CS Saurabh Arora

Saurabh AroraThe term ‘Corporate Social Responsibility’ (CSR) literally means the responsibility of Corporate Entities towards society. The origination of CSR was happened long back in ancient India which lasted till 1850 and Charity and Philanthropy were the main drivers of that time.

Evolutions of CSR are divided in four phases and to have an idea of these phases, please refer below given link:

https://en.wikipedia.org/wiki/Evolution_of_corporate_social_responsibility_in_India

1. APPLICABILITY:

Section 135(1) of the Companies Act, 2013 (hereinafter to be referred as ‘the Act’) provides for the trigger point for the applicability of CSR Provisions and constitution of CSR Committee. The constitution of CSR committee is mandatory in company having:

  • Net Worth of Rs. 500 Crore
  • Turnover of Rs. 1000 Crore
  • Net Profit of Rs. 5 Crore

during any financial year.

2. NET WORTH:

As per Section 2(57),NW’ = (Paid Up Share Capital + All Reserves Created Out of Profits + Securities Premium Account) – (Accumulated Losses + Deferred Expenditure and Miscellaneous Expenditure not Written Off)

3. TURNOVER:

As per Section 2(91), ‘Turnover’ means the aggregate value of the realisation of amount made from the sale, supply or distribution of goods or on account of services rendered, or both, by the company during a financial year

4. NET PROFIT:

As per Rule 2(f) of the Companies (CSR Policy) Rules, 2014,‘Net Profit’ means the net profit of a company as per its financial statement prepared in accordance with the applicable provisions of the Act, but shall not include the following namely:

i) any profit arising from any overseas branch or branches of the company, whether operated as a separate company or otherwise; and

ii) any dividend received from other companies in India, which are covered under and complying; with the provisions of section 135 of the Act;

Provided that net profit in respect of a financial year for which the relevant financial statements were prepared in accordance with the provisions of the Companies Act, 1956, (1 of 1956) shall not be required to be re-calculated in accordance with the provisions of the Act.

Provided further that in case of a foreign company covered under these rules, net profit means the net profit of such company as per profit and loss account prepared in terms of clause (a) of sub-section (1) of section 381 read with section 198 of the Act.

5. ANALYSIS OF THE TERM NET PROFIT:

The aforesaid definition of ‘net profit’ as per Rule 2(f)provides for ‘net profit as per the financial statements prepared in accordance with the applicable provisions of the act’.

If we refer the provisions of the Companies Act, 2013, it is clear that Section 198 heading of which is ‘Calculation of Profits’ is the only provision which we need to consider for the interpretation of the expression ‘net profit’.

However, Section 198 starts with ‘in computing the net profits of a company in any financial year for the purpose of Section 197’. The inclusion of the words ‘for the purpose of Section 197’ created ambiguity whether Section 198 can be referred for the purpose of interpreting the expression ‘net profit’ provided in Section 135(1) and such inclusion of ‘reference to Section 197’, reflected that the intention of law maker may not be so.

If we accept Section 198 for calculation of net profit, then wherever applicability is based on net profit, we always need to look at section 198 which will not hold good in case of Section 181 & 182.

In addition to the above, there is another term namely, ‘average net profit’ which is used in Section 135(5) of the Act for the purpose of computation of expenditure which is to be incurred under corporate social responsibility.

However, good news is that a recent circular dated 12th January 2016, was issued by the Ministry, which provided for ‘average net profit’ criteria as under:

‘Q. Whether the ‘average net profit’ criteria for section 135(5) is Net profit before tax or Net profit after tax?

1. Computation of net profit for section 135 is as per section 198 of the Companies Act, 2013 which is primarily PROFIT BEFORE TAX (PBT).’

And, in addition to the above stated circular, explanation to Section 135 also clarifies it.

So from the above discussion it is clear that for the purpose of ‘average net profit’, computation would be as per the section 198. However, there is no clarity on the interpretation of the term ‘Net Profit’.

Further, the recent report of High Level Committee has also highlighted this ambiguity and stated that “it is necessary to issue clarification regarding the definition of Net Profit under section 135(1) and section 135(5).”

Further, if we look at the definition of net profit provided in Rule 2(f) of the Companies (CSR Policy) Rules, 2014, it explicitly states that net profit as per financial statements. And hence, a view can be taken that subject to two adjustments provided in Rule 2(f), the ‘profit after tax’ in the financial statements shall be considered for the purpose of ‘net profit’ under section 135(1).

6. THE MEANING OF EXPRESSION ‘ANY FINANCIAL YEAR’:

The expression ‘any financial year’ is used in Section 135(1) and to understand the meaning of this term, kindly consider below given points:

♣ Rule 3(2) of the Companies (CSR Policy) Rules, 2014, provides as under:

Every company which ceases to be a company covered under sub-section (1) of section 135 of the Act for three consecutive financial years shall not be required to:

a) constitute a CSR Committee; and

b) comply with the provisions contained in sub-sections (2) to (5) of the said section.

♣ Circular dated 18th June, 2014 provides as under:

‘Any financial year’ referred under Sub-Section (1) of Section 135 of the Act read with Rule 3(2) of Companies (CSR Policy) Rules, 2014, implies ‘any of the three preceding financial years’.

♣ Circular dated 18th June, 2014 provides as under:

Q. What is meaning of ‘any financial year’ mentioned above?

A. ‘Any Financial year’ referred under Sub- Section (1) of Section 135 of the Act read with Rule 3(2) of Companies (CSR Policy) Rules, 2014 implies any of the three preceding financial years.

