Commitment to social causes is best done voluntarily. Accordingly, corporate social responsibility (CSR) was originally introduced in Section 135 of the Companies Act, 2013 (Companies Act), in keeping with global best practices, to provide a framework to encourage companies to meaningfully contribute to communities.
The framework was premised on the principle that companies would contribute the prescribed amount in good faith and the requirement ‘to explain’ any failure to contribute, in their board report, was considered a sufficient disincentive to ensure compliance.
In a recent slew of changes, the Government, noting a significant shortfall in compliance, seems to have veered away from the aforesaid principle and has decided to implement a far stricter regime.
The amendment proposed in the Companies (Amendment) Act, 2019 (2019 Amendment Act), which received the assent of the President on July 31, 2019, makes key changes to Section 135.
Briefly, the amendment to Section 135 contemplates the following:
- Profit-making companies will have to mandatorily spend at least 2% of their average net profits, made during the three immediately preceding financial years, on CSR initiatives (Minimum CSR Amount), in accordance with their CSR policy.
- Any unspent Minimum CSR Amount, pursuant to any ongoing project (undertaken in pursuance of its CSR policy) is to be transferred within 30 days from the end of the financial year to a special account called the Unspent CSR Account. Such amount is to be spent by the company in pursuance of its CSR policy within three financial years from the date of such transfer, failing which, the same is to be transferred to a fund specified in Schedule VII of the Companies Act within 30 days from the date of completion of the third financial year.
- If the unspent amount does not relate to any ongoing project, the company would be required to transfer such unspent amount to a fund specified in Schedule VII, within a period of six months of the expiry of the financial year.
- Non-compliance with the amended CSR provisions can lead to penal sanctions for the company (fine of Rs. 50,000 to Rs. 25 lakh), as well as penalties for every officer of the company who is in default (imprisonment for up to three years or fine of Rs. 50,000 to Rs. 5 lakh, or both).
- The Government may give such general or special directions to a company or class of companies as necessary to ensure compliance with the amended CSR provisions.
Moving Away From The ‘Comply or Explain’ Regime
The above changes are a marked departure from the principle of ‘comply or explain’ that was originally enshrined in Section 135. To contextualise the changes and the scope of the amendments, it is instructive to consider the genesis of the CSR provisions.
When the idea of including CSR provisions into the Companies Act was introduced in 2009, there were those within the Government who supported a mandatory CSR regime. However, in light of the opposition to such a provision and the recommendations of the Standing Committee on Finance on the Companies Bill, 2009 prescribing mandatory disclosures as a sufficient check on non-compliance, the final provisions introduced to the Companies Act only required companies to disclose reasons for not spending the Minimum CSR Amount to avoid being penalised. Mr. Sachin Pilot, the then Minister for Corporate Affairs even emphasised during the debate in the Rajya Sabha (the upper house of the Parliament of India) that the aim of the proposed CSR provisions was to encourage firms to undertake social welfare voluntarily instead of imposing it through the fabled ‘inspector raj’.
The Government has, since 2013, set up multiple committees to review the functioning of CSR enforcement and to suggest measures for improved monitoring, as several companies that were not spending the Minimum CSR Amount also failed to provide justifiable reasons for non-compliance. In short, companies were seen to have neither complied nor explained. Hence, the aforesaid amendments.
However, instead of strengthening enforcement or prescribing guidelines on validity and specificity of reasons disclosed by companies for non-compliance, the amended CSR provisions overhaul the framework from a regime encouraging CSR spending, to one that harshly penalises non-compliance. Such a mandatory regime has so far been adopted by only a handful of countries (such as Indonesia, Mauritius and Nepal) and is an exception to the general approach adopted by most developed and developing countries across the world, all of which at most mandate a disclosure obligation on companies.
At the time of introduction of Section 135, it was stated before the Rajya Sabha that “CSR is not a tax … The money is not flowing into the coffers of the Government”. The contradiction between the original objectives and the present amendment isn’t lost on corporate India. With the amendment, the CSR provisions have become akin to a tax, since spending the Minimum CSR Amount is mandatory, failure to spend within the specified time period ensures that the funds flow into the coffers of the Government and non-payment attracts penal sanction.
Aside from the obvious contradiction, profit-making companies now need to factor in the following intended and unintended consequences of the changes:
- The amendments impinge on a company’s ability to choose how they plan to spend the Minimum CSR Amount and encourages short-termism. The freedom to plan long-term CSR activities such as construction of hospitals, water purification plants etc., which require time and long-term capital commitment, is no longer available.
- The intention was that companies would use the Minimum CSR Amount to fund the betterment of those communities where they operate. Handing over unspent funds to the Government does not ensure the flow of funds to local communities where these companies operate.
- The amended CSR provisions leave certain aspects open to interpretation which may further strain the balance sheet of companies. For example:
- Will the amended CSR provisions retrospectively apply to the unspent Minimum CSR Amount from previous financial years?
- If a company spends more than the Minimum CSR Amount in a particular financial year, can it carry-forward the excess CSR spent to the next financial year?
The Absence of Course Correction
Furthermore, in making the amendment, the Government has unfortunately not used the opportunity to re-evaluate or resolve some of the existing issues with the CSR provisions, including the following:
- The Companies Act only imposes CSR obligations on companies incorporated in India, but the Companies (CSR Policy) Rules, 2014 (CSR Rules) expands the applicability of Section 135 to a foreign company having its branch or project office in India, which meets the specified profit thresholds. Thus, the CSR Rules that are meant to be supplementary to the Companies Act seem to have an overreaching effect well beyond the scope of Section 135 and can be challenged on the grounds that the CSR Rules are ultra vires the enabling Act.
- CSR activities to be undertaken by companies are exclusive of activities undertaken in pursuance of their normal course of business. However, CSR expenditure, if not incurred for capital expenditure or for the purpose of business, won’t be allowed for deductions under the Income Tax Act, 1961 (IT Act). This disconnect in the law, in which CSR spend is mandatory despite the fact that it is not automatically considered a deduction under the IT Act, needs to be bridged so as to encourage CSR activities.
Over the past decade, India has tailored its policies to encourage investments without losing sight of social commitments.
Imposition of a mandatory CSR spend and penalising non-compliance by way of imprisonment is a retrograde step that is reminiscent of socialism, with several intended and unintended consequences. There is certainly a need for re-consideration of the proposed changes in a manner that keeps the legal provisions in line with the principles that preceded their introduction and to ensure that corporate India actively participates in making long-term social contributions.