Since inception, the provisions related to Corporate Social Responsibility (CSR) are ambiguous, and the Ministry of Corporate Affairs (MCA) has been issuing General Circulars and FAQs from time to time. However, some of the issues still not remain answered. In order to examine the issues in the CSR provisions, MCA constituted a High-Level Committee on CSR in September 2018 which gave its report in August 2019 wherein the Committee recommended few changes to be brought under existing CSR Provisions such as carry forward of unspent CSR funds, uniformity in tax treatment for CSR expenditure across all activities, non-monetization of services of CSR employees, creation of capital assets out of CSR Funds, ongoing projects, etc. MCA, on the basis of recommendations of the committee, tried to overhaul the CSR regime by way of amendments in the CSR provisions but the said attempt has also not only left large number of issues unanswered but created new ones too. The state of ambiguity has also divided the India Inc, as some choose to interpret the CSR provisions in spirit considering the objective/intent of the matter where as many choose to interpret aggressively to avoid CSR liability in terms of letter of law.
CSR being a social subject was introduced to connect the corporates with the society and with those who are underprivileged and underserved (i.e. people at the bottom of our society) and thus, for the benefit of the society at large, MCA should endeavor to clear the air on the grey areas and at the same time, the Corporates must understand their responsibility.
In this regard, the MCA has recently issued new FAQs on 25th August, 2021 in supersession of all earlier clarifications and FAQs issued in the matter of CSR but still some issues are not clear. An attempt has been made in the following paragraphs discuss those issues to reach some logical conclusion.
I. Applicability of CSR Obligation
The applicability of CSR provisions depends upon breaching the threshold limits of Net Profit, Turnover or Net Worth in the preceding year. Thus, a newly incorporated company which is only one year old and fulfills one of the three criteria in its first financial year is required to spend the CSR amount in the next financial year. Before amendment made in sub-section (5) of section 135 on 22nd January, 2021 there was a view that CSR expenditure was not applicable to companies which are less than 3 years old and even, the High-Level Committee on CSR 2018 (refer para 3.2) had recommended that a clarification be issued that the CSR obligation shall lie only after the company has been in existence for three years. On the contrary, the said amendment has provided that newly incorporated companies are liable to undertake CSR expenditure based upon the average calculation of the profits made in the past year(s).
The above amendment may impact the financial performance of a newly incorporated company since such company is at a nascent stage where it needs funds for growth and expansion. Further, there may be a possibility that the year in which CSR expenditure is to be made, the company incurs losses and such a company may not have funds/surpluses to meet its CSR obligation.
In sub-section (1) of section 135 of the Act, the eligibility criteria is mentioned and once a company satisfies any of the conditions, it has to comply with the entire section 135 read with the rules. Further, as per sub-section (5), a company, fulfilling the criteria mentioned in sub-section (1), is required to spend 2% of average net profit of three preceding years towards CSR, which means where a company fulfils any criteria in the last financial year is required to make CSR expenditure in the subsequent year. In other words, it can be said that there shall be no obligation of CSR expenditure when a company does not satisfy any of the eligibility criteria in the previous financial year. Contrary to this, sub-rule (2) of rule No. 3 of Companies CSR Rules, 2014 provides that once sub-section (1) of section 135 is applicable, a company shall comply with the entire CSR provisions [incl. sub-section (5)] unless it ceases to meet the criteria during next three years.
The foregoing Rule is against the fundamental principle of law that Rules cannot override the Act. Rules are framed by the executive under powers delegated under the Act and thus rule cannot override or exceed the jurisdiction provided by the statute. On reading of sub-section (1) and sub-section (5) of section 135, no power seems to have been given to the executive to extend the applicability of CSR provisions to the company for the next three financial years even without fulfilling any of the eligibility criteria.
Thus, the aforesaid Rule is very stringent in nature and going beyond the mandate outlined in Section 135.
Before enforcement of the Companies (Amendment) Act, 2017 w.e.f 19th September, 2018, there was no clarity on calculation of net profit to determine the applicability of CSR provisions. Section 135 referred to section 198 for the purpose of calculation of ‘Average Net profit’ but not ‘Net Profit’. Additionally, Net Profit’ was also defined under clause (h) of rule No. 2 of CSR Rules to mean net profit as per its financial statement but shall not include income of company’s foreign branches and dividend received from other Indian Companies to which CSR is applicable. Thus, prior to amendment, some were calculating net profit for the purpose of determining the applicability of CSR provisions as net profits appearing in the audited balance sheet without any adjustments in terms of section 198 of the Act and others were adjusting the net profit with adjustments provided in clause (h) of Rule No. 2 of CSR Rules. As a result of different approaches, many companies could have complied with the CSR provisions and at the same time, there were companies which could have fallen outside the CSR provisions.
