, such Committee is required to recommend the amount of expenditure to be incurred on the CSR activities and also has to monitor the Policy of the company. The Committee has to institute transparent monitoring mechanisms for implementation of the CSR activities.
The Board after approving the recommendations made by the Committee has to disclose the contents of such Policy in its report and also on the company's website, if any, in the format provided under the Rules. It is the responsibility of the board to ensure that all the activities included in the Policy are undertaken by the company.
For ease, a company is allowed to collaborate with other companies for undertaking projects or programs or activities in a manner that the Committees of the respective companies are in a position to report separately on such projects or programs or activities. Further, the Board can undertake its CSR activities through a registered trust or a registered society or a company established by the company or its holding or subsidiary for charitable objects or otherwise if the company has specified the project or programs to be undertaken through these entities, the modalities of utilization of funds on such projects and programs and the monitoring and reporting mechanisms. However, if such trust or society or company is not established by the company or its holding or subsidiary, it should have an established track record of 3 years in undertaking similar programs or projects.
Even though the Companies Act and the Rules do not prescribe for any specific provision for penalty if a company fails to spend on CSR, a company may be covered under the general provision of penalty which is for those contraventions for which there has been no penalty or punishment provided elsewhere under the Companies Act. This general provision of penalty provides for a fine which may extend to INR 10,000, and where the contravention is continuing one, with a further fine which may extend to INR 1000 for every day after the first during which the contravention continues. Even though the amount of fine might not be substantial for a company to pay, it might still give the company a bad name and effect its goodwill and reputation in the market.
There is ambiguity regarding the tax treatment of amount spent on CSR activities. However, logically, depending upon the type of CSR activity done by the companies, tax benefits may be available to such companies accordingly.
In light of above, CSR provisions under the Companies Act and the Rules will ensure a better society as the companies are being obligated to return back to the society what they take from the society. Even though such stringent CSR requirements may be criticised by some as a mandatory expenditure, it is definitely an encouraging initiative to bring about a positive difference to the society in which these companies operate and make it a better place.
Footnotes
1 Company can also be a foreign company having branch office or project office in India.
2 Ministry of Corporate Affairs by way of General Circular No. 21/2014 clarified that the threshold limits of CSR are to be checked for the three preceding financial years.
3 "Net Profit" means the profit of a company as per its financial statement prepared in accordance with the provisions of the Companies Act, but will not include the following, namely: a) any profit arising from any overseas branch or branches of the company, whether operated as a separate company or otherwise; and b) any dividend received from other companies in India, which are covered under the CSR provision of the Companies Act and are complying with such provision.
4 At the time of registration of foreign company, documentation with respect to such a person is submitted with the Registrar.
5 Schedule 7 of the Companies Act provides a list of activities which may be included by companies in their Policy.
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.
