Comprehensive Guide to CSR Activities – Implementation | Monitoring | Tax Implications

Table of Contents

1. CSR Activities
2. Activities Not Qualify as CSR Activity
3. CSR Outlay
4. Calculating CSR Outlay
5. Administrative Overheads
6. Surplus Arising From CSR Activities
7. CSR Activity Through Implementing Agency
8. Ongoing Projects
9. Monitoring of CSR Activity
10. Treatment of Unspent CSR Amount
11. Treatment of CSR Expenses for Tax Purposes
12. Consequences if the Company Made CSR Expenditure Beyond Statutory Requirement
13. Consequences if the Company Failed to Spend the CSR Amount

Check out Taxmann's Law & Practice Relating To Corporate Social Responsibility which is an exhaustive guide to implementing corporate social responsibility (CSR) within an organisation. This detailed handbook delves into the historical background of CSR, discusses pertinent laws, elucidates the implementation and applicability of CSR in organisational settings, and expounds on the roles of various stakeholders. It further delineates reporting obligations, highlights non-compliance repercussions, and compiles relevant notifications and circulars, offering an all-encompassing resource for CSR implementation.

The Corporate Social Responsibility is governed by Section 135 of the Companies Act, 2013, Schedule VII of the Act and Companies (CSR Policy) Rules, 2014 wherein the entire concept, its implementation and reporting mechanism have been provided. In India, we have the most elaborated CSR mechanism and it is a mandatory requirement under the Companies Act for the Corporates to realize their social responsibility and to partner in the sustainability growth and nation building.

1. CSR Activities

The term Corporate Social Responsibility has been defined  under  rule 2(1)(d) of the CSR Rules as under:

Corporate Social Responsibility (CSR) means the activities undertaken by a Company in pursuance of its statutory obligation laid down in section 135 of the Act in accordance with the provisions contained in these rules, but shall not include following, namely—

i. activities undertaken in pursuance of normal course of business of the company:
Provided that any company engaged in research and development activity of new vaccine, drugs and medical devices in their normal course of business may undertake research and development activity of new vaccine, drugs and medical devices related to COVID-19 for Financial Years 2020-21, 2021-22, 2022-23 subject to the conditions that

a. such research and development activities shall be carried out in collaboration with any of the institutes or organisations mentioned in item (ix) of Schedule VII to the Act;

b. details of such activity shall be disclosed separately in the Annual report on CSR included in the Board’s Report;

ii. any activity undertaken by the company outside India except for training of Indian sports personnel representing any State or Union territory at national level or India at international level;

iii. contribution of any amount directly or indirectly to any political party under section 182 of the Act;

iv. activities benefitting employees of the company as defined in clause (k) of section 2 of the Code on Wages, 2019 (29 of 2019);

v. activities supported by the companies on sponsorship basis for deriving marketing benefits for its products or services;

vi. activities carried out for fulfilment of any other statutory obligations under any law in force in India;

The above definition of CSR is an exhaustive definition which has given a very broad canvas. Accordingly, activities, excluding as provided in the definition, in pursuance of its statutory obligation laid down in section 135 of the Act which can be relatable to Schedule VII of the Act as clarified under General Circular No. 21/2014, dated 18th June, 2014 of Ministry of Corporate Affairs and General Circular No. 01/2016, dated 12th January, 2016 may be categorized under as CSR activities. Thus, any activity which can be relatable with the activities as provided in Schedule VII and not excluded in the definition of CSR may be considered as CSR activity.

Companies shall undertake CSR activities as per their CSR policy which shall exclude any activity undertaken in pursuance of its normal course of business.

2. Activities Not Qualify as CSR Activity

As per the definition of the CSR activity as provided in Rule 2(1)(d) of CSR Rules and as clarified by the Ministry of Corporate affairs through various clarifications, FAQs and explanation in this regard following activities would not be considered as CSR activities:

i. Activities undertaken in pursuance of normal course of business of the company;

ii. Activity undertaken by the company outside India;

iii. Any contribution, directly or indirectly, to any political party;

iv. CSR projects or programs or activities that benefit only the employees of the company and or their families;

v. Activities supported by the companies on sponsorship basis for deriving marketing benefits for its products or services;

vi. Expenditure incurred by the Company for meeting statutory obligations laid down under other law in force in India.

