Corporate Social Responsibility (CSR) and its Tax Implications in India

In India, Corporate Social Responsibility (CSR) is a mandatory obligation for certain companies under Section 135 of the Companies Act, 2013. Companies with a net worth of ₹500 crore or more, turnover of ₹1,000 crore or more, or net profit of ₹5 crore or more in the preceding financial year must constitute a CSR committee and spend at least 2% of their average net profits from the preceding three financial years on specified CSR activities. This obligation also extends to holding, subsidiary, and foreign companies meeting these criteria. The “net profit” for CSR calculation excludes profits from overseas branches and dividends from other Indian companies already complying with CSR. Eligible CSR activities are listed in Schedule VII of the Companies Act, covering areas like healthcare, education, environmental sustainability, and support for national funds. Unspent CSR funds for ongoing projects must be transferred to a separate “Unspent CSR Account” and utilized within three financial years, while unspent amounts for other projects must be transferred to designated Schedule VII funds within six months. Non-compliance can result in penalties, and excess spending can be set off against future CSR obligations for up to three years.

The tax treatment of CSR expenditure is governed by the Income Tax Act, 1961. Section 37(1) generally disallows CSR expenditure as a business deduction, explicitly stating it’s not considered for business purposes. This means mandatory CSR spending is treated as an application of income rather than a deductible business expense. However, a key distinction exists: while not deductible under Section 37(1), certain CSR contributions may qualify for deductions under Section 80G. If a CSR activity involves a donation to an institution or fund eligible for 80G deduction, the company can claim this benefit, subject to the conditions of Section 80G. It’s important to note that Section 80G itself contains specific exclusions for CSR contributions to certain government funds, such as the Swachh Bharat Kosh and Clean Ganga Fund. Judicial pronouncements have consistently upheld this view, confirming that while CSR is not a business deduction, donations to 80G-approved entities within CSR activities can still be deducted under Section 80G. Furthermore, under GST laws, Input Tax Credit (ITC) on goods or services used for CSR activities is generally not allowed, as these activities are typically not considered to be in the “course or furtherance of business.”

In India, Corporate Social Responsibility (CSR) is governed primarily by Section 135 of the Companies Act, 2013, making it a mandatory obligation for certain companies. The tax treatment of CSR expenditure has been a point of considerable discussion, particularly after the introduction of specific provisions in the Income Tax Act, 1961.

1. Mandatory CSR under the Companies Act, 2013

Applicability: Section 135(1) of the Companies Act, 2013, mandates CSR for companies that, in the immediately preceding financial year, meet any of the following criteria:

• Net worth of ₹500 crore or more, or
• Turnover of ₹1,000 crore or more, or
• Net profit of ₹5 crore or more.

CSR Committee: Every such company is required to constitute a CSR committee of the Board.

Rule 3(1) of CSR Rules requires compliance of CSR provisions by holding and subsidiary companies, as well as by foreign companies having branches or project office in India, which fulfil the criteria specified under section 135(1) of the Act.

Rule 3(2) of the CSR Rules provides that every company which ceases to be a company covered under section 135(1) of the Act for three consecutive financial years, shall not be required to –

• Constitute a CSR Committee; and
• Comply with the CSR provisions

till such time it meets the criteria specified in sub-section (1) of section 135.

Meaning of Net Profit: The term “net profit” has been referred to in section 135(1) of the Act, as regard applicability of CSR provisions is concerned and in section 135(5) of the Act with respect to the calculation of amount prescribed for spending in any particular financial year.

As per explanation to section 135(5) of the Act, “net profit” shall not include such sums as may be prescribed and it shall be calculated in accordance with the provisions of section 198 of the Act. As per rule 2(h) of CSR Rules, “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:

• any profit arising from any overseas branch or branches of the company, whether operated as a separate company or otherwise; and
• 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 in case of a foreign company covered under CSR Rules, net profit means the net profit of such company as per profit and loss account prepared in terms of section 381(1)(a) read with section 198 of the Act.

Hence, it should be noted that for ascertaining the applicability of CSR provisions and for calculation of the prescribed spending, the net profit shall be calculated as per section 198 of the Act and the relevant adjustments shall be made to the same as stated above under rule 2(h) of the CSR Rules.

Composition of CSR Committee: Every company covered under section 135(1) of the Act is required to constitute a CSR committee of the Board consisting of at least three or more directors with at least one independent director.

As per proviso to section 135(1) of the Act, where a company is not required to appoint an independent director under section 149(4) of the Act, it shall have in its CSR Committee two or more directors.

In addition, rule 5(1) of CSR Rules exempts unlisted public companies and private companies that are not required to appoint an independent director from having an independent director as a part of their CSR Committee. Further, in case where a private company has only two directors on the Board, the CSR Committee can be constituted with these two directors. The CSR Committee of a foreign company shall comprise of at least two persons wherein one or more persons should be resident in India and the other person nominated by the foreign company.

