Aug 17, 2019

CORPORATE SOCIAL RESPONSIBILITY

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-Change in Narrative

Corporate Social Responsibility (‘CSR’) concept recognizes that an entity utilising the resources of society should also contribute towards the social and environmental concerns towards promotion of sustainability. CSR activities are undertaken by corporates voluntarily due to various reasons being sentimental, awareness, marketing strategy, etc. and these activities are undertaken beyond the earning of profits.

CSR being a voluntary act was not legally binding, until the Companies Act, 2013 (‘Act’), for the first time introduced the legal requirement to undertake CSR activities, wherein Section 135 of the Act dealt with the statutory obligations read with the Companies (Corporate Social Responsibility Policy) Rules, 2014 (‘CSR Rules’) and Schedule VII to the Act.

Since its introduction, Section 135 of the Act has been amended twice. First by the Companies (Amendment) Act, 2017 and then by the Companies (Amendment) Act, 2019. Similarly, the CSR Rules have undergone several changes since first notification. This Article discusses the impact of changes made in the provisions of CSR by virtue of Companies (Amendment) Act, 2019 (‘Act 2019’). It may be kept in mind that these amendments are not yet enforced.

1. Clarification for newly incorporated companies

Analysis of Legal Provisions:

  1. Section 135(5) of the Act provides that the Board of every company covered under Section 135(1) shall ensure that the company spends, in every financial year, at least 2% of the average net profits of such company made during the three immediately preceding financial years, in pursuance of its CSR Policy.
  2. There was confusion as to how the average net profits will be calculated in respect of companies which may not have completed the three financial years.
  3. One interpretation was that the net profit for those number of years may be taken as a basis for calculating the expenditure of CSR for which company has been in operation (being less than 3), however another view expressed that since Section 135 provides for average net profit for 3 financial years, the said provisions shall not apply to a company which has not been in existence for a period of 3 financial years.

Amendment and its Impact:

  1. Accordingly, the Act 2019 inserted the words ‘or where the company has not completed the period of three financial years since its incorporation, during such immediately preceding financial years’ after the words ‘three immediately preceding financial years’.
  2. The doubts have thus been set at rest and it has been made clear that the average net profit for the calculation of CSR Expenditure is to be made for the immediately preceding financial years (not exceeding three) for which company has been in existence.

2. Treatment of unspent amount of CSR

Analysis of Legal Provisions and recommendations:

  1. The Second Proviso to Section 135(5) of the Act provides that where company fails to spend the amount as required under the said Section, the Board shall, in its report made under section 134(3)(o), specify the reasons for not spending the amount.
  2. Section 135 is based on the approach “Comply or Explain”. However, it is understood that a large amount of companies adopted the route to ‘Explain” than to “Comply”, finding a way to avoid spending the required amount towards CSR. As result of this, the Government felt constrained to enforce mandatory CSR expenditure by companies.
  3. The High-Level CSR Committee, in paragraph 4.10 of its report issued in the year 2015, had recommended for allowing a carry forward of unspent amount, from a particular year; and for transfer of any unspent balance, after a period of five-years, to one of the funds listed under Schedule VII of the Act. However, the Company Law Committee in its report observed that while a carry forward might be desirable, the requirement of mandatorily transferring the unspent amount at the end of five-years would go against the principle of ‘comply or explain’ and would not be appropriate.

Amendments and its Impact:

  1. a. Although the Company Law Committee has suggested not to undertake any transfer of the unspent amount, the Act 2019 , amended the section to provide, inter alia for—
    1. carrying forward the unspent amounts for any financial year unless the same relates to any ongoing project, to a Fund specified in Schedule VII within 6 months of closure of the financial year;
    2. carrying forward the unspent amounts related to ongoing project, to a special account to be spent within three financial years and transfer thereafter to the Fund specified in Schedule VII, in case of an ongoing project;
  2. Until this amendment, any company which was unable to incur CSR expenditure was required to explain the reasons for the same in its Board Report. But now in addition to said explanation, such company is also required to undertake the following:
    1. Where the Company is not undertaking any CSR projects and it has not spent the required amount towards CSR during any financial year, then such unspent amount shall be transferred to one of funds specified in Schedule VII within a period of 6 months from the close of financial year, to which the unspent amount relates.
    2. Where the Company has undertaken some projects fulfilling the prescribed conditions and has planned the CSR expenditure on the same, out of which some amount still remains unspent, then such Company is required to open a separate bank account to be called as “Unspent Corporate Social Responsibility Account” within 30 days of closure of the financial year and such amount shall be spent by the Company on the ongoing project, within a period of 3 years from the date of transfer and where at the end of said period of 3 years, some amount remains unspent, then the same shall be transferred to in one of funds specified in Schedule VII within 30 days of completion of the said 3 years.
  3. Fund specified in Schedule VII: As per the amended CSR provisions, the unspent amount towards CSR shall be transferred to any of the funds specified in Schedule VII. As on the date, Schedule VII provides for the following funds:
    1. Swach Bharat Kosh set-up by the Central Government for the promotion of sanitation;
    2. Clean Ganga Fund set-up by the Central Government for rejuvenation of river Ganga;
    3. Prime Minister’s National Relief Fund or any other fund set up by the Central Government for socio-economic development and relief and welfare of the Scheduled Castes, the Scheduled Tribes, other backward classes, minorities and women.