Dive Deeper:
[Case Study] ESG & CSR | Project Foot Print – HDFC Bank Limited
Corporate Social Responsibility (CSR) and Implementation Agencies | Legal Analysis

3. CSR Outlay

Every Company which is covered under section 135(1) has to spend, 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, where the company has not completed the period of three financial years since its incorporation, during such immediately preceding financial years, in pursuance of its corporate social responsibility. [Section 135(5)].

Companies have to give preference to the local area and areas around where it operates, for spending the amount earmarked for corporate social responsibility activities. [Proviso to section 135(5)]. In case of multi locational operations, the Company may choose the area for which it wants to give preference.

Further, the spirit of the Act is to ensure that CSR initiatives are aligned with the national priorities and enhance engagement of the corporate sector towards achieving Sustainable Development Goals.

Second proviso to section 135(5) further provides that in case any company fails to spend 2% of average net profits, the Board of Directors of the Company in their Boards’ Report specify the reasons for not spending the amount and unless the unspent amount relates to any ongoing project, transfer such unspent amount to a fund specified in Schedule VII, within a period of six months of the expiry of the financial year.

4. Calculating CSR Outlay

The average net profit for the purpose of determining the spending on CSR activities is to be computed in accordance with the provisions of section 198 of the Act and will also be exclusive of the items given under rule 2(1)(h) of the Companies (CSR Policy) Rules, 2014. Section 198 of the Act specifies certain additions/deletions (adjustments) to be made while calculating the net profit of a company (mainly it excludes capital payments/receipts, income tax, set-off of past losses). Profit Before Tax (PBT) is used for computation of net profit under section 135 of the Act.

Companies (Amendment) Act, 2017 substituted the explanation to the Section 135 w.e.f. 19-9-2018 which now clarifies that for the purpose of this section “net profit” shall not include such sums as may be prescribed, and shall be calculated in accordance with the provisions of section 198.

Further, the net profit has also been defined in the Rule 2(i)(h) as net profit means the net profit of a company as per its financial statements prepared in accordance with the applicable provisions of the Act, but shall not include following namely:

(i) Any profit arising from any overseas branch or branches of the company, whether operated as a separate company or otherwise; and

(ii) Any dividend received from other companies in India, which are covered under and complying with the provisions of section 135 of the Act.

Provided that in case of a foreign company covered under these rules, net profit means the net profit of such company as per profit and loss account prepared in terms of clause (a) of sub-section (1) of section 381, read with section 198 of the Act.

Earlier there was conflict between section 198 and CSR rule as certain incomes such as profits from an overseas branch and dividend from other companies in India, have been excluded from being calculated for net profits while there were no such provisions in section 198. Thus the amendment has addressed this issue and brought clarity on the calculation of net profits for the purpose to determine the applicability of the provisions of CSR as prescribed in section 135(1) the net profit shall be calculated in accordance with the provisions of Section 198 of the Act read with Rule 2(i)(h).

We can say that simply profit before tax or gross profit would not be able to justify the provisions and hence would not be a right parameter to determine the applicability of CSR. Although the profits would be before tax, dividends and appropriations but it need to be calculated in the manner as specified under section 198 all items prescribed under rule 2(i)(h) need to be excluded to arrive at the correct net profit to determine the applicability of section 135(1).

