The Companies Act, 2013 (CA 2013) has introduced path-breaking changes in governance mechanisms, compliances and disclosures, appointment and scope of auditors, responsibilities of independent directors, investor protection and mergers and acquisitions. Introduction of new concepts like ‘corporate social responsibility’ for the first time anywhere in the world is in line with global thinking on corporate giving for social causes.
The origin of this idea is the expectation from government that companies need to spend time, money and effort to meet their social obligations and contribute to social and public welfare on an ongoing basis. Specified companies that make profits are required to set aside a portion of such profits and spend the same in promoting certain notified causes.
Applicability of corporate social responsibility provisions
Section 135 and Schedule VII of CA 2013 and Companies (Corporate Social Responsibility) Rules, 2014 (CSR Rules) state that companies incorporated in India and a foreign company having branch and/ or project office in India, having an annual turnover of at least INR 10 billion and more, or a net worth of at least INR 5 billion, or a net profit of at least INR 50 million must spend 2% of their average net profits made during the three immediately preceding financial years on social activities prescribed in Schedule VII. The section is not applicable to a company which ceases to meet the above criteria for three consecutive years. The term ‘net profit’ as defined under Rule 2(f) of CSR Rules excludes dividend income received from another Indian company and profits made by the company from its overseas branches.
Rule 2(c) of CSR Rules defines corporate social responsibility to mean and include projects or programmes relating to activities specified in Schedule VII to CA 2013. Within these parameters, which the government has also stated are to be interpreted liberally in order to allow companies the flexibility of deciding on its CSR projects, a company may decide the activities that it will undertake for this purpose.
Compliance of CSR provisions
Rule 2(d) of the CSR Rules provides that every company which meets the above-mentioned criteria is required to constitute a CSR Committee of the Board of Directors consisting of three or more directors, one of whom must be an independent director. An unlisted public company or a private company, which is not required to appoint an independent director, need not have an independent director on its CSR Committee and the CSR Committee of such private company having only two directors can be constituted with only those two directors.
In respect of branch office/ project office of a foreign company, the CSR Committee must consist of at least two persons, of which one person must have the authority to accept notices or other documents on behalf of the foreign company in India and the other person should be the one who is nominated by the foreign company.
The CSR Committee is required to formulate and recommend a CSR policy to the Board indicating the activities to be undertaken and expenditure for such activities. The CSR policy once approved by the Board should be disclosed in its report and must also be made available on the company’s website, if any.
The CSR Committee also monitors the CSR activities on a regular basis as well as the expenditure for the same to ensure that the company spends 2% of the average net profit of the three immediately preceding years on such activities. Further, in case the company fails to spend the requisite amount, the CSR Committee is required to disclose the reasons for such non-spending in its report.
CSR activities
Schedule VII of the CA 2013 lists out the activities which may be included by companies in their corporate social responsibility policies. The activities listed in Schedule VII aim at reducing inequalities faced by socially and economically backward groups such as eradicating hunger and promoting health care and sanitation; promoting education and gender equality; setting up homes and hostels for women and orphans; setting up old age homes; ensuring environmental sustainability, ecological balance; conservation of natural resources and maintaining quality of soil, air and water; protection of national heritage, art and culture; measures for benefit of armed forces veterans/ war widows; promotion of rural sports; slum development, contribution to Prime Minister’s National Relief Fund; rural development projects, etc. The government has also stated that the activities are to be interpreted liberally and companies are permitted the flexibility to decide on the activities as long as they are within the broad framework of Schedule VII.
Vehicle for undertaking CSR activities
A company can undertake CSR activities through its holding, associate or subsidiary company or even through a trust, society, or a company incorporated under section 8 of the Companies Act, 2013. However companies should ensure that trust, society or such company not established by the company should have an established track record of three years in undertaking similar programmes or projects. Companies can join together to undertake these activities as long as they are able to monitor progress and spending of their contribution.
In terms of the CSR Rules, projects or programmes or activities undertaken in India only would amount to CSR spend under Section 135. Moreover, CSR programmes or activities that benefit only the employees of the company and their families or any activities that are undertaken in the normal course of its business are excluded for this purpose. Companies are also required to give preference to local areas and areas around it which it operates for spending the amount earmarked for CSR activities.
Critical analysis
Though the principle of CSR is laudable and pioneering in principle, there are some practical difficulties and legal lacunae in implementing the same. Section 135 of CA 2013 only applies to ‘companies’ incorporated in India, however the CSR Rules overreach the statutory provision and attempt to cover and regulate the branch or project office of the foreign company though in general the rules cannot overrule the Act.
Further, taxability of expenditure incurred by a company while complying with the corporate social responsibility provisions are an added concern. Since the rules specify that CSR activities will exclude normal business activities and tax deductibility will only be available for such projects, no tax deduction will be available for CSR activities undertaken by the company. However, if a company discharges its CSR obligations by contributing to a trust, society or the PM Relief Fund, which have a general tax exemption, the company may avail of the benefit of the same.
The clause is also enacted on the basis of “gentle and firm persuasion” since it is based on ‘expense or explain’ principle by permitting a company to explain the reason for not undertaking any CSR activity, there are no penal provisions for not doing or spending. The real challenge thus lies in execution and effective implementation of corporate social responsibility provisions to achieve a higher level of corporate governance and social responsibility.
[The author is a Principal Associate, Corporate Practice, Lakshmikumaran & Sridharan, New Delhi]