Making ‘Corporate Social Responsibility’ Work

I. CSR under the Companies Act 2013

The framework was earlier based on the “Comply or Explain” (COREX) principle which means that the companies would contribute the prescribed amount in good faith and not mandatorily, the board report would only give reasons for not spending. The aim of the CSR provisions was to encourage the companies to spend on social welfare voluntarily and not making it mandatory which would make the whole process look forced.

But the given attitude of the companies in not complying with the same, has been very disappointing, to say the least. The registry offices have issued 1000s of show cause notices to these companies for not spending as required, disregarding the reasons they had stated in their Board Report. The government since 2013, has set up various committees to review the process of CSR enforcement and to suggest reforms for better monitoring, as companies were not able to provide justifiable grounds for non – compliance and were defaulting. They were neither complying nor explaining, hence amendment was much needed.

The Government in view of the same has decided to impose a stricter regime by the introduction of the amendment under Companies (Amendment) Act 2019. The Companies (Amendment) Act 2019 came into force on 31 July 2019. With it, comes various changes to the existing framework of Corporate Social Responsibility (CSR).

This marks the shift of the CSR framework from "comply or explain" principle to "comply or imprisonment".

CSR requirements as mandated earlier under Section 135, Companies Act 2013:

Under the earlier framework, all companies meeting the following criteria that is, having net worth of INR 5 billion (equivalent USD 72.5 million) or more, or turnover of INR 10 billion (equivalent USD 145 million) or more, or net profit of INR 50 million (equivalent USD 725,000) or more during any financial year, were required to constitute a CSR committee. Also, they were required to have a CSR policy and a CSR fund equivalent to 2 percent of the average net profits made by the company in three immediately preceding financial years. In case, the company failed to meet its CSR obligations, the reasons for not Under the Companies Act 2013, if the company failed to meet its CSR obligations, they had to disclose the reasons for the same in the Director’s report.

Companies (Amendment) Act, 2019 brings the following changes in CSR:

1. Transfer of unspent funds: This obligates the company to transfer any unspent CSR funds in respect of an ongoing CSR project during a financial year, to a special account in accordance with its CSR policy, within a period of 30 days from the end of the financial year. This special account is called as Unspent Corporate Social Responsibility Account and it would have to be opened by the company with a Scheduled Bank. The proceeds from this account have to be spent by the company towards CSR projects within 3 financial years from the date of such transfer, failing which, such unspent amount would have to be transferred to a fund specified under Schedule VII of the Companies Act 2013 (For example: Prime Minister’s National Relief Fund), within 6 months from the end of the relevant financial year. However, in case if there are any unspent CSR funds at the end of a financial year and there are no ongoing CSR projects, the funds have to be directly transferred to the Schedule VII Fund,²within 6 months from the end of the relevant financial year.

2. Penal liability for non-compliance: The amendment provides for a penalty in case of non-compliance of the above stated obligations.

A penalty of not less than INR 50,000 (equivalent USD 725) but which may extend to INR 2.5 million (equivalent USD 36,250) may be imposed. The amendment also provides that every officer of the company in default may be sentenced to an imprisonment for up to 3 years and a fine of not less than INR 50,000 (equivalent USD 725) but which may extend up to INR 500,000 (equivalent USD 7,250) or with both. Additionally, separate penalty for continuing offences has also been prescribed.

3. CSR provisions for new companies: The amendment has clarified the position that if the company has not completed 3 years from incorporation, the amount to be mandatorily spent on CSR fund will be equivalent to 2 percent of the Net Profits made by the company in the previous financial year (as against average net profits made by the company in 3 immediately preceding financial years).

4. Central government empowered to make rules: The new amendment empowers the central government to make rules and issue directions to ensure compliance.

These changes mark a departure from the principle of “ comply or explain” that was originally contained in Section 135.

II. Changes under amendment act, 2019 and their impact

1. CLARIFICATION FOR NEWLY INCORPORATED COMPANIES-

Existing Legal Provision:

Section 135(5) of the Companies Act 2013 provides that the Board of every company covered under Section 135(1) shall ensure that the company spends, in every financial year, atleast 2% of the average net profits of such company made during the three immediately preceding financial years, in pursuance of its CSR policy. It was not clear as to how the average net profits will be calculated for companies, which have not completed 3 financial years.

2019 Amendment and its impact:

In view of the above, 2019 Act 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’. Thus, it has now been made clear, that the average net profit for the calculation of CSR expenditure is to made for the immediately preceding financial years (not exceeding three) for which company has been in existence.

2. TREATMENT OF UNSPENT AMOUNT OF CSR-

Existing Legal Provision:

The second proviso to section 135(5) of the Company Act 2013 provides that where the 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.

Section 135 is based on the “Comply or Explain” approach. However, most companies took to “ Explain” route than “ Comply” to avoid spending funds on CSR activities. Due to which, government had to mandate the CSR expenditure by companies.