Therefore, it is clear that if as per latest audited financial statements, a company hits the any of the financial strengths, then it is required to constitute and have CSR Committee for three consecutive years irrespective of the financial strength. And in case, in the fourth year, such company does not hit any of the financial strengths, then such company does not need to have and constitute CSR Committee.”

7. COMPOSITION OF CSR COMMITTEE:

As per Section 135(1), three or more Directors including at least one Independent Director shall form CSR Committee.

However, for the companies which are not required to have Independent Director shall constitute CSR Committee without Independent Director and the private companies having only two Directors shall constitute CSR Committee only with two such Directors as provided in Rule 5(1) of the Companies (CSR Policy) Rules, 2014.

8. DISCLOSURE IN BOARD REPORT:

As per Section 135(2)read with Rule 8, the Board’s Report prepared under Section 134 shall contain the disclosures of the Composition of CSR Committee as per prescribed Annexure under Companies (CSR Policy) Rules, 2014.

9. ROLE OF CSR COMMITTEE:

As per Section 135(3), following are the roles and responsibilities of CSR Committee:

  • Formulate a CSR Policy indicating the activities as per Schedule VII to the Act;
  • Recommend the policy to Board of the Company;
  • Recommend the amount of expenditure on the activities; and
  • Monitor CSR Policy by way of instituting a transparent monitoring mechanism for implementation of CSR projects or programmes or activities undertaken by the company as provided in Rule 5(2).

10. ROLE OF BOARD OF DIRECTORS:

As per Section 135(4), following is the role of Board of Directors:

  • Approve the CSR Policy;
  • Disclose the contents of policy on the company’s website, if any; (Format in this regard has been annexed as Annexure) [Also see Rule 9]
  • Ensure that activities as included in CSR Policy have been undertaken.

11. CSR EXPENDITURE:

As per Section 135(5), at least 2% of the average net profits of the company during three immediately preceding financial years must be spent against CSR as provided in CSR Policy.”

12. FAILURE TO SPEND CSR FUND:

If a company fails to pay amount allocated for CSR, then such company shall make such disclosure in the Board’s Report. Such company shall also specify the reason of failure to spend CSR Fund.

13. CSR Policy:

As per Rule4, following points must be considered while drafting the CSR Policy:

(1) CSR policy shall specifically provide activities which are to be undertaken by the Company during the financial year;

(2) CSR Policy shall not include the activities which are in the normal course of the business of the Company;

(3) CSR policy shall provide for the activities to be executed in India only to be covered under Section 135;

(4) CSR policy may provide for the activities which are for the benefit of the employees of the company. However, such expenditure on such activity will not considered as CSR expenditure;

(5) The companies can build their own capacities of their own personnel as well as those of their implementing agencies through Institutions with established track records of last three financial years. However, administrative overhead in any case shall not exceed 5% of total CSR expenditure in one financial year.

As per Rule 6, following shall be included in CSR Policy:

(1) The list of programmes or projects which finds its place in the purview of Schedule VII;

(2) The modalities for exaction of CSR projects;

(3) The schedules for implementation of CSR projects;

(4) Monitoring process of such projects;

(5) Specific declaration to the effect that surplus arising out of the CSR projectsshall not form part of the business profit of a company.

14. CSR ACTIVITIES:

As per Rule 4, following points must be considered while taking decisions on the activities to be undertaken by the Companies:

(1) CSR activities shall be undertaken as per its formalised CSR Policy;

(2) Any activity which is undertaken in the normal course of business cannot be termed as CSR activities of the Company;

(3) Two or more companies can also come together and collaborate for the purpose of undertaking projects or programmes under their CSR Policy in such a manner that the CSR Committees of respective companies are in position to report separately;

(4) To term any activity as ‘CSR activity’, the same shall be undertaken in India only;

(5) The companies can have CSR activities which will benefit the employees of such company. However, such activities will not be considered as CSR Activities pursuant to Section 135 of the Act;

(6) Political contribution shall not be considered as CSR activities.

15. CSR THROUGH TRUST, SOCIETY AND SECTION 8 COMPANY:

As per Rule 4(2), the Companies can spend its CSR expenditure through registered trust, society or section 8 companies.

1. The law has granted companies to come together to form a trust, society or section 8 company for this purpose. Such companies coming together not necessarily required having some relations with each other such as associate, holding-subsidiary relation, etc. and hence, even unrelated companies can come together for this purpose.

2. The Companies can also undertake CSR activities through a company established under section 8 of the Act or a registered trust or a registered society established by the Central Government or State Government or any entity established under an Act of Parliament or a State Legislature.

However, if a company doesn’t opt for any of the aforesaid options for undertaking CSR activities and decide to undertake CSR activities through a company established under section 8 of the Act or a registered trust or a registered society other than those specified above then:

1. Such company or trust or society shall have an established track record of three years in undertaking similar programs or projects;

2. The Companies have specified the projects or programs which shall be undertaken with their funds;

3. Modalities of utilization of funds; and

4. Monitoring and reporting mechanism.

Though, the above stated provisions and interpretation thereof provide clarity over CSR provisions, still there are different thought of schools which interpret meaning of the expression ‘Net Profit’ for the purpose sub-section (1) and (5) of section 135 in the spirit of section 198.

(Author can be reached at sarora18@gmail.com)

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