Post amendment, the Act has clarified that the ‘Net Profit’ wherever appearing in the section 135 including its Rules shall be calculated as per section 198 of the Act. However, the definition as provided in the CSR Rules hasn’t undergone any change and it is still referring to net profit as per the financial statements. With this dual definition of ‘Net Profit’, the confusion to some extent still persists since one may take ‘Net Profit’ as per audited balance sheet and other one may calculate the ‘Net Profit’ as per section 198, which in turn will still lead to different approaches being followed to determine the applicability of CSR provisions.
II. What constitutes CSR
Before the amendment made in the CSR Rules on 22nd January, 2021, the definition of CSR was inclusive in nature as it used to refer projects/activities mentioned in schedule VII of the Act as a result of which determining whether an activity qualifies as CSR or not, was very challenging at times. Subsequently, MCA through its general circulars clarified that entries in the schedule VII must be interpreted liberally along with host of other related issues and also provided an illustrative list of CSR activities. But since then, the CSR provisions have been amended drastically, a question remains as to whether the circulars issued from time to time regarding CSR provisions are still relevant? While it may be wrong to say that all such circulars shall be redundant since majority of them were in the form of clarifications in the context of then prevalent CSR provisions and now when the CSR provisions have been amended but not in toto, so the doctrine of repugnancy shall be applicable to all such previous circulars and therefore only that part of the circular(s) shall be repugnant which is inconsistent with the current CSR provisions. For example:
|General Circular||New Requirement||Impact|
Circular dated 18th June, 2014:
(ii) It is further clarified that CSR activities should be undertaken by the companies in project/programme mode [as referred in Rule 4 (1) of Companies CSR Rules, 2014]. One-off events such as marathons/ awards/ charitable contribution/ advertisement/ sponsorships of TV programmes etc. would not be qualified as part of CSR expenditure.
Section 2 (d) “Corporate Social Responsibility (CSR)” means the activities undertaken by a company in pursuance of its statutory obligation laid down in section 135 of the Act in accordance with the provisions contained in these rules, but shall not include the following:
(v) activities supported by the companies on sponsorship basis for deriving marketing benefits for its products or services
Under the erstwhile CSR provisions, one-off events were not eligible for CSR but now it shall be part of CSR unless such activity is based on sponsorship alone.
For eg. a company organizes a cricket tournament at a district level or amongst schools in any particular state without any commitment to carry out the such events in the future or a company organizes a Marathon Race.
However, in the recently issued FAQs, MCA considers one-off event as more of a marketing/branding activity than CSR activity and at Q. No. 4.3 in this regard says:
“the intent of CSR is to encourage companies to undertake the activities in a project or programme mode rather than as a one-off event. Companies shall not use CSR purely as a marketing or brand building tool for their business, but brand building as a collateral benefit does not vitiate the spirit of CSR.”
In the first line as mentioned in the above para, the companies are suggested to undertake project or programme but not one-off events however, this is in direct contradiction with the definition of CSR since the definition does not exclude such one-off events if such one-off events are not carried out solely for marketing purpose. In this regard, there may be companies which generally carry out one-off events in different fields or in different regions catering to different class of persons which have a material impact on the society, have other similar features/ qualities and where same energy and planning is required as in the case of other normal CSR activities. Thus, undertaking one-off events like organizing tournaments, medical camps, etc. shall be considered as a CSR project or programme as good as we consider building a school or hospital as a CSR Project irrespective of time in completing the project. As far as branding is concerned, in all CSR activities, the companies generally carry out their branding but we need to make distinguish between the CSR activities that which one is purely for marketing purpose. Thus, considering One-Off event as a brand building activity will be unjustified to companies which wish, or have the capacity, to organize such events which are useful for the society.
Under old CSR Rules, more specifically sub rule (5) of rule no.4, a project which benefits only employees of the company and their family shall not be considered as CSR project/activity. However, under New CSR Rules, the definition of CSR inter-alia excludes activities benefitting employees of a company and the words ‘their families’ are missing therefrom. Consequently, one may interpret the new rules as activity providing benefits only to families of employees of a company shall qualify as CSR if the respective employees are not covered under such activities. However, this interpretation will defeat the objective of the CSR provisions since object is to provide benefit to the society at large without discrimination and moreover, benefiting the family members of an employee is indirectly benefiting the employees of a company. Thus, activities benefiting either employees or their families or both only shall not be considered as CSR activity. In the light of this matter, the MCA in its recent issued FAQ has clarified that where if the employees and their family members are incidental beneficiaries, then, such activity would not be considered as “activity benefitting employees” and this it shall qualify as CSR Expenditure.
