CSR Evolution - Part 2: Legal Framework

 As corporate governance becomes increasingly driven by ethical norms and the need for accountability, and CSR adapts to prevailing business practices and legal framework, a potential convergence between them surfaces. Corporate Social Responsibility is an indispensable part of corporate planning, strategy and operational performance. 

Time line of evolution of legal framework for CSR in India

In India, the provisions relating to Corporate Governance and CSR are covered under following heads:

 

· The Companies Act, 1956 (applicable to both listed and unlisted companies)

· Securities and Exchange Board of India and regulations (applicable to listed companies)

A. The Companies Act  Provisions

The companies Act 1956 was replaced with Companies Act 2013 and brought an end to the long wait by inserting Sec. 135 on Corporate Social Responsibility  as follows. 

1. Every company having net worth of rupees five hundred crore or more, or turnover of rupees one thousand crore or more or a net profit of rupees five crore or more during any financial year shall constitute a Corporate Social Responsibility Committee of the Board consisting of three or more directors, out of which at least one director shall be an independent director. 
2. The Board’s report under sub-section (3) of section 134 shall disclose the composition of the Corporate Social Responsibility Committee. 
3. The Corporate Social Responsibility Committee shall,— (a) formulate and recommend to the Board, a Corporate Social Responsibility Policy which shall indicate the activities to be undertaken by the company as specified in Schedule VII; (b) recommend the amount of expenditure to be incurred on the activities referred to in clause (a), and (c) monitor the Corporate Social Responsibility Policy of the company from time to time. 
4. The Board of every company referred to in subsection (1) shall,— (a) after taking into account the recommendations made by the Corporate Social Responsibility Committee, approve the Corporate Social Responsibility Policy for the Stakeholder Companies respond to the needs of stakeholders, customers, employees, communities, etc and disclose contents of such Policy in its report and also place it on the company’s website, if any, in such manner as may be prescribed; and (b) ensure that the activities as are included in Corporate Social Responsibility Policy of the company are undertaken by the company. 
5. The Board of every company referred to in subsection (1), shall ensure that the company spends, in every financial year, at least two percent. of the average net profits of the company made during the three immediately preceding financial years, in pursuance of its Corporate Social Responsibility Policy: Provided that the company shall give preference to the local area and areas around it where it operates, for spending the amount earmarked for Corporate Social Responsibility activities: Provided further that if the company fails to spend such amount, the Board shall, in its report made under clause (o) of sub-section (3) of section 134, specify the reasons for not spending the amount. Explanation – For the purposes of this section – “average net profit” shall be calculated in accordance with the provisions of section 198. 

 

Under the Act, if companies that have to provide for CSR, do not fully spend the funds, they must disclose the reasons for non-spending in their annual report.  Under the Bill, any unspent annual CSR funds must be transferred to one of the funds under Schedule 7 of the Act (e.g., PM Relief Fund) within six months of the financial year. 

However, if the CSR funds are committed to certain ongoing projects, then the unspent funds will have to be transferred to an Unspent CSR Account within 30 days of the end of the financial year and spent within three years. Any funds remaining unspent after three years will have to be transferred to one of the funds under Schedule 7 of the Act.  Any violation may attract a fine between Rs 50,000 and Rs 25,00,000 and every defaulting officer may be punished with imprisonment of up to three years or fine between Rs 50,000 and Rs 25,00,000, or both.  

By keeping the implementation of Section 21 (amendments to the CSR provisions in Companies Act 2013) in abeyance, the government has restored status quo ante as regards CSR provisions, say company law experts. 

Thiswould mean that CSR, for now (Sep 2018), would only be voluntary for corporate India and not spending the 2 percent on CSR would not be treated as a criminal offense, attracting jail term for company officials.

However, this position will only hold true till the time the government takes a call on the recommendations of the high-level panel on CSR headed by MCA Secretary Injeti Srinivas, it is learned. It may be recalled that the Panel report was submitted to Finance Minister Nirmala Sitharaman after Parliament had passed the Companies (Amendment) Bill 2019. 

Indian CSR model is quite different from the popular and dominant western model. In the western model companies has option to voluntarily engage in the CSR activities of their choice with the spend decided by the management. On the other hand, Indian companies are bound by the law to not only spend mandated amount but also engage in CSR activities listed in Schedule VII of the companies Act. The CSR policy and decision has also been mandated on the board of the companies. The companies are also required to present the details of CSR activities in their annual report.

