Companies Act 2013 and CSR

Corporate Social Responsibility (CSR) has become an important part of company’s functioning. With companies having a legal entity and existence in the eyes of law are required to contribute towards the society that they operate in. This has given emergence to CSR activities being evolved over a period of time. Corporate Social Responsibility (CSR) refers to various activities being undertaken with the aim of social welfare and welfare of the masses at large and includes various activities like Healthcare facilities, education, women empowerment, sanitation and hygiene etc.

Though expenditures are incurred by the companies with regard to CSR activities since long ago, but the evolution of CSR activities can be broadly classified into Pre Companies Act 2013 and post Companies Act 2013 era. Further there are various income tax implications which are associated with CSR activities both in pre and post Companies Act 2013. Discussing the same in detail as follows:

Prior to Companies Act, 2013:

Prior to Companies Act 2013, the regulations as per Companies Act 1956 were applicable wherein there was no mandatory requirement on behalf of the companies to undertake CSR activities. It was on the company’s option to decide whether to undertake CSR activities or not. There were many companies who did undertake CSR activities but not out of legal compulsion but to enhance their goodwill and set up better networks etc.

Tax Implication:

Thus, as the CSR activities was voluntary for companies there was no separate provision mentioned in this regard in the Income Tax Act, 1961 and various amendments thereon until 2013. Any expenditure incurred by companies as part of their CSR programmes was treated in the similar fashion and were guided by the other provisions of the Income Tax Act. Thus, such expenditures were claimed as deduction for companies to arrive at their taxable income as per sections like 35(2AA), 35(AC), 80G etc. Furthermore, such CSR activities related expenditure was generally claimed as a general deduction as per section 37(1) of Income Tax Act, 1961 rather than under sections 30 to 36 dealing with specific expense related deductions. This was the treatment for CSR activities and their tax implications.

Post Companies Act 2013:

With the advent of Companies Act, 2013 making several amendments to the original Companies Act of 1956, there was an important amendment with regard to the Corporate Social Responsibility. With Companies Act, 2013 section 135(1) was introduced which made CSR activities mandatory for companies to be incur under certain application criteria. Thus companies with certain level of turnover or profits (mentioned further) would be compulsorily required to spend a certain percentage of their profits as CSR activities. Definition for the same is also mentioned in the act.

Applicability:

The section 135(1) as per Companies Act 2013is applicable to all the companies whether they are domestic company or foreign company, holding or subsidiary company, public or private company, if during any of the three preceding financial year

  • Turnover of the company is 1000 cr. or more.
  • Net worth of the company is 500 cr. or more.
  • Net profit of the company is 5 cr. or more.

On fulfilling any of the above three mentioned criteria, CSR obligations arise for the company.

Quantum of Money to be Spent on CSR Activities:

As per the mandate of the Companies Act 2013 u/s 135(1), the company which fulfils the above mentioned criteria is required to spend minimum of 2% of Average Net profit of the company for immediately three preceding financial years as CSR activities.

Further, such amount should be spent in accordance with the items falling within the regulations of Schedule 7 of the Companies Act, 2013. This list of activities which are regarded as the broad spectrum of social welfare activities is not considered an exhaustive list. Thus, any expenditure for social welfare as approved by the company’s board and CSR committee would be considered as CSR related expense provided it should not be with regards to the business and its operations in any way and should primarily focus upon the welfare of the society or masses at large.

In case the company is not able to spend the required amount and fulfil its CSR obligation, they are required to disclose the same in their Annual reports.

Computation of Average Net Profit:

The computation of Average net profit which forms the base for determining the minimum amount to be spent on CSR activities is discussed in the section 198 As per companies Act 2013. This should not include the following:

  • Any profits or gains of any overseas branch of the company.
  • Any dividends received from any Indian company which is already in compliance with the Section 135 of the Companies Act 2013 i.e. it already complies with the CSR related obligation and thus dividend would have been distributed after complying with CSR obligation.