But at the same time, the CSR provisions still fail to clarify cases, where employee or their family benefits as a part of general public, out of the CSR projects undertaken by a company. While the draft CSR Rules issued during 2020 proposed to cover such cases by way of excluding projects, where 25% of beneficiaries are employees, as CSR projects but the final rules remain silent on the said issue.
Under both Old and amended CSR Rules, the expenditure towards any person other than the employees of a company can be considered as CSR Expenditure and moreover, under the amended CSR Rules, ‘Employee’ is referred to as defined under Wages Code, 2019 which expressly excludes ‘Apprentice’ from the definition of Employee and thus, any expenditure towards apprentices whether as a stipend or otherwise shall form part of CSR Expenditure.
On the contrary, under Apprentice Act, 1961 read with rules, every establishment to which the Act applies shall be required to hire minimum 2.5% of total workforce as Apprentice in the establishment subject to maximum of 15%. Thus, the expenditure made towards stipend or otherwise on apprentice hired by a company shall not form part of the CSR since a company is under statutory obligation to engage the apprentices.
However, the Ministry of Skill Development and Entrepreneurship through its Memorandum dated 11th March, 2020 and MCA circular dated 12th February, 2016 has clarified that where the company engages over and above the minimum number of apprentices as required under the Apprentices Act, the expenditure on training being provided to such excess apprentices but subject to maximum limit shall form part of the CSR Expenditure under the head of ‘skill development’ of Schedule VII of the Act.
III. Ongoing Projects
Under the earlier CSR Rules, the term ‘ongoing projects’ was not defined and discussed. However, the companies had been spending on such CSR Projects which run into multiple years particularly large companies having huge CSR obligation.
New CSR Rules define ‘ongoing projects’ as a multi-year project undertaken by a Company in fulfilment of its CSR obligation having timelines not exceeding three years excluding the financial year in which it was commenced, and further project that was initially not approved as a multi-year project but whose duration has been extended beyond one year by the board based on reasonable justification.
We discuss below some of the issues related to ongoing projects:
A question which comes for consideration is what is a multi -year project i.e. project which is for more than 12 months or which extends beyond any financial year. Before deliberating further on this it is important to note that CSR expenditure is required to be undertaken during a financial year and not calendar year. In this regard, the MCA through its recent FAQs clarified that ongoing project refers to such project which has an identifiable commencement and completion date. Further, the FAQs have clarified that CSR activity shall be commenced from date of issue of the work order pertaining to the project or the award of the contract for execution of the project.
In order to ensure that CSR expenditure is undertaken, mandatory transfer of unspent CSR funds to funds specified in Schedule VII of the Act where 100% expenditure hasn’t been undertaken during a particular financial year has been mandated but at times companies fail to spend the full amount of CSR obligation in a particular year for certain reasons beyond their control or due to longevity of the projects, as a result genuine entities end up in non-compliance of CSR provisions which is envisaged by many people as ‘not-so social companies’. Thus, in order to remove this shortcoming and support the projects which extend beyond a particular financial year, the ‘ongoing project’ is allowed for CSR expenditure. This will also cover projects which extend from one financial to another but may not last for 12 months or more. Excluding such projects will defeat objective behind introducing the concept of ongoing project. It is necessary that MCA should suitably amend the definition of ‘ongoing project’ to cover such a situation or issue necessary clarification.
Another issue in connection with ‘ongoing project’ which remains, is whether amount transferred for one project in an unspent account can be utilized for another CSR project whether ongoing or not. Following situation can be considered for this:
|Financial Year in which CSR obligation arises||CSR Obligation||Maximum time of CSR Spending||Project No.|
Rs. 50 crores
FY 2023 till 2025
Rs. 40 crores
FY 2024 till 2026
From the above situation, there may be situation that Project No. P1 needs more CSR Funds than allocated to execute the project, whether the company in this situation is allowed to divert the funds allocated to Project No. 2 since the amount to be spent in Project No. 2 is already transferred to a special account. In this context, provisions of Sub-section (6) of Section 135 are important since it provides that when an amount is transferred to an unspent account, then the same shall be spent by the company in pursuance of its obligation towards the Corporate Social Responsibility Policy. Surprisingly instead of providing a specific utilization with reference to the ongoing project in connection with which the amount has been transferred, the provisions provide for usage of such amount as per the CSR policy, which gives an indication that such amount can be used for other purposes as well. It seems that the legislature has intentionally provided for such usage to cover a situation envisaged in this para with respect to Project P1 and P2. The liberal usage has been allowed to empower the Board to allow fund earmarked for one project to other ongoing or standalone project. The onus is on the Board to determine the best utilization of the unspent amount in accordance with its CSR policy. Further in this regard, the MCA through its recent FAQs has clarified that budget outlay dedicated for one project can be used against another project.
