On 27 February 2014, the Ministry of Corporate Affairs, Government of India (Ministry) notified Section 135 of the Companies Act, 2013 (CA 2013) and with it the Companies (Corporate Social Responsibility Policy) Rules, 2014 (CSR Rules) in terms of which companies satisfying the specified thresholds would need to, inter alia, constitute a CSR committee and spend a minimum 2% of their ‘net profit’ for certain CSR activities. The CSR Rules are broadly prescriptive in nature and in line with the draft CSR rules issued in September 2013 with a few exceptions. Section 135 and the CSR Rules have now been made applicable with effect from 1 April 2014.
Key Provisions of the CSR Regime
Applicability to Foreign Companies
The CSR Rules provide that the CSR provisions of Section 135 shall be applicable to foreign companies with branches or project offices in India. This is a significant change as it makes foreign companies having Indian businesses subject to mandatory CSR provisions. The Ministry appears to have exceeded its legislative mandate as Section 135 is applicable only to ‘companies’ as defined in CA 2013 i.e., companies incorporated under Indian company law, while the CSR Rules have extended these provisions to foreign companies as well. ‘Foreign companies’ are governed by the provisions of a separate chapter and the move of the Ministry to include such companies within the CSR purview comes as a surprise. The implementation of the norms to foreign companies are also likely to result in several practical hurdles as the corresponding sections of CA 2013 for computation of financial accounts of foreign companies are yet to be notified.
Calculation of Net Profits
Profits arising from overseas operations conducted through foreign branches / subsidiaries and dividend received from other companies in India will be excluded from the calculation of net profit for the purposes of determining compliance with the CSR requirements under the CSR Rules. This is a welcome change as it will prevent multiple counting for conglomerates which consolidate income upwards.
References to Holding / Subsidiary Company
The CSR Rules mandate that the norms shall be applicable to every company including its holding / subsidiary company. The reference to holding / subsidiary companies appears to be superfluous as the norms apply to every Indian company and as such every holding / subsidiary company would be independently covered under the provisions provided the prescribed test is satisfied.
With the confusion prevailing under the draft rules regarding inclusion of political funding towards the satisfaction of responsibilities under the CSR norms, the Ministry has inserted a specific clarification prohibiting direct or indirect contributions to political parties as part of CSR spends.
Broadening of Permitted Scope of Activities
Schedule VII of the CA 2013 has been amended and the list of permitted CSR activities has been enhanced to include projects promoting rural sports, protection of national-heritage art and culture and steps for the benefit of armed forces veterans.
The CSR Rules have clarified the confusion over non-applicability of the norms to companies that subsequently do not satisfy the financial thresholds under Section 135. The CSR norms will not apply to any company which does not satisfy these thresholds based on turnover / net profit / net worth for three consecutive financial years.
The Ministry has permitted expenditure towards CSR capacity building to be counted towards CSR spending limit, so long as such expenditure is up to 5% of the total CSR amount that a company is obliged to spend. These limits would apply to personnel employed directly by the companies as well as those of the implementing agencies.
Non-utilisation of CSR Funds
The ambiguity regarding the utilisation of the unexpended portion of the CSR budget continues to subsist. Although, Section 135 mandates adequate disclosures regarding the non-utilisation of the outstanding amount, it is silent on obligations regarding its subsequent utilisation. The Ministry should clarify whether adequate disclosures regarding the unutilised portion would imply satisfaction of obligations and result in the withdrawal of the obligation to expend the entire amount of the CSR funds.
Constitution of the CSR Committees
There was significant confusion over constitution of the CSR committees by companies which otherwise do not need to appoint independent directors. The CSR Rules have cleared this confusion by clarifying that the requirement of having an independent director on the CSR committee will not apply to such companies. However, it would have been better if the Ministry had granted this exemption by way of a notification instead. Nevertheless, this clarification in the CSR Rules has come in a timely manner.
Surplus Profits & CSR Expenditure
The CSR Rules require that the surplus generated pursuant to CSR activities are to be treated as separate from the business profits generated in the ordinary course of business. One would like to believe that the surplus amount would not be subject to income tax as the amount, to be utilised solely for the purposes of CSR activities, would be held by the company as a ‘trustee’. Accounting treatment of the expenditure incurred towards the implementation of CSR projects has also not been specified. The assumption would be that the CSR expenditure (which is a statutory liability / obligation) is to be allowed as a deduction from the taxable business income of the company. In light of the ambiguities prevailing, a clarification under the Income Tax Act, 1961, regarding the treatment of the surplus as well as expenditure amounts is required.
Rule 3 of the CSR Rules which deals with the CSR obligations of companies has been incorrectly numbered as ‘8’ in the notification issued by the Ministry.
The Government of India has made Section 135 of CA 2013 and the CSR Rules applicable with effect from 1 April 2014. Hence, all the companies which satisfy the CSR criteria will have to undertake CSR activities under the new CSR regime during financial year 2014 – 2015. This step appears to have been taken by the Government in its efforts to bolster societal developmental projects with the professional management capabilities of the private sector.
The norms do clarify some doubts that will lead to a more effective CSR implementation. However, the Ministry has decided not to accommodate requests received for restricting the applicability of the ‘2% of net profit’ clause to the group level as opposed to every individual company in a group. Other provisions of the draft rules relating to (i) restricting CSR activities to India; (ii) using trusts to implement CSR activities; and (iii) inter-corporate pooling, remain unchanged and will provide corporate India various options to fulfil their now mandatory CSR obligations.
(Surbhi Kejriwal and Harsh Kabra work with Khaitan & Co. , a full service law firm.)
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