4.1 Calculation of Net Profit as per Section 198

4.2 Calculation of CSR Statutory Requirement for the year (Exhibit year 2022-23)

While calculating average net profit of the preceding financial year(s) the consideration should also be given if the company had loss in any of the year. For example: A Company has following net profit/losses (Exhibit year 2022-23):

4.3 Calculation of CSR Expenditure made during the year (Exhibit year 2022-23)

4.4 Calculation of amount unspent for the year: Amount to be transferred to Unspent CSR Account or to any fund Specified under Schedule VII

4.5 Calculation of Excess Amount for Set Off in next financial years

Option 1

Option 2

5. Administrative Overheads

CSR expenditure includes administrative overheads for management of CSR activities. Rule 7(1) provides that the administrative overheads shall not exceed 5% of total CSR expenditure of the Company for the financial year.

“Administrative overheads” has been defined in Rule 2(1)(b) as the expenses incurred by the Company for general management and administration of CSR functions in the company but shall not include the expenses directly incurred for the designing, implementation, monitoring and evaluation of a particular CSR project or programme.

The above upper cap of 5% would be applicable if the CSR activities are undertaken by the Company directly itself only. According to rule 2(1)(b) of the CSR Rules, administrative overheads mean the expenses incurred by the company in the general management and administration of CSR functions in the company. Therefore, expenses incurred by implementing agencies on the management of CSR activities shall not amount to administrative overheads and cannot be claimed by the company.

Administrative overheads generally comprise of items such as employee costs, utilities, office supplies, legal expenses, etc. However, expenses which are attributed to the project implementation shall be included in project cost only.

Example: Salary and training for the employees working in the CSR division of a company, stationery cost, travelling expenses, etc. may be categorised as administrative overheads. However, salary of school teachers or other staff, etc. for education-related CSR projects shall be covered under education project cost.

It is further provided that the expenditure made on impact assessment of projects shall also be considered as administrative expenses. However, the expenditure incurred on impact assessment is over and above the specified administrative overheads of 5%. Expenditure up to a maximum of 2% of the total CSR expenditure for that financial year or 50 lakh rupees (whichever is higher) can be incurred separately for impact assessment.

6. Surplus Arising From CSR Activities

Surplus refers to income generated from the expenditure of CSR activities, e.g., interest income earned by the implementing agency on funds provided under CSR, any revenue received from the CSR projects, disposal/sale of materials used in CSR projects, and other similar income sources. The surplus arising out of CSR activities shall be utilised only for CSR purposes and it would not be considered while determining the total expenditure of the CSR activities in a financial year vis-à-vis statutory requirement.

Surplus out of CSR Activities [Rule 7(2)]

Any surplus arising out of the CSR activities shall not form part of the business profit of a company and shall be: –

• ploughed back into the same project or
• transferred to the Unspent CSR Account and spent in pursuance of CSR policy and annual action plan of the company or
• transfer such surplus amount to a Fund specified in Schedule VII, within a period of six months of the expiry of the financial year.

7. CSR Activity Through Implementing Agency

The Company may undertake its CSR activities itself directly or indirectly through any implementing agency. The Company may take the services of following implementing agencies:

(a) a company established under section 8 of the Act, or a registered public trust or a registered society, exempted under sub-clause (iv), (v), (vi) or (via) of clause (23C) of section 10 or registered under section 12A and approved under section 80G of the Income-tax Act, 1961, established by the Company, either singly or along with any other company; or

(b) a company established under section 8 of the Act or a registered trust or a registered society, established by the Central Government or State Government; or

(c) any entity established under an Act of Parliament or a State Legislature; or

(d) a company established under section 8 of the Act or a registered public trust or a registered society, exempted under sub-clause (iv), (v), (vi) or (via) of clause (23C) of section 10 or registered under section 12A and approved under section 80G of the Income-tax Act, 1961, and having a track record of at least three years in undertaking similar activities.

With effect from 1st April, 2021, it is further required that every entity, who intends to undertake any CSR activity shall register itself with the Central Government by filing Form CSR-1 with the Registrar of Companies. Thus effecting from 1st April, 2021 no company can implement its CSR activity through any implementing agency unless it (implementing agency) has filed Form CSR-1 and a CSR number has been allotted to it. Companies need to obtain CSR number of implementing agency before giving any contribution of its CSR activity for implementation. This CSR number need to be disclosed in the annual report of CSR.