Section 135 (9) of the Act as introduced by the Companies (Amendment) Act, 2020 provides for an exemption from the requirement to constitute a CSR Committee where the amount to be spent by the company under section 135(5) of the Act does not exceed Rs. 50 lakh in a financial year. In such cases, the functions of CSR Committee as provided under section 135 of the Act shall be discharged by the Board of Directors of such company.

Spending Obligation: Eligible companies are required to spend at least 2% of their average net profits of the immediately preceding three financial years on CSR activities. If the company has not completed three financial years, the average net profit of the preceding financial years since its incorporation is considered.

Applicability of CSR provisions to newly incorporated companies: Section 135(1) of the Act specifies eligibility for undertaking CSR activities as net worth of Rs. 500 crore, or turnover of Rs. 1000 crore, or net profit of Rs. 5 crore for the preceding financial year. The criteria is mutually exclusive. While, section 135(5) of the Act enunciates that the quantum of CSR amount to be spent should be calculated as 2% of average net profit made during the immediately preceding three years, it also says that for the companies which have not completed the period of three financial years since incorporation, the quantum of CSR amount to be spent shall be 2% of the average net profits of the company made during such immediately preceding financial years

Eligible Activities (Schedule VII): The Companies Act, 2013, along with the Companies (CSR Policy) Rules, 2014 (and subsequent amendments), specifies a list of activities under Schedule VII that qualify as CSR. These include:

• Eradicating hunger, poverty, and malnutrition; promoting health care and sanitation.
• Promoting education, including special education and employment-enhancing vocational skills.
• Promoting gender equality, empowering women, setting up homes for women and orphans.
• Ensuring environmental sustainability, ecological balance, protection of flora and fauna.
• Protection of national heritage, art, and culture.
• Measures for the benefit of armed forces veterans, war widows, and their dependents.
• Training to promote rural sports, nationally recognized sports, Paralympic sports, and Olympic sports.
• Contribution to the Prime Minister’s National Relief Fund or any other fund set up by the Central Government for socio-economic development and relief.
• Contributions to incubators funded by the Central or State Government or Public Sector Undertakings.
• Rural development projects.
• Slum area development.
• Disaster Management

Treatment of Unspent CSR Amount:

• Ongoing Projects: If the unspent amount relates to an ongoing project, it must be transferred to a separate “Unspent CSR Account” within 30 days from the end of the financial year(Section 135(6)). This amount must be spent within three financial years from the date of transfer.
• Other than Ongoing Projects: Any unspent amount for projects other than ongoing projects must be transferred to a fund specified in Schedule VII (e.g., Prime Minister’s National Relief Fund, PM CARES fund, Clean Ganga Fund setup by Central Government for rejuvenation of river Ganga, Swach Bharat Kosh set up by Central Government for promotion of sanitation) within six months of the end of the financial year.
• Penalty for Non-Compliance: Non-compliance with CSR spending obligations or proper transfer of unspent funds can attract penalties for the company and its officers.

The Companies (Amendment) Act, 2020 has amended the penal provisions under section 135(7) of the Act effective from 22nd January 2021 as under:

“(7) If a company is in default in complying with the provisions of sub-section (5) or sub-section (6), the company shall be liable to a penalty of twice the amount required to be transferred by the company to the fund specified in Schedule VII or the Unspent Corporate Social Responsibility Account, as the case may be, or one crore rupees, whichever is less, and every officer of the company who is in default shall be liable to a penalty of one-tenth of the amount required to be transferred by the company to such Fund specified in Schedule VII, or the Unspent Corporate Social Responsibility Account, as the case may be, or two lakh rupees, whichever is less.”;

Treatment of Excess spending: With effect from 22nd January 2021, a new proviso has been inserted in section 135(5) of the Act which says that if the company spends an amount in excess of the requirements provided under this sub-section, such company may set off such excess amount spent against the requirement to spend for such number of succeeding financial years and in such manner, as may be prescribed.

Rule 7(3) of CSR Rules prescribes that the set-off can be claimed up to immediately succeeding three financial years subject to the condition that –

• the excess amount available for set off shall not include the surplus arising out of the CSR activities, if any, in pursuance of rule 7(2) of CSR Rules.
• the Board of the company shall pass a resolution to that effect.

For detailed analysis refer the issued Guidance Note on CSR

2. Income Tax Treatment of CSR Expenditure

The tax treatment of CSR expenditure is primarily governed by Section 37(1) of the Income Tax Act, 1961, and more specifically, Explanation 2 inserted into this section by the Finance (No. 2) Act, 2014, with effect from April 1, 2015 (Assessment Year 2015-16 onwards).