The computation of the Average net profit can be summarised as follows:

Particulars

Amount

Net profit After tax

XXX

Add:

Allowed Credits

Subsidies received from any government or public authority

XX

Gain on sale of any immovable property (original cost – WDV)

XX

Less:

Credits disallowed:

Profit of capital nature like sale of any undertaking or unit

XX

Profit earned on sale of forfeited shares

XX

Premium received on debentures or shares

XX

Gain on sale of any immovable property (sales consideration – original cost)

XX

Surplus on revaluing asset or liability at fair value (routed through P/L)

XX

Less:

Expenses Allowed

Directors Remuneration

XX

Bonus/ commission paid to staff

XX

Interest on debentures

XX

Usual working Charges

XX

Interest on loans (secured or unsecured)

XX

Tax on business profits (for any special reason)

XX

Tax on abnormal profits of the business

XX

Depreciation extent to Section123

XX

Insurance expenses

XX

Bad debts written off

XX

Repairs (other than included in capital expenditures)

XX

Prior period items

XX

Contributions to charitable trusts

XX

Legal liability for any form of damages or compensations

XX

Add:

Expenses Disallowed

Income tax

XX

Capital loss on any sale of undertaking

XX

Expenses on revaluing asset and liabilities on fair value

XX

Compensations damages or any voluntary payments

XX

RESULTING AMOUNT- NET PROFIT FOR CSR

XXX

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Average of such net profit for immediately preceding three financial years would be the Average Net profit for CSR obligation. 2% of such Average Net Profit amount would be the minimum CSR expenditure to be incurred.

Activities not falling under the purview of CSR activities.

All expenses cannot be considered as CSR expense. As stated earlier, they should be in conformity with the activities mentioned in the list / schedule VII of the Companies Act. Any activity undertaken by the company which is in conformity with the normal course of running the company’s business would not be regarded as CSR activity. The activities which are regarded to be in the normal course of running the company’s business are:

  • Pre-condition of incorporating or running a business
  • Any contractual obligation on part of the company requiring to undertake such activities
  • If such activity falls under the legal obligation for the company as per any other law ir statutory provision governing the company.

Further any activity conducted outside the geographical boundary of India or benefiting only the employees of the company or any contribution made to political parties would not fall under the purview of CSR activities.

Discharge of CSR Related Obligation:

The companies can carry out their CSR expenses in the following three ways:

  • Fulfilling the CSR related obligation by making any form of contribution to specified funds as per the list included in the Schedule VII.
  • By means of any registered NGO, society, trust etc.
  • In other ways as mandated in the Companies (Corporate Social Responsibility) Rules 2014.

Penalties with Regard to Non-Compliance:

Any non-compliance on part of the company in fulfilling their CSR obligation would attract penalties as follows:

  • Fine for the company of not less than 50,000 Rs. which may extend up to Rs. 25 lakhs.
  • Officers of the company which are convicted of default would attract imprisonment of up to 3 years or Fine of not less than Rs. 50,000 which may extend up to Rs. 5 Lakhs.
  • Both the penalties (for the company and the officers in default) may be attracted as the case may be.

Other Regulations:

Following other attributes and regulations regarding CSR obligation are as follows:

  • CSR expenditure can be both in the form of spending or contribution made by the company.
  • CSR expenditure is not regarded as a charity or donation made by the company in any form.
  • Any form of surplus or any amount unspent arising out of the concerned CSR activity would not be regarded as the business profits for the company.
  • Further no provision for unspent amount to be made. Only disclosure in the board report is required.
  • Any form of excess expenditure incurred beyond the concerned limit of 2 % of average net profit is voluntary and cannot be set off against future CSR obligations of the company.
  • If any grant is received for undertaking any CSR expenditure, the amount spent should be considered net of grants

Tax Implications:

After the introduction of mandatory Corporate Social Responsibility (CSR) obligation as per the companies Act 2013, there was an explanation issued as per the Finance Act, 2014. It stated that any form of CSR expenditure that is incurred by the company shall NOT be regarded as the expenditure incurred by the company for its business or profession. As a result, deductions with regard to CSR expenditure for reducing the corporate income are not justified and hence can’t be claimed.

