The Ministry of Corporate Affairs (‘MCA’) notified the amendments made to Section 135 of the Companies Act, 2013 (‘the Act’) – via the Companies (Amendment) Act, 2019, and the Companies (Amendment) Act, 2020, on January 22, 2021.
On the same day, the MCA also notified the Companies (Corporate Social Responsibility) Amendment Rules, 2021 (‘new CSR Rules’). These Rules have made significant changes to the regulatory framework governing the monitoring and evaluation of CSR activities, and the utilisation of CSR expenditure.
In this blog, we shall focus on the new CSR Rules, and examine its implications for India Inc. The implications of the changes made by the new CSR Rules are analyzed below.
1. List of activities not covered under CSR
Rule 2(1)(d) prescribes a list of activities that shall not fall within the ambit of ‘CSR’. This list includes –
- Activities undertaken by the company in its normal course of business. The only exemption granted is for companies that are in their normal course of business undertaking R&D activities for Covid-19 related vaccines, drugs and medical devices (for FY 2020-21, FY 2021-22, and FY 2022-23).
- Activities undertaken outside India, except training of sports personnel representing India in national/ international competitions.
- Contribution of any amount to any political party under Section 182 of the Act;
- Activities benefitting employees of the company, as defined under Section 2(k) of the Code on Wages, 2019.
- Activities supported by the company on sponsorship basis, for deriving marketing benefits for its products/services.
- Activities carried out to fulfill statutory obligations under any law.
Companies must ensure that their CSR Policy does not include any of these activities, as they have been specifically excluded from the ambit of ‘CSR’. Any expenditure incurred with respect to these activities cannot be accounted as CSR expenditure.
2. Appointment of Implementing Partners
Rule 4(1) prescribes the list of implementing partners that can be appointed by the company, for undertaking CSR activities. This list includes a Section 8 company, registered public trust, registered society, etc. Only those entities covered under Rule 4(1) can be appointed as implementing partners by the company. With effect from April 1, 2021, every entity appointed as an implementing partner must register with the Central Government.
3. Enhanced obligations of the Board & CSR Committee
The new CSR Rules have imposed additional obligations on the Board and the CSR Committee – for monitoring, evaluation and reporting of CSR activities. Rule 4(5) states that the Board must satisfy itself that CSR funds are utilised in the manner approved. Under Rule 4(6), in case of an “ongoing project”, the Board has to monitor the implementation of the project, with reference to the approved timelines, and it can also make modifications for smooth implementation of the project.
Rule 5(2) introduces a new obligation on the CSR Committee. Under Rule 5(2), the CSR Committee must prepare an “annual action plan” in pursuance of the CSR Policy. The annual action plan should include –
- list of approved CSR projects.
- manner of execution of CSR projects.
- implementation schedules and modalities for fund utilisation.
- monitoring & reporting mechanism.
- impact assessment.
A conjoint reading of Rules 4(5), 4(6) and 5(2) highlights that the CSR Committee and the Board have an enhanced monitoring role – in ensuring that CSR activities are undertaken in accordance with the CSR Policy and annual action plan. The monitoring/ evaluation obligations must be complied with even when the CSR projects are undertaken directly by the implementing partners of a company. These obligations cannot be evaded by disbursing CSR grants directly to implementing partners.
Furthermore, under Rule 9, the Board must disclose the composition of the CSR Committee, the CSR Policy and the approved projects on the company’s website, for public access.
4. “Administrative overheads” relating to CSR
Rule 2(1)(b) defines “administrative overheads” as the expenses incurred by the company for ‘general management and administration’ of CSR functions. This shall not include the expenses directly incurred for designing, implementation, monitoring, and evaluation of a CSR project/ programme. Rule 7(1) mandates the Board to ensure that expenses falling within the ambit of ‘administrative overheads” do not exceed 5% of the total CSR expenditure for a financial year.
