Corporate Social Responsibility - Is it really that social?

Finally, after much debate among corporate circles, on the impact it will have on India Inc. pocket, the section on corporate social responsibility (‘CSR’), along with CSR rules (‘CSR Rules’) and amendment to schedule VII has been notified by the Ministry of Corporate Affairs (‘MCA’) vide various notifications dated 27 February, 2014, however to be in effect from April 1, 2014.

INTRODUCTION – BEING SOCIAL

Social responsibility is an ethical theory that an entity, be it an organization or individual, has an obligation to act to benefit society at large.The concept of embracing social responsibilities by the corporate is not new, neither to India Inc. nor to other concerned all over world. Many corporate houses used to and still are doing their bit for the society, however for the first time this being incorporated in law makes it imposing on few to adhere to the requirements prescribed. Like to human nature, we never appreciate someone imposing anything on to us, irrespective of the result, so is the case here as well.

The underlying want of introducing this concept is to make profit making companies, to help in growth of the society actively and not merely through charity or donations. Hopefully, the initiative can bring the much needed change in the approach towards societies by the people at large.

ANALYSIS – IMPACT

Without reproducing the sections and rules in verbatim, I will try and discuss the relevant provisions with the impact on corporate India.

I. Applicability:

Let’s examine the applicability of the section 135 of the Companies Act, 2013 (‘Act’). The section provides that:

Every company (i.e. including private companies) having:

a)     having net worth of INR 500Cr. or more; or

b)     turnover of INR 1000Cr or more; or

c)      a net profit of INR 5Cr or more;

during any financial year shall constitute a CSR committee as per the said provision. Hence it is quite clear that any companies with either of above figures boasting in their financial records are needed to comply with above.

II. Once a CSR compliant, always a CSR compliant?

The lawmakers have considered confusions, circling around on the CSR initiative and have come out with much needed clarity.

Section 135 (5), stipulates expenditure of 2% of the average net profits of the company made during the 3 immediately preceding financial years on CSR activities. In case the company fails to spend this amount on CSR, the board must disclose why in its Board report, which considering Indians it would be interesting to see the range of excuses companies might come up with.

Now, rule 3 (2), of the said CSR Rules provides for a situation where if the company ceases to be covered, for 3 consecutive financial years it shall not be required to comply with provision of this section. In nutshell, if an eligible company fails to meet any of criteria laid under section 135(1) of the Act, for three consecutive years, it can simply forego the section. The catch here is 3 consecutive financial years to prove, which entrepreneurs will not try to aim just for evading any CSR compliance, more so if company is aiming for a big fund investment in near future.

III. Composition of CSR Committee

With the rules being notified, the loopholes created by the draft rules read with section 135 of the Act, has been set right. To put the context, earlier with the section being not notified and with draft rules as well reading stated that every company falling under the criteria lay above needs to appoint a CSR committee of the directors of the company (‘Board’) comprising of minimum three directors, out of which one should be independent.

As per the extant provision under the Act, a private company shall have minimum of 2 directors, with no need to have an independent director. This created challenge for the private companies as they were to increase their Board size and appoint an independent director on their board.

Current Status:

With the CSR Rules being notified by MCA, there has been much clarity on composition of the CSR committee. Rule 5 of the said CSR Rules provides that, in case:

• of unlisted companies or private companies, who are not required to have independent director, shall have such committee without such director. Hence section 135 of the Act, doesn’t mandate a company to appoint an independent director if not required otherwise as per other provisions of the Act.
• A private company, with only 2 directors on Board, shall have such committee with such directors only. This translates, in case a private company increases its Board size to 3 or more, minimum of 3 directors will comprise the committee.
• A foreign company shall have one resident Indian as appointed under section 380(d) of the Act and other to be nominated by the company.

IV. Is it Mandatory to spend 2% of the average net profits?

The simple answer to the above question is a big NO. Yes though the Act, provides expenditure of the said amount and lays onus on the Board to ensure the same, it also does provide that in case a company fails to do so, or say in case company doesn’t wish to spend a single penny on a CSR, it will not be held in violation of the section, provided it has disclosed the reason for such failure in the Board Report.

V. Rationale of penal provision if spending amount is no violation u/s134 (8) of the Act?

As discussed above, if the company has disclosed the reason for not spending the said amount, it is still in compliant of the provisions. However in case it doesn’t do so or the Board report doesn’t contains detail about the CSR policy and its implementation than, the company shall be:

a)     punishable with fine which shall not be less than fifty thousand rupees but which may extend to twenty-five lakh rupees; and

b)     every officer of the company who is in default shall be:

(i)     punishable with imprisonment for a term which may extend to three years; or

(ii)   with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees,

(iii)  or with both.

VI. What constitutes CSR now?

After the recent amendment to schedule VII of the Act, vide notification dated 27 February 2014, MCA have clearly explained what can be constituted a CSR and what cannot be. MCA has added few points on the list of ten items under schedule VII. There are few additions and deletions in the amendment notification for schedule VII, the said amended notification can be accessed here, however there is one interesting which stands out and requires more attention.

ü Contributions and funds provided to technology incubators located within academic institutions, which are approved by Central Government: -

This might sound great prima facie; however think on the bigger picture. I see companies taking refugee under this category for complying with CSR. First, on the social aspect, you are playing an indirect role in empowering the business orientation and mentoring to the startups. However, if a “corporate puts in money, they would like to monitor it closely”. Well that’s true they will monitor it closely enough to think of the returns they can make if the venture turns out as a success and corporate are ready to invest in.

VII. Conclusion:

While the notified CSR Rules along with amendment in schedule VII of the Act, lays rest to many speculations doing round on the interpretation of the concept, it still hasn’t cleared air on tax treatment of CSR expenditure; so it still remains to be seen if at all tax benefits can be claimed on such contribution.. Around 8,000 companies would fall under the said sections ambit and this mandate would translate into an estimated CSR spending of Rs 12,000-15,000 crore annually. If these numbers can be put to use in right direction and spirit, than we can definitely hope to see better India, and better ranking by World Bank.

Disclaimer: This is not a legal opinion and should not be construed as one. Author is a Senior Associate at V Law Partners and can be reached at [email protected].

About the authorDheeraj Khanna is Senior Associate with V Law Partners and focuses on the firm’s corporate and transaction practice. His areas of practice include private equity, business structuring, intellectual property and real estate. He also advises clients on a host of corporate commercial, labor/employment and on foreign investment related issues.