Thus, on one side it is compulsory to undertake CSR related expenditure as mandated by Companies Act, 2013 while on the other hand Income Tax Act does disallow such expenditure to be claimed as deductions.

General Deductions under section 37(1):

The income tax provisions as per Section 37(1) states that expenditure not falling under the section 30 to 36 of the income tax act would be allowed as general deduction under this section if the following conditions are satisfied:

  • Expense is not in the form of Capital Expenditure
  • Expense is not a form of Personal Expense
  • Expense is not related to any form of offense which is prohibited by any law
  • Such expense should necessarily be undertaken for the purpose of conducting the business or profession (wholly and exclusively).

Thus, as per amendment made in the Finance Act 2014, any form of CSR expenditure which does fall under the provisions of section 30 to 36 and 80G of Income Tax Act, 1956, would be allowed as deduction to be claimed by the company. But any other form of CSR expenditure not falling under the above mentioned provisions cannot be claimed as general deduction under section 37 of the act.

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As a result, companies as a part of their tax planning measures should undertake CSR activities (as mentioned in schedule VII) which can also be claimed as deductions under section 30 to 36 and 80G of Income Tax Act 1961. This would help the companies to fulfil their CSR obligation requires as per Companies Act and also claim deduction in the Income tax act so that their taxable income can be reduced. This would serve dual purpose for the companies.

Concept of Application of Income:

As per the Finance ministry and Income Tax authorities, any form of Expenditure incurred for CSR activities are in the form of APPLICATION OF INCOME. This means that it is not an expense incurred to earn income rather it is the usage of already earned income towards the welfare of the society as their social responsibility. The Income Tax Act had been developed on the grounds that any form of expenditure which involves “Application of Income” would not be allowed to claim as a deduction as per the provisions. Thus, any form of CSR expenditure cannot be claimed as a deduction and thus would be disallowed in the hands of the company (for income tax purposes).

Contrary to the above view there are certain people who believe that CSR activities being mandatory for the company should be allowed as a deduction.

Further it was argued by experts that Director’s remuneration is also computed as percentage of net profit which is allowed as a deduction in income tax act and so CSR related expenditure should have been allowed as deduction. It is opposed by income tax authorities on the ground that director’s remuneration falls under the normal course of running the business and therefore I allowed under section 37(1) as a general deduction which is not the case with CSR expenditure. The basis of including any expenditure as related to CSR is that it should not fall under the normal course of running the business and thus does not adhere to the provisions of Section 37(1).

Differential Form of Tax Treatment Pre and Post Companies Act, 2013:

The major form of difference in tax treatment pre and post introduction of Companies Act 2013 is that deduction for CSR expenditure was allowed also as a general deduction under section 37(1) along with deduction claim under sec 30 to 36 or 80G for CSR activities, prior to introduction of companies Act 2013. This changed post introduction of Companies Act 2013 whereby the CSR expenditure could not be claimed as a general deduction under section 37(1) but could be claimed as deduction if it falls under the purview of section 30 to 36 and section 80G of the Income Tax Act.

Details of CSR Spending of Companies

ITC LIMITED

Net Average Profit for the last 3 years = Rs. 12338.22 crores

CSR Expenditure according to rules = Rs. 246.76 crores

Actual CSR Spending = Rs. 247.50 crores

Amount unspent = Zero

Activities conducted in CSR which can be claimed as deduction in Income Tax:

Activities Under Company’s Act 2013

Deduction under Income Tax Act, 1961

Promoting Preventive Healthcare, Sanitation & Poverty Alleviation (Schedule VII – (i))

Section 35AC r.w. Rule 11k(i)(a),(f),(j) of the 1962 Rules

80G(2)(iiihk)

Livelihood Enhancement (Schedule VII – (ii))

Section 35AC r.w. 11K(i)(c),(i),(o),(p),(s) of the 1962 Rules

Economic Empowerment of Women (Schedule VII – (iii))

