Compulsory CSR – A Socialist Narrative?

Background

The Preamble to the Constitution of India states that India is a Sovereign, Socialist, Secular, Democratic Republic. The words ‘Socialist’ and ‘Secular’ were added by the 42^nd Amendment to the Constitution.

Closely following the surcharge on the super-rich in Budget 2019, the criminalisation of failure to spend on CSR in the manner prescribed indicates a social narrative completely contrary to the agenda of growth through development and the path of investment that was indicated in the economic survey.

The Government raises revenue through taxes for the purpose of spending on defence, infrastructure, social welfare and overall development of the country and the polity and it is the responsibility of the Government to provide for social welfare.

Tax is a compulsory extraction by law and the taxes garnered by the Government are spent on various activities including social welfare. At every point of time the levy or increase in the rate of taxes is justified on the ground that revenue has to be raised for spending on welfare.

Surcharge and Cess

The revenue is still considered inadequate and the law makers resort to fiscal tools such as surcharge and cess to raise money for specific contingencies. There are enough instances of such levies after calamity or disaster or where there is a surge in oil price or a war.

While cleanliness is imperative and it was unfortunate that the citizens had to be nudged to take the path of Swachh Bharat and there was a levy of Swachh Bharat Cess to fund the initiative upto introduction of GST.

In fact, even in a scenario where the Centre is required to compensate States on account of introduction of GST, the funds are raised only through a GST Compensation Cess on certain categories which is ultimately borne by the consumer.

Corporate Social Responsibility

Even before the term CSR gained traction, this country has seen many businesses and business houses spending huge amounts on charity and social welfare. All this happened voluntarily and out of passion without any element of compulsion. In fact, many business houses have carried out social welfare projects from inception.

Over the years CSR has gained traction and there is a new thinking that a company should be socially responsible and should necessarily spend on social welfare. While the original philosophy of profit at any cost does not exist and Companies have to factor environment, sustainable growth, consumer rights, avoid anti-competitive practices and still make profit, the new thought process is to compel CSR through legislative mechanism.

The entire compulsory CSR concept with imprisonment for breach seems to be based on the premise that profits are ugly and corporates have to bear the cost of social welfare even though they already bear the cost by contributing to exchequer in the form of duties and taxes.

No Deduction for CSR

The irony is that the Income Tax Act was amended by adding explanation with effect from 01.04.2015 to declare that any expenditure incurred by an assessee on activities relating to CSR referred to in Section 135 of the Companies Act shall not be deemed to be an expenditure incurred by the assessee for the purpose of business or profession.

When a certain percentage of profit has to be identified for CSR and it is spent on CSR, through a deeming provision no tax benefit can be claimed. Thus, while the company has to forego a portion of its profits, the Government does not forego the tax on the profit.

Companies Amendment Bill, 2019 – Changes to CSR

The Companies Amendment Bill, 2019 has been passed by the Rajya Sabha and the amendment has introduced significant changes to CSR which are given below:

(i) Originally, Section 135(5) provided that the Board had to 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 Corporate Social Responsibility Policy. This indicated that the company would have a run for at least three years before the CSR obligations kicked in subject to applicability. The amendment now provides that where a company has not completed the period of three financial years since its incorporation, then it has to spend at least 2% of the average net profits during such immediately preceding financial years.

(ii) Originally, if a company which was required to spend on CSR could not spend the same for any reason, it was only required to disclose the reasons for not spending the amount in the Board Report. The second proviso to Section 135(5) is being amended to provide that unless the unspent amount relates to any ongoing project referred to in Section 135(6), the company should transfer such unspent amount to a fund specified in Schedule VII within a period of six months of the expiry of the financial year.

(iii) Section 135(6) has been inserted which provides that the amount remaining unspent for an ongoing project which fulfils conditions as may be prescribed shall be transferred to a special account in a scheduled bank within 30 days from the end of the financial year. This account is to be called unspent CSR account and the amount has to be spent within a period of 3 financial years from the date of transfer. If the amounts are not spent within the said timeframe, the company has to transfer the same to a Fund specified in Schedule VII within 30 days from the date of completion of the third financial year.