3. General Rule: Non-Deductibility as Business Expenditure (Section 37(1))

• Section 37(1) allows for the deduction of any expenditure (not being capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purposes of the business or profession.
• However, Explanation 2 to Section 37(1) explicitly states: “For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred by the assessee for the purpose of business or profession.”

Implication: This explanation clarifies that mandatory CSR expenditure, as per Section 135 of the Companies Act, 2013, is considered an application of income rather than an expenditure incurred for the purpose of carrying on business. Therefore, it is not allowed as a deduction while computing profits and gains from business or profession. The legislative intent behind this was to prevent subsidizing CSR expenses through tax deductions, as CSR is seen as a social obligation.

4. Specific Deductions for Certain CSR Contributions (Section 80G)

While CSR expenditure is generally disallowed under Section 37(1), certain contributions made as part of CSR activities may still qualify for deduction under other specific sections of the Income Tax Act, notably Section 80G.

• Section 80G allows deductions for donations made to certain funds, charitable institutions, etc.
• Key Distinction: The disallowance under Section 37(1) applies to CSR expenditure as a business expense. However, if the CSR activity involves making a donation to an institution or fund that is eligible for deduction under Section 80G, the company can claim the 80G deduction subject to the limits and conditions prescribed therein.
• Important Caveat: Section 80G itself contains specific exclusions for CSR contributions to certain government funds. For example, clauses (iiihk) and (iiihl) of Section 80G(2) explicitly state that sums spent by an assessee in pursuance of CSR under Section 135(5) of the Companies Act, 2013, to the Swachh Bharat Kosh and Clean Ganga Fund are not eligible for deduction under Section 80G. This implies that for other contributions to 80G-approved entities, a deduction can be claimed.

5. CBDT Clarifications:

• CBDT Circular No. 01/2015 dated January 21, 2015, which provided explanatory notes to the provisions of the Finance (No. 2) Act, 2014, clearly stated that CSR expenditure, being an application of income, cannot be allowed as a deduction under Section 37(1).
• General Circular No. 01/2016 dated January 12, 2016 issued by the Ministry of Corporate Affairs (MCA) also reiterated that the amount spent by a company towards CSR cannot be claimed as business expenditure.

6. Judicial Pronouncements (Case Laws)

Several rulings by the Income Tax Appellate Tribunal (ITAT) have consistently affirmed the position that while CSR expenses are not deductible under Section 37(1) due to Explanation 2, deductions can be claimed under Section 80G if the conditions are met.

• JMS Mining (P.) Ltd. vs. Principal Commissioner of Income Tax (ITAT Kolkata): This is a prominent case where the Tribunal held that if a donation is made to an institution eligible under Section 80G as part of CSR activities, the deduction under Section 80G cannot be denied merely because it is a mandatory CSR expenditure. The ITAT emphasized that the disallowance under Explanation 2 to Section 37(1) only pertains to business expenditure and does not restrict deductions available under Chapter VI-A (like Section 80G).
• Goldman Sachs Services Pvt. Ltd. vs. JCIT (ITAT Bangalore): Similar to JMS Mining, this ruling confirmed that CSR contributions eligible for Section 80G deductions should be allowed, even if they are mandatory under the Companies Act, 2013. The Tribunal looked at the specific exclusions mentioned in Section 80G(2) (like Swachh Bharat Kosh and Clean Ganga Fund for CSR contributions) and inferred that other CSR contributions to 80G-eligible entities would qualify for deduction.
• Allegis Services (India) (P.) Ltd. vs. Asstt. CIT (ITAT Bangalore): This case also aligned with the above view, allowing 80G deductions for CSR payments made to eligible charities.

Summary of Judicial View: The tribunals have consistently drawn a clear distinction:

• CSR expenditure is generally not allowed as a business deduction under Section 37(1) due to Explanation 2.
• However, if a CSR activity involves making a donation to an institution/fund specified under Section 80G, the company can claim the 80G deduction, provided all other conditions of Section 80G are satisfied and it’s not a contribution specifically excluded by Section 80G itself for CSR purposes.

7. GST Implications (Briefly)

It’s also important to note that Input Tax Credit (ITC) on goods or services used for CSR activities is generally not allowed under GST laws. Section 17(5)(fa) of the CGST Act specifically blocks ITC in respect of goods or services used for activities relating to obligations under corporate social responsibility. This is because CSR activities are typically not considered to be in the “course or furtherance of business” for the purpose of ITC.

Conclusion

While the Companies Act, 2013, mandates CSR spending, the Income Tax Act, 1961, clearly states that such expenditure is generally not deductible as a business expense under Section 37(1). However, companies can still avail tax benefits under Section 80G if their CSR activities involve donations to eligible charitable institutions or funds, with specific exceptions. This dual approach ensures that while companies fulfill their social obligations, they can strategically plan their CSR initiatives to align with available tax incentives. Companies should meticulously document their CSR expenses and classify them correctly to avoid disallowances during tax assessments.