Self-reporting and transparency promise to be the hallmarks of India’s new legal provisions on corporate social responsibility, but there are several grey areas that may hinder compliance. Vandana Chatlani reports
Starting this month, corporate projects tackling poverty alleviation, gender inequality and environmental degradation will no longer be confined to companies looking for a reputational boost or a means to gratify their social conscience. Instead, such activities are to become a regular feature of corporate life for many entities following the introduction of corporate social responsibility (CSR) provisions under section 135 of the Companies Act, 2013.
The Companies (Corporate Social Responsibility Policy) Rules, 2014, which are effective from 1 April, are believed to be the first of their kind in the world.
The emphasis is on practicality and flexibility. Sachin Pilot, the 26-year-old minister of corporate affairs, said in a Google Hangout interview organized by CNBC TV18 and NextGen (an Indian CSR and sustainability management company) that he did not wish to “straitjacket” corporate India into a CSR policy and was keen to avoid imposing an “Inspector Raj” regime with the new rules. “Every company is different and not all of them will qualify for CSR, but for those which do, we want to make it very open and transparent in terms of what the companies can and should do,” he said.
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“The ultimate objective of the exercise is not to write a cheque and spend money, it’s how you deploy those funds,” he said. “The outcomes will hopefully be tangible within India itself and create goodwill among the companies in the area and in those communities [in which they operate].”
Catching the big fish
The push to encourage more spending for CSR initiatives is targeted at companies which have the financial clout to make significant contributions. The provisions apply to companies which have a net worth of ₹5 billion (US$83 million) or more, or a turnover of ₹10 billion or more, or a net profit of ₹50 million or more. Companies which cross one of these thresholds are expected to spend at least 2% of their average net profit (calculated over the previous three financial years) on CSR.
For the purpose of calculating CSR obligations, net profits will not include profits generated from a company’s overseas branches or dividends received from other companies in India covered under and complying with section 135.
One question is whether a company will be expected to abide by the rules if it crosses one of the thresholds in one financial year, but fails to do so in the next. “There is not much clarity on this issue,” says Rahul Rishi, a member of the social sector practice team at Nishith Desai Associates. Rishi adds that a company has the freedom to not spend money on CSR provided they offer reasons for the same, even if one of those thresholds is met.
“Even if you trigger the threshold requirements and you have been making profits for the preceding three years, if you do not wish to spend on CSR, as long as you report and provide reasons for not spending, that should suffice,” he says.
“Presuming that section 135 applies to you, forming a CSR committee is compulsory; having board members on the CSR committee is compulsory; framing a CSR policy is compulsory; reporting is compulsory; but spending is not,” says Rishi.
Presumably this would require some creative thinking, or a justifiably good reason for keeping the company purse strings tied. But more importantly, it implies that at least for the moment, the government is empowering businesses to decide where, why, how and when to implement their CSR policies.
Legal obligations
Every company that has a CSR obligation is required to draw up a CSR policy which includes a list of projects or programmes that the company plans to carry out, along with details of how the programmes will be monitored. The policy must indicate that the surplus arising out of any CSR activity will not form part of the company’s profits.
Companies are required to disclose the details of their CSR policies in reports and on their website, if they have one.
Companies are also expected to set up CSR committees which consist of three members, of whom at least one must be an independent director. The rules state, however, that unlisted and private companies may set up a CSR committee without an independent director since they are not required to appoint one in the first place. Private companies with only two directors may appoint these directors as their committee members.
The new rules apply to foreign companies incorporated outside India which have a physical or online business in India whether on their own or through an agent. Foreign companies must set up a CSR committee comprising two individuals, of which at least one must be an Indian resident.
Sharad Abhyankar, a partner at Khaitan & Co, believes not all foreign companies that fulfil the above criteria (and cross the financial thresholds) will be liable for CSR contributions. “The concept of a foreign company under section 2(42) [of the Companies Act] includes a very large number of foreign companies with a place of business in India or having any business connection with India in any form,” he says. “However, section 379 of the act limits the applicability of that chapter [relating to companies incorporated outside India] (and other provisions of the act) to only those foreign companies in which more than 50% of the total paid-up share capital is held by one or more Indian citizens or one or more companies or bodies corporate incorporated in India.”
The method of calculating a foreign company’s net profits for CSR purposes remains uncertain. “It is unclear whether the net profits would be those arising out of the Indian operations of a branch office or of the foreign company itself,” says Aliff Fazelbhoy, a senior partner at ALMT Legal. “While one would expect and hope that the net profits would only refer to the Indian profits, the latter view, if adopted, would mean a much greater CSR burden for foreign companies in India” he adds.