(iv) Section 135(8) has been inserted to enable the Central Government to give general or special directions to a company or a class of companies as it considers necessary to ensure compliance of the provisions of this section and such company or class of companies shall comply with such directions.

Fine and Imprisonment         

Section 135(7) has been inserted and provides that if a company contravenes Section 135(5) or 135(6) it shall be punishable with a fine not less than Rs. 50,000/- but which may extend to 25 Lakhs and every officer of such company who is in default shall be punishable with imprisonment for a term which may extend to 3 years or fine not less than Rs. 50,000/- but which may extend to 5 lakhs or with both.

The law in a nutshell requires the Company to which the provisions apply to either spend on CSR or transfer it to a fund listed in the VII Schedule. The exception is in the case of an ongoing project which would require monies to be kept in a separate bank account and rules are likely.

If any person watches films on a regular basis, they would have noticed that the villains in the film change over a period of time. The film industry has moved from Zamindar, dacoit leader, gangster, bad politician, evil minister, terrorist and finally in the recent films, the villain is always identified as a company which is obsessed with markets and profits. The legislation seems to echo the sentiments of the film industry by prescribing imprisonment for not spending on social welfare.

If social welfare is the responsibility of the State, mandating CSR on Companies and prescribing punishment for failure is as good as an admission that the State has not been able to take care of the needs of social welfare. If that be the case, where does the accountability lie?

Domestic Companies with a turnover for the previous year not in excess of Rs. 400 Crores pay an effective Corporate Tax of 29.12%. If the profits are distributed, there is a Dividend Distribution Tax. This itself is double taxation since the profits have already been taxed. If the dividend in the hands of the shareholder is in excess of Rs. 10 lakhs, then the shareholder is taxed again. The highest individual tax rate is now at 42.74%. Apart from this, there is GST. All these are levies effected by the Government for the purpose of ensuring a good life for the citizens and also to ensure that welfare projects are undertaken for the needy.

Has CSR attained the Nature of Tax?

The Supreme Court in the case of Jagannath Ramanuj Das Vs. State Of Orissa AIR 1954 SC 400, observed that tax is undoubtedly in the nature of compulsory exaction of money by a public authority for public purposes the payment of which is enforced by law. But the essential thing in a tax is that imposition is made for public purposes to meet the general expenses of the State without reference to any benefit to be conferred upon the payers of the tax. The taxes collected are all merged in the general revenue of the State to be applied for general public purpose.

When payment is mandated and there is fine and penalty for non-payment to a particular fund, there is an element of compulsory extraction. The logical question would be whether such an extraction is permissible under the Companies Act, 2013. The Preamble to the Companies Act, 2013 states that it is an Act to consolidate and amend the law relating to Companies.

When Entry 43 and Entry 44 of the Union List, Schedule VII, Constitution of India covers incorporation, regulation and winding up of trading and other corporations and the Companies Act can be traced to this Entry, the question therefore would be whether mandated CSR with imprisonment for breach is within the powers conferred under this Entry?

Other Aspects of Compulsory CSR

Indian Company Law is primarily based on UK Company Law. UK does not mandate CSR. Even countries such as Sweden, Norway, Netherlands, France and Australia have only mandated CSR reporting. When investment is considered as a driver of growth, compulsory CSR in a country does not give any encouragement for an investor to invest in India.

Some of the activities set out in the Seventh Schedule are activities referred to in Article 243G and 243W. For example: Drinking water, eradication of poverty, education, sanitation, water supply, public health, etc. One cannot but ask the question as to whether the corporate sector is being compelled to do what the State has to do?

When the fundamental objective of a company is to run its business legally and effectively and maximise the profits and grow in a sustainable manner, can it be given a social responsibility when it already discharges its social responsibility by payment of taxes?

A butterfly effect is created when a company is profitable whereby vendors, suppliers, consumers, service providers, employees and other participants in the ecosystem are all benefitted and contribute to exchequer through taxes. What more is needed?