The High–Level CSR Committee, in paragraph 4.10 of its report issued in 2015³, had recommended allowing a carry forward of unspent amount from a particular year and for transfer of any unspent amount, after a period of five years, to the funds listed under Schedule VII of the Act. However, the Company Law Committee observed in its report⁴, that while a carry forward might be fine but mandatory transfer of unspent amount at the end of five years would go against the principle of ‘Comply or Explain’ and would not be appropriate.

2019 Amendment and its impact:

• As stated above, though the Company Law Committee had suggested to not mandate the transfer of any unspent amount, the Amendment Act 2019 has made the following amendment to Section 135 to provide for-

i. “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;

ii. 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;”.

• Until now, the company which was not able to undertake CSR expenditure had to explain the reasons for the same in its Board Report, but now, after the amendment they would also be required to:

i. “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.

ii. 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.”

• The funds that are provided under Schedule VII are as follows:

i. Swach Bharat Kosh set-up by the Central Government for the promotion of sanitation;

ii. Clean Ganga Fund set-up by the Central Government for rejuvenation of river Ganga;

iii. 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 was proposed that the government would set up some specific fund for transferring the unspent amount. However, as on date, no such fund has been set-up.

• The amended provision on ongoing projects, provides for transferring the unspent amount on ongoing projects to a separate bank account and after a period of three financial years from the said date of transfer to one of the funds specified in Schedule VII. In this regard, following may be taken into consideration:

i. It appears that the ongoing projects shall only include the CSR programs or activities undertaken by company directly and where the expenditure on these, extends beyond the financial year to which the expenditure relates.

ii. The ongoing projects shall not include any project carried out by a Trust/ Society/ Section 8 Company as given under Rule 4(2) of CSR Rules 2014. Since MCA had clarified⁵ 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.

iii. To qualify as ongoing project, such project would have to adhere to the prescribed conditions of MCA, but these conditions are yet to be prescribed.

3. PENAL PROVISIONS-

The Companies (Amendment) Act 2019 has inserted the penal provisions in case of non- compliance with the provisions relating to the disclosure in the Board report or Transfer of Unspent CSR funds.

Earlier, in case of non- compliance with the provisions related to the disclosure in the board report, the residuary penal provisions as given under section 450 of the act were applicable. Section 450 states, “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.”

After the 2019 amendment, if there is any non compliance with Section 135 (5) or (6), 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. DIRECTIONS TO ENSURE COMPLIANCES-

The Companies (Amendment) Act 2019 has also inserted the provisions to empower the Central Government to issue directions to ensure compliance of provisions of Section 135 of the Act. According to 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 with the provisions of this section and they would have to comply with such directions. It appears that the aim of such an insertion is to authenticate the move of the Central Government, which is already in motion.

III. Critical analysis:

At the time of introduction of Section 135, it was stated that “CSR is not a tax a and the money is not flowing into the coffers of the Government.”⁶ However, with the current amendment, the CSR provisions have become similar to a tax, since spending minimum CSR amount is mandatory, failure of results in funds flowing into the coffers of the Government and penal sanction is attracted thereby. The intention of introducing CSR was to fund the betterment of the communities but handing over the unspent funds to the Government doesn’t ensure flow of funds to the local communities.

There are also certain lacunas in the amended CSR provisions, for example, will the amended CSR provisions retrospectively apply to the unspent Minimum CSR Amount from previous financial years or if the company is spending more than Minimum CSR amount in a particular financial year, can it carry- forward the excess to the next financial year.

The Government has not utilized the opportunity to resolve some of the existing issues with the CSR provisions, like CSR activities undertaken by the companies are exclusive of activities undertaken in pursuance of their normal course of business.⁷ However, CSR expenditure, if not incurred for capital expenditure or for purpose of business, won’t be allowed for deductions under Income Tax Act 1961. This gap in law, in which CSR spend is mandatory despite the fact that it is not automatically considered a deduction under IT Act, needs to be bridged so as to encourage CSR activities.

IV. Conclusion

The current regime of CSR enforcement has been quite weak with many companies openly flouting the norms. Despite not meeting the CSR obligations; they have not received any strict action from the side of Ministry of Corporate Affairs, seeking reasons for the same. However, this position is intended to be now corrected by the latest amendment providing for Penal Action for the non- compliance with CSR obligations. This is to bring more effectiveness to the whole CSR regime. It would be too early to comment on the effectiveness of the same. It is too soon to assess the exact impact of the CSR related Amendment.

The Companies (Amendment) Act 2019 has changed the entire scenario of Section 135 from “Comply or Explain” to “Comply or Imprisonment”. The Government over the period of 5 years since the inception of Section 135 in 2014, has realized that the CSR provisions are not being complied in totality and there was a lot of misuse of the “Comply or Explain” principle by the companies, which was not the intent of the Government.

The 2019 amendments seek to make incurring CSR expenditure as mandatory and no longer 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-

i. 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.

ii. 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 loophole may be addressed by the Government by amending the CSR Rules.

iii. 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.

*****