CSR – Interplay between Income-Tax Act & Companies Act

Corporate Social Responsibility or CSR is a known name in the new ERA of corporate culture where now-a-days every company is trying to get a name in the list of socially responsible entities. Every penny spend on towards CSR activities plays an important role from the angle of Companies Act, 2013 as well as Income Tax Act, 1961.

At one side where it has been made mandatory for every profit making company to spend on CSR, on the other hand the allowability of CSR expenditure (or similar expenditure by whatever name called) under the Income Tax Act, 1961 has been always a matter of contention over the years. The statutory compulsion to comply with CSR obligations has arisen only now, consequent to notification of section 135 of the Companies Act, 2013 with effect from 1st April, 2014, however, some big corporates over a period of time have been incurring social costs voluntarily and claiming such costs as business expenditures for income-tax purposes.

Obligation under Companies Act, 2013

CSR in India has become a statutory requirement under the Companies Act, 2013. The provisions are contained in section 135 of the Companies Act, 2013 r.w. CSR rules which came into effect from 1 April, 2014. Now it is statutory responsibility of every profit making company to spend some part of their profit on the CSR. If we go deep into the provisions of Companies Act, 2013, Section 135 of the Companies Act, 2013, provides that every company fulfilling any of the following criteria during any financial year, shall constitute a CSR committee i.e.

1. Net worth of rupees five hundred crore or more; or
2. Turnover of rupees one thousand crore or more; or
3. Net profit of rupees five crore or more.

‘Any financial year’ referred under Section 135 of the Act implies ‘any of the three preceding financial years i.e., CSR provisions shall be applicable in FY 2014-15, if either of the conditions specified above is satisfied in either of the three preceding financial years i.e., FY 2013-14, FY 2012-13 or FY 2011-12.

The Board shall ensure that the company spends, in every financial year, at least 2% of average net profits made during three immediately preceding financial years, in pursuance of CSR policy. If company fails to spend such amount, the Board shall specify the reasons for not spending in Board’s report.

CSR expenditure shall include all expenditure including contribution to corpus on projects or programs relating to CSR activities, approved by the Board on the recommendation of its CSR Committee, but does not include any expenditure on an item not in conformity or not in line with activities which fall within the purview of Schedule VII of the Act.

It may be noted that, u/s 134(3)(o) of the Companies Act, 2013, the Board is required to report on the CSR policy and its implementation during the year. Further, section 134(8) of the Companies Act, 2013, provides that if a Company contravenes the provisions of this Section, 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 the 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.

Obligation under Income Tax Act, 2013

W.e.f. AY 2015-16 i.e. FY 2014-15 Explanation 2 has been inserted by the Finance (No.2) Act, 2014. Explanation 2 has been worded as follows:

“any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.”

Further while explaining the provisions of Finance (No.2) Act, 2014 in the circular no. 1/2015 Dated 21/1/2015, it has been explained by the CBDT that.

1. “Under the Companies Act, 2013 certain companies (which have net worth of Rs.500 crore or more, or turnover of Rs.1000 crore or more, or a net profit of Rs.5 crore or more during any financial year) are required to spend certain percentage of their profit on activities relating to Corporate Social Responsibility (CSR). Under the existing provisions of the Income-tax Act, expenditure incurred wholly and exclusively for the purposes of the business is only allowed as a deduction for computing taxable business income.
   

2. CSR expenditure, being an application of income, is not incurred wholly and exclusively for the purposes of carrying on business. As the application of income is not allowed as deduction for the purposes of computing taxable income of a company, amount spent on CSR cannot be allowed as deduction for computing the taxable income of the company. Moreover, the objective of CSR is to share burden of the Government in providing social services by companies having net worth/turnover/profit above a threshold. If such expenses are allowed as tax deduction, this would result in subsidizing of around one-third of such expenses by the Government by way of tax expenditure.
   

3. The provisions of section 37(1) of the Income-tax Act provide that deduction for any expenditure, which is not mentioned specifically in section 30 to section 36 of the Income-tax Act, shall be allowed if the same is incurred wholly and exclusively for the purposes of carrying on business or profession. As the CSR expenditure (being an application of income) is not incurred for the purposes of carrying on business, such expenditures cannot be allowed under the provisions of section 37 of the Income-tax Act. Therefore, in order to provide certainty on this issue, said section 37 has been amended to clarify that for the purposes of sub-section (1) of section 37 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 have been incurred for the purpose of business and hence shall not be allowed as deduction under said section 37. However, the CSR expenditure which is of the nature described in section 30 to section 36 of the Income-tax Act shall be allowed as deduction under those sections subject to fulfillment of conditions, if any, specified therein. “
   

It has been mentioned clearly while explaining the provision of section 37(1) that as CSR expending is application of income and is not incurred for the purposes of carrying of business such expenditure cannot be allowed under the provision of section 37 of the Income-Tax Act.

Though the CSR expenditure is not an allowable deduction under section 37(1) of the IT Act, yet the Explanatory Memorandum goes on to clarify that the CSR expenditure which is of the nature specified under sections 30 to 36 of the IT Act, shall be eligible for deduction under these sections, subject to fulfillment of the conditions specified therein.

After evaluating the provisions of Companies Act, 2013 & Income Tax Act, 1961 where at one side it is necessary to spend money on CSR and on the other side the same is disallowed under the Income Tax Act, 1961, the CSR policy should be formulated by the CSR Committee in such a manner as to require CSR expenditure to be incurred on such activities as laid down in Schedule VII that are also eligible for deduction under sections 30 to 36 of the IT Act, it would facilitate companies in complying with the CSR obligations under the Companies Act, 2013 as well as in availing of the tax benefit under the Income Tax Act, 1961.