    It is proposed that for the purpose of transferring unspent amount, the Government may set up some specific fund. However, as on date, no such fund has been set-up.

  4. Ongoing projects: The amended provisions provide for transferring unspent amount on ongoing projects to a separate bank account and after a period of 3 financial years from the said date of transfer to one of the funds specified in Schedule VII, in this regard, the following may be taken into consideration—
    1. It seems that ongoing project(s) shall only mean any CSR program or activity being undertaken by a Company directly and where expenditure on such program or activity, extends beyond the financial year to which the expenditure relates.
    2. The ongoing project(s) shall not include any project carried out by a Trust/Society/Section 8 Company as prescribed under Rule 4(2) of the CSR Rules since MCA vide its General Circular No. 21/2014 dated 18.06.2014 (‘Circular’) had clarified that amount transferred to Trust/Society/Section 8 Company for carrying CSR activities shall be deemed to have been spent for the purpose of Section 135 and if the amount is deemed as spent then the provisions of second proviso to Section 135(5) and 135(6) shall not be applicable on such amount.
    3. In order to qualify as ongoing project(s), such project(s) should adhere to the prescribed conditions. MCA will prescribe the said conditions in the days to come.

3. Penal Provisions

  1. The Act 2019 has also inserted the penal provisions in connection with non-compliance of provisions related to disclosure in Board report or transfer of unspent CSR funds.
  2. Earlier in case of non-compliance of provisions related to disclosure in Board report, the residuary penal provisions as prescribed under Section 450 of the Act were applicable. As per Section 450 of the Act, the company and every officer of the company who is in default or such other person shall be punishable with fine which may extend to ten thousand rupees, and where the contravention is continuing one, with a further fine which may extend to one thousand rupees for every day after the first during which the contravention continues.
  3. As per the Act 2019, in case of non-compliance of provisions of sub-section (5) or sub-section (6) of Section 135, the company shall be punishable with fine which shall not be less than fifty thousand rupees but which may extend to twenty-five lakh rupees and every officer of such company who is in default shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees, or with both.
  4. So, non-compliance of provisions of sub-section (5) or sub-section (6) of Section 135, can now call for imprisonment of officer in default of the Company for a term which may extent to 3 years. The Finance Minister has however, assured to review the imprisonment provision and may take longer to notify these provisions.

4. Directions to ensure Compliances

  1. The Act 2019 has also inserted provisions to empower the Central Government to issue directions to ensure compliance of provisions of Section 135 of the Act.
  2. As per sub-section (8) of Section 135 of the Act, the Central Government may give such general or special directions to a company or class of companies as it considers necessary to ensure compliance of provisions of this section and such company or class of companies shall comply with such directions
  3. It seems that such an insertion aims to authenticate a move of the Central Government that is already in motion. The Central Government has issued letters to various companies which have not spent towards CSR activities in full or part, seeking justification for the reasons disclosed in the Board report for not spending the amount and also directing to spend the unspent amount towards CSR.

Conclusion

The Act 2019 seems to change the entire narrative of Section 135 from being “Comply or Explain” to “Comply” and failure to do so will entail heavy punishment. During the course of last 5 years since notification of Section 135 in the year 2014, the Government has realized that CSR provisions are not being complied in letter and spirit and companies are misusing the liberty to explain by disclosing the reasons for not incurring CSR expenditure under Section 135, which as per the Government was not the intent of the provisions.

The latest amendments seek to make incurring CSR expenditure as mandatory requirement and not discretionary. While the amendments will definitely fill the corpus of various funds of the Government by the unspent CSR amount but the following impacts may be perceived in due course—

  1. The requirement of transferring unspent CSR amounts in case of ongoing projects after a period of 3 years may discourage the companies to undertake long drawn CSR projects i.e. where the benefits to Society may arise over a course of time.
  2. While the provisions provide for treatment of unspent CSR money with the companies but fails to address a similar situation arising of non-utilization by the Trust/Society/Section 8 companies to which the funds have been contributed for undertaking CSR projects or programs. This lacuna may be addressed by the Government by amending the CSR Rules.
  3. The requirement to contribute unspent CSR amount into the funds specified under Schedule VII post closure of financial year will encourage companies to transfer money to such funds at the end of relevant financial year itself.

AUTHORED BY

Mr. Ankit Singhi

Partner & Head - Company Law Advisory

ACS,LLB

ankit@indiacp.com

+91 11 40622208

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