It may be further noted that the projects which run into long gestation period i.e. for period more than three years or which are continuous in nature shall not be covered under the definition of ‘Ongoing CSR Project’ but shall be considered as ‘projects other than ongoing’ (may be referred to as ‘Perpetual CSR Projects’). Such CSR Projects are generally carried out by the big corporate houses through their own Trust/ Society/ Sec. 8 companies which may never end or have perpetual life such as to build schools/ colleges and provide education, open up of sports complexes/stadiums (indoor/ outdoor) for any or all kind of sports, etc. Thus, the time line of spending the CSR Budget as applicable to ‘Ongoing CSR Projects’ shall not be applicable to ‘Perpetual CSR Projects’. Consequently, the CSR Obligation of any particular year in case of ‘Perpetual CSR Projects’ shall be met in that year and any deficiency in that year would force the company to spend in any fund mentioned under schedule VII of the Act.
As discussed above, on-going project is a project whose duration doesn’t exceed three years excluding the financial year in which it was commenced and where the entire amount can’t be spent during the defined period, the unspent amount at the end of defined period needs to be transferred to funds specified in Schedule VII. But the provisions fail to consider the situation where the project exceeds the timeline on account of reasons beyond control of the Company like COVID-19 or delay in receiving regulatory approvals. Transfer of unspent amount to funds specified in Schedule VII in such cases, may ruin the entire project. Provisions of section 135 provide for a very strict interpretation of ongoing projects. While the Central Government needs to provide clarification for utilization of unspent CSR funds in such a situation, company in order to tide over such issues may break the ongoing project into different phases.
IV. Excess vis-à-vis Surplus CSR Spending
As per the amended CSR Rules, where a company spends in excess of the obligation in any financial year then the company is eligible to set-off against the subsequent CSR obligation upto next three financial years subject to passing of board resolution. However, the previous years’ (i.e. upto FY 2020) excess CSR expenditure shall not be eligible for carry forward since the amendment of CSR Rules is not made retrospective. In other words, the calculation of excess CSR expenditure has to be made from the FY 2020-21 which is eligible to be carried forward till FY 2024.
In case any company has not spent the CSR funds in the past years and has resolved to spend the same in the future and the provision thereof has also been made in the financials then, the company has two choices either to pass requisite board resolution not to carry forward the unspent previous years’ CSR funds and write back the provisions, or, to spend the CSR expenditure in the coming years but such expenditure shall not be consolidated with the current CSR obligation for the purpose of calculating the excess CSR expenditure since such unspent expenditure is a liability which is being carried forward in the current financial years.
V. Whether loss making company can make CSR contribution and take the advantage of setting off
In this, there are two categories of companies first, a company on whom CSR provisions are applicable such as constitution of CSR committee, adoption of CSR Policy, etc but not obliged to make CSR contribution because of negative average net profits and second, a company on which CSR provisions are not applicable per se i.e. section 135 is not applicable at all. In the case of first mentioned company, any CSR expenditure in a financial year in which there is no statutory requirement to spend, can be carried forward and set off against the CSR obligation in the succeeding three years. Whereas, in the second category, where a company voluntarily incurs CSR expenditure or undertakes any Charity, Donation, etc., such an expenditure cannot be set-off against statutory CSR obligation in succeeding years since the expenditure was undertaken on voluntary basis.
VI. Creation of Capital Assets through CSR Expenditure
As a common practice, companies having large CSR obligations used to create fixed assets out of CSR expenditure such as hospitals, schools, etc., and such assets remain with the companies. Further said companies had claimed depreciation on such capital assets against their profits which in turn set-off the liability of CSR expenditure to the extent of depreciation. However, this vitiates the very object of the CSR obligation as companies were able to benefit out of its CSR obligation and thus, the expenditure so made to create the assets ought not to be considered as ‘CSR Expenditure’. Considering the said issue, the High-Level Committee in its report 2018 recommended to amend the CSR Rules in this regard.