Section 35AC r.w. Rule 11K(i)(n),(i) of the 1962 Rules

Ensuring Environmental Sustainability (Schedule VII – (iv))

Section 35AC r.w. Rule 11K(i)(d),(h),(l),(q),(r) of the 1962 Rule & 80G(2)(iiihl)

Protection of National Heritage, Art & Culture (Schedule VII – (v))

Section 35AC r.w. Rule 11K

Rural Development (Schedule VII – (x))

Section 35AC and Section 35CCA

TATA MOTORS

Net Average Profit for the last 3 years = Loss of Rs. 2034 crores

CSR Expenditure according to rules = Not Applicable due to loss

Actual CSR Spending = Rs. 20.57 crores

Amount Unspent = Zero

Activities conducted in CSR which can be claimed as deduction in Income Tax:

Activities Under Company’s Act 2013

Deduction under Income Tax Act, 1961

Promoting Preventive Healthcare, Sanitation & Poverty Alleviation (Schedule VII – (i))

Section 35AC r.w. Rule 11k(i)(a),(f),(j) of the 1962 Rules

80G(2)(iiihk)

Livelihood Enhancement (Schedule VII – (ii))

Section 35AC r.w. 11K(i)(c),(i),(o),(p),(s) of the 1962 Rules

Economic Empowerment of Women (Schedule VII – (iii))

Section 35AC r.w. Rule 11K(i)(n),(i) of the 1962 Rules

Ensuring Environmental Sustainability (Schedule VII – (iv))

Section 35AC r.w. Rule 11K(i)(d),(h),(l),(q),(r) of the 1962 Rule & 80G(2)(iiihl)

INFOSYS

Net Average Profit for the last 3 years = Rs. 12,800 crores

CSR Expenditure according to rules = Rs. 256.01 crores

Actual CSR Spending = Rs. 202.30 crores

Amount Unspent = Rs. 53.71 crores (some of the projects undertaken are multi – year)

Activities conducted in CSR which can be claimed as deduction in Income Tax:

Activities Under Company’s Act 2013

Deduction under Income Tax Act, 1961

Promoting Preventive Healthcare, Sanitation & Poverty Alleviation (Schedule VII – (i))

Section 35AC r.w. Rule 11k(i)(a),(f),(j) of the 1962 Rules

80G(2)(iiihk)

Livelihood Enhancement (Schedule VII – (ii))

Section 35AC r.w. 11K(i)(c),(i),(o),(p),(s) of the 1962 Rules

Ensuring Environmental Sustainability (Schedule VII – (iv))

Section 35AC r.w. Rule 11K(i)(d),(h),(l),(q),(r) of the 1962 Rule & 80G(2)(iiihl)

Protection of National Heritage, Art & Culture (Schedule VII – (v))

Section 35AC r.w. Rule 11K

Rural Development (Schedule VII – (x))

Section 35AC and Section 35CCA

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BRITANNIA

Net Average Profit for the last 3 years = Rs. 523.00 crores

CSR Expenditure according to rules = Rs. 10.46 crores

Actual CSR Spending = Rs. 10.46 crores

Amount Unspent = Zero

Activities conducted in CSR which can be claimed as deduction in Income Tax:

Activities Under Company’s Act 2013

Deduction under Income Tax Act, 1961

Promoting Preventive Healthcare, Sanitation & Poverty Alleviation (Schedule VII – (i))

Section 35AC r.w. Rule 11k(i)(a),(f),(j) of the 1962 Rules

80G(2)(iiihk)

Livelihood Enhancement (Schedule VII – (ii))

Section 35AC r.w. 11K(i)(c),(i),(o),(p),(s) of the 1962 Rules

Rural Development (Schedule VII – (x))

Section 35AC and Section 35CCA

WIPRO

Net Average Profit for the last 3 years = Rs. 7800.2 crores

CSR Expenditure according to rules = Rs. 159.82 crores

Actual CSR Spending = Rs. 159.82 crores

Amount Unspent = Zero

Activities conducted in CSR which can be claimed as deduction in Income Tax:

Activities Under Company’s Act 2013

Deduction under Income Tax Act, 1961

Promoting Preventive Healthcare, Sanitation & Poverty Alleviation (Schedule VII – (i))

Section 35AC r.w. Rule 11k(i)(a),(f),(j) of the 1962 Rules

80G(2)(iiihk)

Livelihood Enhancement (Schedule VII – (ii))

Section 35AC r.w. 11K(i)(c),(i),(o),(p),(s) of the 1962 Rules

Ensuring Environmental Sustainability (Schedule VII – (iv))

Section 35AC r.w. Rule 11K(i)(d),(h),(l),(q),(r) of the 1962 Rule & 80G(2)(iiihl)

Rural Development (Schedule VII – (x))

Section 35AC and Section 35CCA

CASE LAWS:

P. Balakrishnan, Commissioner Of … vs Travancore Cochin Chemicals Ltd. on 25 October, 1999

In this case law, the assesse had paid an amount to the FACT school and wanted to claim it as a deduction under the welfare expenditure. The AO denied the assessee’s claim and denied the deduction. The matter then went on the Tribunal where the assessee argued that the amount was not a donation but was paid as part of an expenditure to the school, as the children of most of its employees studied there. The assesse wanted to claim the deduction under Section 40A(9) but since, it was for the welfare of business and not in the form of capital expenditure, so it was allowed as a deduction under Section 37(1) and Section 40A(10).

ACIT v Jindal Power Limited (IT APPEAL NO. (BLPR) OF 2012)

In this case law, the assessee had claimed a certain amount paid for the CSR activity as deduction. But the AO, had rejected the claim based on the fact that it was not a statutory but a voluntary expenditure and not for the purpose of business. In this case, since it was a case before the amendments were brought up in Section 37(1). The Tribunal allowed the voluntary CSR to be treated as business expenditure. The Tribunal based its decision on that the Explanation 2 of the Act, which states for disallowance only on statutory expenditures. Since, it was not triggered, so it was allowed as a deduction.

The Commr Of Income Tax vs M/S Infosys Technologies Ltd on 22 April, 2013

In this case law, the assessee had installed a traffic signal near to his office and claimed it under deduction under Section 37(1). The AO denied the claim of the assessee describing that it was not for the purpose of business. It has to be treated as a donation and cannot be claimed as a deduction. But, based on the claims of the assessee that the traffic signal would help its employees as it would help them to save time and reduce stress. The Tribunal than granted the company a deduction under Section 37(1).

Mysore Kirloskar Ltd. vs Commissioner Of Income-Tax on 8 September, 1986

In this case, the assessee had a plant in a remote location and to attract best talents it had built a school for their children and donated it to a trust. The assessee had claimed it as a deduction under Section 37(1) stating that it was for the welfare of the business. The AO rejected the claim stating that it cannot be claimed as an expenditure. In this case the amount was paid to a trust which comes under Section 80G and the assessee can claim deduction under that. And also, only 61% students were the children of the assessee’s employees and so it can be stated that it was not fully for the welfare of the business.

Commissioner Of Income Tax vs Rajasthan Spg. And Wvg. Mills Ltd. on 17 September, 2004

In this case, the assessee had given a bus to a school and claimed the expenditure as a deduction under Section 37(1), considering the fact that most of its employee’s children study in that school and the bus would benefit them as the school didn’t have enough buses. The AO rejected the claim of the assessee terming the expenditure as a donation to the school and not for the welfare of the business. The Tribunal however ruled in the favour of assessee based on the several old cases which allowed such deductions under Section 37(1).

Synopsis of Case Laws:

In the case laws studied above, it has been made clear that prior to the Companies Act, 2013 and the Finance Amendment Bill, 2014, the companies had been claiming any sort of donation under the Section 37(1). The AOs rejected the Company’s claims but they were randomly rejected by the Tribunals based on the several old judgements. The new amendment has brought about clarity as to what can be claimed as a deduction under CSR and what not can be.

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