Companies may engage the international organizations for designing, monitoring and evaluation of the CSR projects or programmes as per its CSR policy as well as for capacity building of their own personnel for CSR. [Sub-rule (3) of Rule 4].

Further, sub-rule (4) of Rule 4 provides that a Company may also collaborate with other companies for undertaking projects or programmes or CSR activities in such a manner that the CSR committee of respective companies are in a position to report separately on such projects or programmes in accordance with these rules.

The Board of Directors of a company satisfy itself that the funds so distributed have been utilized for the purposes and in the manner as approved by it and the Chief Financial Officer or the person responsible for financial management shall certify to the effect. [Sub-rule (5) of Rule 4].

8. Ongoing Projects

Ongoing project means a multi-year project. If a company undertakes any CSR activity of project which will not complete in a year or will be completed not exceeding 3 years it will be considered as the Ongoing Project. The Ongoing Projects have been defined under Rule 2(1)(i) of CSR Rules as under:

“Ongoing Project” means 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 shall include such project that was beyond one year by the board based on reasonable justification.

As the definition suggest that ongoing project is a multi-year project. An ongoing project will ‘commence’ when the company either issue the work order pertaining to the project or award the contract for execution of the project and document so as an ongoing project.

The maximum permissible time period shall be three financial years excluding the financial year in which it is commenced i.e., (1+3) financial years.

In case of ongoing projects, the major responsibilities of the Board, inter alia, include:

(i) identification of the ongoing projects;

(ii) year-wise allocation of funds;

(iii) transferring the unspent money to a separate bank account as prescribed under sub-section (6) of section 135;

(iv) monitoring the implementation of the projects with reference to the approved timelines and year-wise allocation; and

(v) making modifications, if any, for smooth implementation of the projects within the overall permissible time period.

As per provisions of the CSR Rules, the Board may abandon or modify an ongoing project, partially or wholly, under exceptional circumstances, during the prescribed project period as per the recommendation of its CSR Committee, and by providing reasonable justification to that effect.  It is important to keep in mind that the maximum permissible period for an ongoing project is three years excluding the year of its commencement.

9. Monitoring of CSR Activity

CSR is a Board-driven process, and the Board of the company is empowered to plan, decide, execute, and monitor the CSR activities of the company based on the recommendation of its CSR Committee. The CSR architecture is disclosure-based and CSR-mandated companies are required to file details of CSR activities annually in MCA 21 registry in prescribed form CSR-2. Companies are required to make necessary disclosures in the financial statements regarding CSR including non-compliance. The existing legal provisions such as mandatory disclosures, accountability of the CSR Committee and the Board, and provisions for audit of accounts of the company provide sufficient mechanism for monitoring.

In case of ongoing project, the Board of a Company shall monitor the implementation of the project with reference to the approved timelines and year wise allocation and shall be competent to make modifications, if any, for smooth implementation of the project within the overall permissible time period. [Sub-rule (6) of Rule 4]

The Government monitors the compliance of CSR provisions through the disclosures made by the companies in the MCA 21 portal. For any violation of CSR provisions, action can be initiated by the Government against such non-compliant companies as per provisions of the Companies Act, 2013 after due examination of records, and following due process of law. Non-compliance of CSR provisions has been notified as a civil wrong w.e.f. 22nd January, 2021.

10. Treatment of Unspent CSR Amount

If a company fails to spends or spend less than the amount required to be spent under their CSR obligation, the Board shall specify the reasons for not spending in the Board’s report and shall deal with the unspent amount in the following manner:

In case the company fails to spend the requisite amount within the financial year, it shall fulfil its obligation by transferring the unspent amount to any fund included in Schedule VII of the Act. The same will be considered as compliance with section 135(5) of the Act. Further, the Board of the company is required to give the requisite disclosure in the Board report and annual report on CSR.

Companies are not permitted to spend the unspent CSR amount, other than the amount pertaining to ongoing projects, on any CSR activity during the intervening period of six months after the end of the financial year. Such unspent CSR amount is required to be transferred to any fund included in Schedule VII of the Act.