The companies are required to disclose theamount which they spend on CSR activities. This provision is going to make CSR spend transparent and comparable at least from the input perspective. It also made CSR a regular exercise which is dependent on the profits made by companies. This will make CSR a regular phenomenon for the companies, as in majority of the cases profits are not going to fluctuate much. The third aspect of this provision is that it also fixed the responsibility of the CSR which is on the board itself. All decision and spend must be authorised by the board and none lower them. The fourth aspect is fixing the CSR budget by connecting it with profits of the company. Fifth aspect is to align CSR activities with the Schedule VII of the Act. The activities listed in Schedule VII is supposed to be aligned with the inclusive development agenda of the nation. The schedule may be amended depending on the changing priorities of the nation. Finally, the spirit of the legal mandate is that CSR is for the poor, the marginalised, the deprived, the downtrodden, and handling of difficult situations. Thus, the law obligates companies to perform activities beyond the legal mandate. It is assumed that the corporate sector in India has many strengths which can be used to solve larger social, environmental, and economic issues with the right framework. Further CSR is not expected to be the core business of the companies. They are expected to associate with the non-profit sector which has got a strong presence in India and have long standing capabilities to implement social projects. One important aspect is the reporting of CSR activities by the company. For the said purpose, a template has been designed which the companies are expected to fill and report.

The law has provided a format, the corporates has the ability, the NGOs are willing to cooperate which takes whole process of CSR at a different level.

 

The Government of India notified amendments to the Companies (Corporate Social Responsibility) Rules, 2014 and Section 135 of the Companies Act, 2013 on January 22nd, 2021, which means that these are now effective.

Impact oncorporates

1. Eligible CSR spends

Specifically Excluded Activities

The following activities cannot be included as part of a company’s eligible CSR spend:

• Activities which are undertaken in the normal course of business of a company, or those benefitting only its employees.
• Political contributions.
• Sponsorship activities.
• Fulfilment of statutory obligations and activities undertaken outside India (except for training of sports personnel representing a state or country at the national or international level).

Activities that can now be included as CSR:

• COVID-19-related activity in the normal course of business: This covers companies undertaking research and development into vaccines, medical devices, and drugs related to COVID-19, even if such activity is in their normal course of business. This exemption is allowed up to the financial year 2022-2023. However, the company must make separate disclosures in their annual report and must undertake such research and development in collaboration with an institute specified in Schedule VII of the act.
• Acquisition or creation of a capital asset provided that it is not owned by the company: The asset created using CSR funds must be owned either by the organisation supported, or the people served by the project (for instance, collectives such as self-help groups), or by a public authority.

Administrative overheads

While the term administrative overheads has not been listed exhaustively, the amendment defines it as expenses incurred for ‘general management and administration’ of CSR functions in a company.

With this notification, it now excludes “…expenses directly incurred for the designing, implementation, monitoring, and evaluation of a particular Corporate Social Responsibility project or programme…”. This means that these expenses can now be considered as part of the programme itself, thereby allowing for greater allocation of resources for these activities. However, the cap on administrative costs of five percent of CSR expenditure remains.

2. Treatment of unspent, excess, or surplus CSR amounts

Unspent CSR funds

Any unspent CSR funds remaining at the end of a financial year should be transferred in any of the following ways:

• Transfer to an Unspent CSR Account: Any unspent amount from an ongoing project should be transferred within 30 days of the end of the financial year, to the specifically designated ‘Unspent Corporate Social Responsibility Account’ to be opened by the company. These amounts should be spent within the next three financial years, in accordance with the company’s CSR policy. If these amounts remain unspent even after the three-year period, then they should be transferred, within 30 days of the end of the third financial year, to any fund specified in Schedule VII of the act (such as the PM National Relief Fund, PM CARES Fund, Disaster Management Fund, Clean Ganga Fund, and so on).
• Transfer to a Schedule VII fund: If the funds are unallocated to any CSR project, then such unspent amount shall be transferred, within six months of the end of the financial year, to any fund specified in Schedule VII of the act.

There is a new requirement for mandatory impact assessment of CSR projects. | Picture courtesy: Ayesha Marfatia/Canva

Surplus CSR funds

If any surplus arises out of the CSR activities, it must be:

• Spent on the same project which gave rise to the surplus, or
• Transferred to the Unspent CSR Account of the company, or
• Transferred to a fund as specified in Schedule VII of the act.

