Corporate Social Responsibility (CSR) (Section 135)

Mandate for CSR

Corporate Social Responsibility (CSR) under the Companies Act, 2013, represents a shift from voluntary engagement to a mandatory requirement for certain classes of companies in India. **Section 135** of the Act, along with the Companies (Corporate Social Responsibility Policy) Rules, 2014 (and subsequent amendments), lays down the framework for CSR in India. The underlying idea is that companies operating in society have a responsibility towards the environment and stakeholders beyond just profit generation.

Applicability: Companies with net worth, turnover, or net profit above prescribed limits

Section 135 mandates that every company, including its holding or subsidiary, and a foreign company having a branch office or project office in India, which fulfills any of the following criteria during the **immediately preceding financial year**, shall be required to comply with CSR provisions:

Applicability Thresholds:

• Has a **net worth** of **₹500 Crore** or more, OR
• Has a **turnover** of **₹1,000 Crore** or more, OR
• Has a **net profit** of **₹5 Crore** or more.

If a company ceases to meet any of these criteria for **three consecutive financial years**, it is not required to comply with Section 135 and the CSR Rules until it again meets any of the specified thresholds.

Companies that meet these thresholds are required to:

1. Constitute a CSR Committee of the Board.
2. Formulate a CSR Policy.
3. Ensure that the company spends a certain amount on CSR activities as per the rules.
4. Disclose details about CSR activities in the Board's report and on the company's website.

The term 'net profit' for the purpose of CSR calculation is defined under the Companies Act, 2013, and the CSR Rules, and it excludes certain items like profit from any overseas branch of the company, or dividends received from other companies covered under and complying with the provisions of Section 135.

CSR Committee

For companies falling under the purview of Section 135, the first mandatory step is the constitution of a Corporate Social Responsibility Committee of the Board. This committee is responsible for guiding and overseeing the company's CSR activities.

Composition and functions

Composition of the CSR Committee (Section 135(1) and CSR Rules):

The CSR Committee shall consist of:

• **Three or more directors**, out of which at least **one director shall be an independent director**.

However, there are exceptions:

• An unlisted public company or a private company that is not required to appoint an independent director does not need to have an independent director on its CSR Committee.
• A private company having only two directors on its Board shall constitute its CSR Committee with two such directors.
• In the case of a foreign company, the CSR Committee shall comprise of at least two persons, one of whom shall be a person resident in India authorised to accept on behalf of the company service of process and any notices or other documents required to be served on the company, and the other person shall be nominated by the foreign company.

Functions of the CSR Committee (Section 135(3) and CSR Rules):

The CSR Committee has significant responsibilities in formulating, monitoring, and recommending the company's CSR initiatives:

1. **Formulate and recommend a CSR Policy:** The committee is responsible for formulating and recommending to the Board, a Corporate Social Responsibility Policy which shall indicate the activities to be undertaken by the company as specified in Schedule VII of the Act.
2. **Recommend the amount of expenditure:** The committee recommends the amount of expenditure to be incurred on the activities referred to in the CSR Policy.
3. **Monitor the CSR Policy:** The committee is responsible for monitoring the Corporate Social Responsibility Policy of the company from time to time.
4. **Formulate Annual Action Plan:** The committee is required to formulate and recommend to the Board, an annual action plan in pursuance of its CSR policy. This plan outlines the projects, activities, execution modalities, implementation schedules, fund utilisation, and monitoring mechanism for the financial year.

The Board of Directors is required to approve the CSR Policy after considering the recommendations of the CSR Committee and disclose the contents of such policy in its report and on the company's website, and ensure that the activities included in the CSR Policy are undertaken by the company.

The meetings of the CSR Committee are conducted as per the internal procedures framed by the committee or the Board.

CSR Expenditure

A key obligation under the CSR provisions is the mandate to spend a prescribed amount on eligible CSR activities. This is intended to ensure that companies meeting the applicability thresholds contribute meaningfully to societal development.

Amount to be spent (2% of average net profits of preceding three financial years)

As per **Section 135(5)**, the Board of every company referred to in Section 135(1) shall ensure that the company spends, in every financial year, at least **two per cent of the average net profits of the company made during the three immediately preceding financial years**, in pursuance of its CSR Policy.

Calculation:

The amount to be spent is calculated using the following formula:

$ \text{Minimum CSR Expenditure} = 2\% \times \left( \frac{\text{Net Profit}_{FY-1} + \text{Net Profit}_{FY-2} + \text{Net Profit}_{FY-3}}{3} \right) $

Where $ \text{FY-1}, \text{FY-2}, \text{FY-3} $ refer to the three immediately preceding financial years relative to the current financial year for which the CSR expenditure is being calculated.

For example, if a company is calculating its minimum CSR spending obligation for the financial year 2023-24, it would take the average net profit of FY 2022-23, FY 2021-22, and FY 2020-21.

If the company has not completed three financial years since its incorporation, the average net profits of the financial years since its incorporation will be considered for calculating the 2% spending obligation.

Treatment of Excess Spending:

The CSR Rules allow companies to set off any excess amount spent beyond the mandatory 2% in a financial year against the CSR spending obligation for the subsequent **three** financial years. This excess amount available for set-off cannot exceed 25% of the total CSR obligation for the subsequent year. This is subject to the excess amount not including any surplus arising out of the CSR activities.