11. Treatment of CSR Expenses for Tax Purposes

The amount spent by a company towards CSR activities cannot be claimed as business expenses. The Finance Act, 2014 provides clarification to that effect. Union Budget 2014 inserted Explanation to section 37(1) of the Income-tax Act, 1961:

Explanation 2 it is declared that for the purposes of sub-section (1), 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 be an expenditure incurred by the assessee for the purposes of the business or profession.”

Thus, the expenditure on CSR activities is non-deductible for tax purposes and no specific tax exemption have been extended to CSR expenditure per se. The Finance Act, 2014 also clarifies that expenditure on CSR does not form part of business expenditure. While no specific tax exemption has been provided to the expenditure incurred on CSR activities, spending on several activities like contribution to Prime Minister’s Relief Fund, scientific research, rural development projects, skill development projects, agriculture extension projects, etc., which find place in Schedule VII, already enjoy exemption under different sections of the Income-tax Act, 1961. Thus, deductions can be claimed under specific section company cannot claim CSR activities as their business expenses.

12. Consequences if the Company Made CSR Expenditure Beyond Statutory Requirement

In terms of section 135(5), the Board of every company to which section 135 is applicable, shall ensure that the company spends, in every financial year, at least 2% of the average net profits of the company made during the three immediately preceding financial years since its incorporation (in case the company has not completed the period of three financial years since its incorporation such financial years after its incorporation), on CSR activities in a financial year.

Effecting from 22nd January, 2021 vide Companies (Amendment) Act, 2020 companies can carry forward and set off the over expenditure made in any financial year till the next three financial year, subject to the approval of the Board of Directors.

Companies (Amendment) Act, 2020 inserted a third proviso to Section 135(5) provides that in case the Company spends an amount in excess of the requirements provided under section 135(5), such company may set off such excess amount against the requirement to spend under this sub-section for such number of succeeding financial years and in such manner, as may be prescribed.

Rule 7 of CSR Rules as amended by the Companies (Amendment) Act, 2020 provides that if a company spends an amount in excess of required contribution, as mentioned in section 135(5), such excess amount may be set off against the requirements to spend upto immediately succeeding three financial years provided:

i. the excess amount shall not include the surplus arising out of the CSR activities, if any

ii. the Board resolution is required to be passed

Before 22nd January, 2021 there was no provision of setting off the over expenditure of CSR amount. Hence, before this amendment if any company made any excess expenditure of CSR outlay, it was lapsed at the end of the said financial year. Thus no carry forward and set off was allowed prior to financial year 2020-21. It is to be noted that set-off of excess amount of CSR expenditure is applicable from financial year 2020-21 only i.e. if a Company spends more than 2% of average net profit in FY 2020-21, the Company may set-off such excess amount against the requirement of CSR expenditure up to FY 2023-24.

13. Consequences if the Company Failed to Spend the CSR Amount

Section 135(5) and Section 135(6) of the Act provides that in case the com- pany fails to spend its statutory obligation of CSR outlay of 2% of its average profits during immediately preceding three financial years, following are the consequences:

i. Explanation has to be given in the Boards’ Report

ii. Disclosure in the Annual Report on CSR

iii. Transfer such unspent amount to a fund specified in Schedule VII within a period of 6 months of the expiry of the financial year (in case of non-ongoing projects)

iv. Transfer the unspent CSR amount to any of the funds specified in Schedule VII within a period of 30 days from the date of completion of the 3rd financial year (in case of ongoing projects)

Companies (Amendment) Act, 2020 has further provided that if a company defaults in complying with the provisions of Section 135(5) or 135(6), Company is 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 CSR Account, as the case may be or ` 1 Crore, whichever is less and every officer in default is liable to a penalty of 1/10th of the amount required to be transferred by the Company to such fund specified in Schedule VII or the CSR A/c, as the case may be, or ` 2 Lakhs, whichever is less.