Excess CSR spends

If a company has spent amounts more than the mandatory two percent on CSR, the company can set off such excess amounts against the CSR spends in the next three financial years. The board of directors however, needs to pass a resolution for this. It’s important to note that such excess amounts cannot include the surplus arising out of CSR activities. For instance, if any interest is earned out of the assets acquired through the CSR funds, such interest would be treated as a surplus, but cannot be set off from the CSR budget of the following year.

3. Impact Assessment

There is a new requirement for mandatory impact assessment of CSR projects.

• This requirement applies to companies that have an average CSR spend of INR 10 crore or more in the past three financial years.
• It must be conducted for all CSR projects that have budgets of INR 1 crore and more; and have been completed one year prior to undertaking the impact assessment.
• An ‘independent’ agency must be appointed to undertake the impact assessment. The costs of such an agency cannot exceed INR 50 lakh or five percent of the total CSR spend for that financial year (whichever is lower).

4. Governance and Transparency

• Mandatory disclosures on the website: If a company has a website, it is mandatorily required to disclose the composition of the CSR committee, its CSR policy, and the projects approved by the board.
• CSR committee: This committee must formulate an annual action plan for CSR spends, which lists the CSR projects, implementation and monitoring schedules, and details of impact assessment (if applicable). However, if a company’s CSR spend is less than INR 50 lakh it is not required to create a CSR committee. The board of directors will perform the functions of the committee in such a case.
• CSR policy: A company’s CSR policy must include further details of its CSR philosophy, its guiding principles for selecting projects, implementation and monitoring of activities, as well as the formulation of the annual action plan.
• Annual disclosures: These are now more detailed, requiring information on the CSR committee’s composition, its meetings, amounts transferred to the Unspent CSR Account or to a fund specified in Schedule VII, and the capital assets that have been created, acquired, or transferred. Additionally, the rules now require the company’s Chief Financial Officer (or equivalent) to certify that the CSR funds have been disbursed and utilised in the manner approved by the board of directors. Details of the impact assessments undertaken, specific disclosures of the amounts incurred towards administrative overheads, and any other information on CSR projects—whether they are new projects or ongoing projects—should be included.
• Monetary penalties for non-compliance: Departing from the previous philosophy of ‘name and shame’, the amendments have introduced monetary penalties for the company and every officer in default for non-compliance. A defaulting company is now liable for the lesser of INR 1 crore or twice the amount that should have been transferred to the Unspent CSR Account or the Schedule VII specified fund. Additionally, a defaulting officer is now liable for the lesser of INR 2 lakh, or one-tenth the amount that should have been transferred to the ‘Unspent CSR Account’ or the Schedule VII specified fund.

5. Support from ‘international organisations’

 

For the first time, CSR rules have allowed international organisations to assist and play a role in the CSR ecosystem. The rules define an ‘international organisation’ as one that is notified under the United Nations (Privileges and Immunities) Act, 1947. This covers entities such as the International Labour Organization, the World Health Organization, the Food and Agriculture Organization of the World Bank, the United Nations Educational, Scientific and Cultural Organization (UNESCO), and the International Monetary Fund, among others.

 

The rules permit companies to appoint an international organisation for designing, and monitoring and evaluation of CSR projects or programmes as per its policy, as well as for building the capacity of their own CSR teams. However, the costs or fees paid to such entities may be subject to the cap of five percent on administrative overheads, if it relates to the general management and administration of CSR functions in a company. (This might be the case if the international organisation is providing capacity building services.)

 

B. SEBI (LODR) Regulations 2015

SEBI has amended the SEBI(Listing Obligations and Disclosures Requirement ) Regulations 2015 and notified on 9th May 2018

The SEBI(LODR) provides obligatory to constitute following committees

1. Audit Committee
2. Nomination and Remuneration Committee
3. Stakeholders Relationship committee
4. Risk Management Committee

It also insists disclosures on company website/annual reports and hold directors responsible for the committees in which they are members for smooth functioning and oversight extended. Popularly known as 'clause 49' , it binds the company to provide information and SEs to demand same.

C. Directions for CPSEs

Detailed  guidelines for CSR expenditure of CPSES were modified  in 2018 irrespective of whether they are listed or not. However listed companies need to observe those instructions applicable to them as well.

 

Those who read this also read on historical evolution of CSR in India