How much autonomy?
CSR is in not new to corporate India. Companies such as Reliance, Wockhardt, Bharti and Adani have long had their own foundations, investing in education, community healthcare initiatives, rural infrastructure, artistic and cultural development, poverty alleviation, sanitation and many other projects. India’s new CSR policy allows these companies and others to continue contributing to their own philanthropic organizations or alternative charities of their choice.
On the other hand, companies unused to spending on such activities may take time to acclimatize to their new legal obligations.
Schedule VII of the Companies Act contains an exhaustive list of the types of activities that fall under the CSR umbrella. These include, among others, eradicating hunger; enhancing vocational skills especially among young children, women, the elderly and differently abled; setting up old age homes; protection of flora and fauna; measures for the benefit of armed forces veterans, war widows and their dependants; training to promote rural sports; and contributions or funds provided to technology incubators located within academic institutions approved by the government.
Social business projects were included when schedule VII was enacted but removed when it was later amended. “The kind of enthusiasm we had seen from corporates before may no longer exist under the CSR rules,” points out Milind Antani, a partner and head of the CSR group at Nishith Desai Associates. “The activities that companies carry out would need to fit within the confines of schedule VII, so the kind of flexibility that companies may envisage now may not be totally true.”
Justin Bharucha, a partner at Bharucha & Partners, believes the biggest challenge lies in finding the right projects to sponsor. “There are a lot of NPOs [non-profit organizations] looking to receive moneys and I believe that corporates will want to choose the right NPO to partner,” he says. “The adverse consequences of a decision which isn’t thought through or properly explored will likely be significant in terms of reputational and other risk.”
Companies may also find themselves forking out more than the provisions demand to nurture their CSR projects. “A related issue,” adds Bharucha, “is that, as the law stands, the costs of incubating a proper CSR programme and reviewing projects, etc., may not be counted towards the mandatory CSR spend.
“The easiest way, and arguably most productive way, for a corporate to fulfil its CSR obligations – generally speaking, and not in terms of the law – is providing skilled volunteers for NPO projects,” says Bharucha. “That is not addressed by the present legislation.”
Unanswered questions
According to the notification of the rules from the Ministry of Commerce, companies should undertake CSR activities (either new or ongoing) in line with their policies, however, this must exclude those activities carried out “in pursuance of its normal course of business”.
This appears to undermine the philosophy of CSR, suggesting that any activity intrinsic to the workings of a business that may benefit local communities will not be recognized as a contribution to CSR. For example, a company which hires local artists to produce goods for sale may be generating employment for disadvantaged communities, increasing income and creating social cohesion through its training programmes. But many companies are uncertain whether this will qualify as CSR, or if an additional 2% must be dedicated to such activities to fulfil the government’s requirements.
Pilot offers a reassuring view, explaining that policies can be tailored in different ways as long as they are approved by a company’s CSR committee, its independent directors and shareholders. “For a company to go out and sell FMCG [fast-moving consumer goods] products, or insurance or opening bank branches – sure it’s empowering people, people are getting added benefits and facilities,” he said. The pressing question, according to Pilot, is whether a company is performing the activity primarily to enhance markets and generate more profits, or because there is a need and a dearth of money to be deployed to help communities in need. “That decision is up to the board,” maintained Pilot. “It’s a grey area not for me, but for the CSR committee on the board because they will have to declare this on their website and it’s for the shareholders to approve.”
Company executives such as Anand Mahindra, the chairman of Mahindra & Mahindra, worry that the concept of shared value – where businesses create social enterprises which include profit – may not find room in the government’s CSR agenda. Pilot acknowledged that each case would be different.
“When you make profits, it’s your hard-earned money, it’s your capital, your idea, your efficiency that creates the profit, but to share a bit of that in endearing the people you’re working with – then we come into a grey area,” he said. “We will learn as we go along … It’s premature to do the hair-splitting now.”
Another area of concern is taxability of CSR expenditure. On 1 April, the Ministry of Finance issued a revised Direct Taxes Code Bill, 2013, rejecting a proposal to deduct from taxable income CSR expenditure in backward regions and districts. The ministry stated that CSR expenditure could not be allowed as a business deduction “as it is an application of income”, adding that allowing deductions for CSR expenditure “would imply that the government would be contributing one-third of this expenditure as revenue foregone”.
Such comments could curb any enthusiasm associated with meaningful investments in CSR. Abhyankar warns: “This is likely to dampen the sentiment of companies operating in India and may result in a more check-box compliance rather than a cultural shift of corporations towards CSR.”
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