Treatment of Surplus:

Any surplus arising out of the CSR activities shall not form part of the business profit of the company and shall be used for the same project or transferred to the Unspent CSR Account and spent in pursuance of the CSR policy and annual action plan of the company or transferred to a fund specified in Schedule VII, within a period of six months of the expiry of the financial year.

Prescribed activities for CSR expenditure

The activities that qualify as CSR expenditure are listed in **Schedule VII** of the Companies Act, 2013. This Schedule is amended by the government from time to time to include relevant areas. The broad categories of activities currently listed include:

• Eradicating hunger, poverty and malnutrition, promoting health care including preventive health care and sanitation including contribution to the Swachh Bharat Kosh set-up by the Central Government for the promotion of sanitation and making available safe drinking water.
• Promoting education, including special education and employment enhancing vocation skills especially among children, women, elderly and the differently abled and livelihood enhancement projects.
• Promoting gender equality, empowering women, setting up homes and hostels for women and orphans; setting up old age homes, day care centres and such other facilities for senior citizens and measures for reducing inequalities faced by socially and economically backward groups.
• Ensuring environmental sustainability, ecological balance, protection of flora and fauna, animal welfare, agroforestry, conservation of natural resources and maintaining quality of soil, air and water including contribution to the Clean Ganga Fund set-up by the Central Government for rejuvenation of river Ganga.
• Protection of national heritage, art and culture including restoration of buildings and sites of historical importance and works of art; setting up public libraries; promotion and development of traditional arts and handicrafts.
• Measures for the benefit of armed forces veterans, war widows and their dependents.
• Training to promote rural sports, nationally recognised 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 and funds for the welfare of the Scheduled Castes, the Scheduled Tribes, other backward classes, minorities and women.
• Contributions or funds provided to technology incubators located within academic institutions which are approved by the Central Government.
• Rural development projects.
• Slum area development.
• Disaster management, including relief, rehabilitation and reconstruction activities.
• Contribution to the Prime Minister's Citizen Assistance and Relief in Emergency Situations Fund (PM CARES Fund).
• Any other fund as may be notified by the Central Government.

Activities Generally Excluded:

The CSR Rules clarify activities that do *not* qualify as CSR, such as:

• Activities undertaken in the normal course of business.
• Activities undertaken outside India.
• Contribution of any amount directly or indirectly to any political party.
• Activities that substantially benefit employees of the company.
• Activities supported by the companies on sponsorship basis for deriving marketing benefits for their products or services.
• Activities carried out for fulfilment of any other statutory obligations under any law in force in India.

Local Area Preference (Section 135(5)):

The Act states that the company shall give preference to the **local area** and areas around where it operates for spending the amount earmarked for CSR activities.

Non-compliance with CSR provisions

The Companies Act, 2013, and the subsequent amendments to the CSR Rules have introduced stricter provisions regarding non-compliance with the CSR spending mandate. Initially, the requirement was primarily 'comply or explain', but this has evolved into a more stringent framework.

Consequences of Failing to Spend:

If a company fails to spend the mandatory 2% of its average net profit on CSR activities in a financial year, the consequences depend on whether the amount was allocated to an ongoing project or not.

Unspent Amount NOT related to Ongoing Projects (Section 135(5)):

If the unspent amount is *not* related to an ongoing project, the company shall transfer such unspent amount to a Fund specified in Schedule VII (such as the Prime Minister's National Relief Fund, PM CARES Fund, Swachh Bharat Kosh, etc.) within a period of **six months** of the expiry of the financial year.

Unspent Amount related to Ongoing Projects (Section 135(6)):

If the unspent amount is related to an 'ongoing project' (a multi-year project undertaken by a company in fulfilment of its CSR obligation having timelines not exceeding three years excluding the financial year in which it was commenced, and which is carried out in accordance with the CSR Policy), the company shall transfer such unspent amount to a special account called the "**Unspent Corporate Social Responsibility Account**" opened by the company in any scheduled bank, within a period of **thirty days** from the end of the financial year. This amount then must be spent by the company in pursuance of its CSR Policy within a period of **three financial years** from the date of such transfer. If the company fails to spend the amount in the Unspent CSR Account within the said three financial years, the unspent amount must be transferred to a Fund specified in Schedule VII within a period of six months of the expiry of the three financial years.

Penalties for Non-Compliance (Section 135(7)):

Failure to comply with the requirement to transfer the unspent amount as per Section 135(5) or Section 135(6) attracts penalties:

• 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**.
• 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 the Fund specified in Schedule VII or the Unspent Corporate Social Responsibility Account, as the case may be, or **two lakh rupees, whichever is less**.

These penalties are aimed at ensuring serious compliance with the mandatory spending and fund transfer requirements.

Disclosure Requirement (Section 134(3)(o)):

Even if a company does not face penalties for technical reasons (e.g., if it couldn't find suitable projects), the Board's report under **Section 134(3)(o)** must include an **Annual Report on CSR Activities**, containing prescribed particulars, including the details of the amount required to be spent and the amount actually spent during the financial year. If the company fails to spend the minimum required amount, the Board shall **explain the reasons for not spending** the amount in its report.

The CSR framework under the Companies Act, 2013, has evolved to ensure greater accountability and transparency in corporate contributions towards social and environmental causes.