Now, as per the amended CSR Rules, companies which has created any capital asset(s) out of its CSR obligation and which is registered in its name, such assets have to be transferred to section 8 company, Registered Public Trust, Registered Society, any beneficiaries in the form of self-help groups or any public authority. Such transfer has to be carried out within 180 days w.e.f January 22nd, 2021 and with further extension of 90 days upon passing board resolution with proper justification. Further, where the expenses are incurred in transferring such assets shall form part of the CSR Expenditure for the year in which transfer is taking place as clarified by the MCA in its recent FAQs dated 25th August, 2021.
Here, it is important to clarify that creation of capital assets out of CSR Funds is still eligible as CSR Expenditure under the Act but these assets have to be registered in the name of an entity which is eligible to receive CSR funds at the time of creation of assets and not afterwards. In other words, the capital assets created out of CSR funds registered in the name of company or where the ultimate beneficiary is company itself then, such expenditure shall not be construed as CSR Expenditure.
It is also important to note that the obligation to transfer capital asset will arise only when the expenditure towards the same has been booked as CSR expenditure and not otherwise.
VII. Impact Assessment vis-à-vis Evaluation of CSR Projects/Programmes
The dictionary means of both the words ‘Impact Assessment’ and ‘Evaluation’ is same and object of both the activities is also same. Both words can be used synonymously in general parlance and there is no such difference. However, in the amended CSR Rules, both the words have different usages and conditions which are contradictory to each other.
In terms of definition of ‘Administrative Overheads’, the expenses which are directly incurred for designing, implementation, monitoring and evaluation of CSR projects shall not form part of overheads. This means expenditure made on designing, implementation, monitoring and evaluation shall form part of CSR Expenditure and this statement can be supported from another provisions of CSR Rules where a company is allowed to engage international organisation for designing, monitoring and evaluation of the CSR projects or programmes as per its CSR policy. Thus, it can be said that any expenditure made on evaluation of any CSR Project/programme shall be eligible for CSR expenditure which shall form part of Annual Action Plan and that too without subject to any limits. However, the evaluation of CSR project is not compulsory but many companies generally carry the assessment of their projects to analyze the impact created in the society and where there are gaps, such projects may be modified accordingly.
Whereas in case of ‘Impact Assessment’, a company whose average CSR obligation is Rs. 10 crore or more in last three financial years, is required to carry out impact assessment of each project whose total outlay is Rs. 1 crore or more. Accordingly, a company may book the expenditure made towards impact assessment as CSR Expenditure but subject to Rs. 50 lacs or 5% of total CSR expenditure, whichever is less.
Based upon the above, there is no rationale provided in the CSR Rules, why ‘Impact Assessment’ in case of large CSR Expenditure is subject to a specified limit whereas in case of ‘Evaluation’ there is no limit provided.
VIII. Section 135 vis-à-vis section 181
In terms of Section 181 of the Act, Board of Directors are empowered to contribute to charitable and other funds and where the contribution exceeds 5% of its average net profits for the 03 preceding financial years, prior approval of shareholders is also required. Here, ‘Charitable Contribution’ denotes donation, gifts, help, assistance, charity and like nature in whatever name called.
Now, it is important to note that the contribution towards charitable funds may or may not qualify under activities as mentioned in Schedule VII of the Act whereas in case of CSR contribution, it shall definitely be ‘charitable contribution’ since CSR in itself is a charity. Further, the company is not required to follow section 181 till it is making required CSR Expenditure since CSR is an obligation on the company whereas the company decides to make excess CSR expenditure then, such excess has to be in the limits of 5% of its average net profits for the 3 preceding financial years otherwise shareholders’ approval is required to undertake excess CSR expenditure without affecting any privilege/right of setting-off the excess expenditure in subsequent years.
From the above discussion, it is clear that few critical matters in CSR provisions are ambiguous even after recently released FAQs of MCA. However, it is very much clear that the CSR Rules in original form were simple and easy to understand as compare to the CSR Rules existing as on date. Under the erstwhile CSR Rules, the good/ honest Corporates, in case of failure to spend the CSR contribution, were used to carry forward and spend in the subsequent years in their projects but now, such Corporates are forced to divert the budget of a CSR Project towards few Central Government funds (such as PM Cares, PM Relief, etc.) as mentioned in Schedule VII of the Act. With this, one could identify and distinguish amongst companies with regard to seriousness and commitment towards ESG (Environment, Social and Governance) whereas under New CSR Rules the companies has to spend either in CSR Project or Funds so such identification may not be possible. With the New CSR Rules come into effect, it is evident that there is a shift in the thinking of the MCA towards CSR contribution and the newly released FAQs has superseded all previous FAQs and Clarifications and thus, the corporates need to be more careful about their expenditure towards their existing CSR Projects in order to comply with the New Rules.