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Corporate social responsibility: Easy to understand, hard to legislate

24 August, 2016

There’s no denying the fact that India’s economic diversity is rooted in brutal inequality. Our trade and commerce, on the one hand, are bursting at the seams of hectic activity while on the other, abject poverty is a defining feature of the country where basic amenities like clean drinking water for the masses are still a distant dream.

Having said that, our commitment to social and economic emancipation may be weak in structure but hardly in doubt. On April 1, 2014, India became the first country to mandate Corporate Social Responsibility (CSR) under the new company law regime. The rationale for this decision, principally at least, is indisputable, that contributing to the welfare of society is an inherent responsibility of corporates given the fact that they operate in the realm of society and draw their resources from it. Section 135 of the Companies Act 2013 (Companies Act) read with Schedule VII and the Companies (Corporate Social Responsibility) Rules, 2014 (CSR Rules) have accordingly made CSR a mandatory corporate spend. Let’s examine the net effect of these provisions:

Companies can implement CSR activities with the approval of the board of directors by preference being given to the local areas of the company’s operations. Only CSR activities undertaken in India would be taken into consideration and activities meant exclusively for employees and their families would not qualify. The company can implement its CSR activities through the following methods:

  • Directly on its own
  • Through its own non-profit foundation constituted to facilitate this initiative
  • Through independently registered non-profit organisations that have a record of at least three years in similar activities
  • Through collaboration or pooling of resources with other companies 

While the purpose seems justified, the purview of the law raises elementary questions. Under the Companies Act, any company having a net worth of Rs 500 crore or more or a turnover of Rs 1,000 crore or more or a net profit of Rs 5 crore or more is mandated to spend at least 2% of last three years average net profits on CSR activities in accordance with Schedule VII of the Companies Act. Companies matching the stipulation are only a small percentage. So a vast majority has been squarely exempted of its social obligations. If such a large chunk is outside the purview, why bother with statutory provisions in the first place?

Of the small bracket governed by the provisions of the Companies Act, most are family run businesses which are traditionally known for philanthropy. Given the fact that these companies are spending amounts way more than 2%, the minimum standard compliance could negatively influence them into reducing their CSR spends to minimum standard compliance. A law can set a standard but in this case, it may also foster an attitude among corporates to comply with the law in letter but not in spirit.  

Further, the statute inadvertently houses an escape route which virtually makes a mockery of the whole exercise. Even though the 2% spend is mandatory, corporates that do not comply with it are simply required to specify the reasons for the non-compliance in their annual report to the shareholders. As a result, section 135 essentially runs on a ‘comply-or-explain’ regime, which is in line with the ‘Corporate Governance Voluntary Guidelines’ issued in 2009 by the Ministry of Corporate Affairs. When CSR has been a mandate, how can the law choose to overlook the valid reasons for non-compliance? Does this imply that a company can conveniently choose to steer clear of its CSR on some pretext or the other given that it won’t be examined for its legitimacy? If that’s the case, CSR as a statutory provision hardly makes sense.

While CSR is undoubtedly cardinal to the development of our society, that it is possible to regulate corporate social behaviour through statutory provisions is a bit of a far-fetched notion.

Even if we somehow rationalise the decision of mandating CSR, another fundamental question comes to mind; why mandate only companies? Section 135 brings within its ambit not only public companies but also private as well as non-profit (section 8) companies. Then why not bring proprietary firms, partnerships, LLPs and co-operatives into the fold? Many of these entities fall within similar monetary caps and make profits too.

It’s been more than two years now that the CSR law has been in place. Dozens of clarifications in this time frame have left corporates fatigued at best and perplexed at worst. Each time the law undergoes a change, the corporates are burdened with compiling heaps of information and conducting strenuous impact assessments only to stay compliant. This administrative saddle, without a doubt, snags CSR spending rendering it self-defeating to a large extent.

Another key challenge in CSR spending is the taxation facet. On one hand, section 80G of the Income Tax Act, 1961 (IT Act) allows 50% to 100% deduction as an adjustment to gross total income of an assessee as the case may be, including donations to the Prime Minister’s National Relief Fund which is an eligible CSR activity as per schedule VII of the Companies Act.

On the other hand, section 37 of the IT Act, disallows any expenditure incurred by an assessee on the activities relating to CSR referred to in section 135 of the Companies Act, 2013 in computing the income chargeable under the head “Profits and gains of business or profession” and hence it is not eligible as a deduction.

The sharp anomaly in the treatment of CSR housed under needlessly constricting sectional compartments is nothing short of absurd. There is a clear line of demarcation between the expenditure incurred by the taxpayer under a statutory obligation and under a voluntary assumption of responsibility. What purpose does this discrimination serve? Why should voluntary CSR be deemed any different from statutory CSR, more so from a taxpayer’s perspective? The nature of expenditure made by the taxpayer would technically be on the same terms; if one is eligible for relaxation, why not the other? The taxman seems to be unsure of his own stand in this situation.

The most important argument against the CSR mandate is, however, none of the above. It points to the very substratum of company formation. The fundamental objective of all business activities is to maximise profits for shareholders. The interests of other stakeholders come down the line because when corporations make donations to charity or spend money on social causes, they part with shareholders’ money, which ideally merits a justification from purely commercial perspective.  Philanthropy is a matter of corporate ethics and question can be as to whether one should mandate ethics through law-making.

Having said that, the government’s intentions to make CSR mandatory are undeniably noble and the stress on making CSR more inclusive is indeed laudable, but a uniform policy to regulate CSR is clearly the need of the hour where CSR eligibility would benefit the society and tax deductibility would benefit the company. CSR will then become an effective tool towards bridging the great divide that yet mars the country’s economic prosperity.

(Nitin Potdar is partner at J. Sagar Associates. Views are personal.)

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Corporate social responsibility: Easy to understand, hard to legislate

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