From a conjoint reading of Rule 2(1)(b) and 7(1), we may infer that there is no cap placed on the expenses that can be incurred for monitoring, evaluation and designing of a CSR project/programme.
5. Utilisation of surplus arising out of CSR
Under Rule 7(2), any surplus arising out of CSR activities shall not form a part of the business profit of the company. The surplus can be utilised through either of the following options only:
- It shall be ploughed back to the same project;
- transferred to the Unspent CSR Account and spent in pursuance of the CSR Policy;
- transferred to any Fund specified in Schedule VII of the Act.
Rule 7(2) intends to curb the practice of utilising surplus generated through CSR for non-CSR purposes. The surplus generated cannot be re-invested by the company, and can be utilised only through either of te methods prescribed under Rule 7(2).
6. “Set-off” of excess CSR amounts spent in a financial year
Through the Companies (Amendment) Act, 2020, a proviso was added to Section 135(5) – permitting a company to “set-off” the excess CSR amount spent during a financial year, for such number of future finacial years as may be prescribed through regulations. Under Rule 7(3), the excess CSR amount must be set-off within the next three immediately succeeding financial years. Rule 7(3) also prescribes two pre-conditions before the excess CSR amount is set off –
- the excess CSR amount should not include any surplus generated out of CSR activities;
- the Board should pass a resolution permitting the set-off.
Companies must ensure that a “set-off” is undertaken only after satisfying the pre-conditions mentioned under Rule 7(3). For excess CSR amounts spent in the current financial year, the option of “setting off” shall be available for the next three financial years.
7. Holding of Capital Assets ‘created or acquired’ out of CSR funds
Under Rule 7(4), the CSR amount may be spent by the company for ‘creation or acquisition’ of a capital asset. This capital asset ‘created or acquired’ out of CSR funds cannot be held directly by the company. It can only be held by any of the entities prescribed under Rule 7(4) – which includes a Section 8 company, registered trust/ society, etc. The proviso to Rule 7(4) states that any capital asset created by the company, prior to January 22, 2021, must be transferred to any of the entities prescribed under Rule 7(4), within 180 days.
This Rule can be interpreted by referring to the observations made by the High-Level Committee on CSR (‘CSR HLC’), which submitted its Report on August 7, 2019. The CSR HLC stated that –
“….if a company creates an asset by spending CSR funds, the asset shall continue to hold the value till it depreciates or gets liquidated….the creation of an asset by the company in its name, especially appreciable assets, would tantamount to non-spending of the CSR monies. This means that an asset created out of CSR funds must not be held by the company in its name or in the name of any other incorporated or unincorporated entity of which it is the ultimate beneficiary”.
The CSR HLC opined that assets created out of CSR funds should not be held directly or indirectly by the company. Rule 7(4) takes this forward to state that any capital asset ‘created or acquired’ out of CSR funds shall not be held directly by the company. The proviso to Rule 7(4) states that any such capital asset created prior to January 22, 2021, must be transferred to any of the entities prescribed under this rule.
Capital assets ‘created or acquired’ by the company prior to January 22, 2021, shall fall under two categories –
- Capital assets ‘created or acquired’ out of the profits of the company (e.g. land, building, etc) that are incidentally used for CSR activities.
- Capital assets ‘created or acquired’ out of the CSR funds allocated for a financial year.
The proviso to Rule 7(4) requires a transfer of only those capital assets that are ‘created or acquired’ out of CSR allocations made previously. These capital assets cannot be held directly by the company. On the other hand, capital assets that are created out of profits and used incidentally for CSR activities can be held by the company, and need not be transferred.
8. Impact assessment
Under Rule 8(3)(a), every company, which is obligated spend a minimum CSR amount of INR 10 crore and above, should undertake impact assessment (through an independent agency) for those CSR projects that have outlays of INR 1 crore and above. The impact assessment can be undertaken only after one year has passed since the date of completion of the project.
This requirement has been introduced following the recommendations of the CSR HLC. The CSR HLC recommended that impact assessment should be undertaken for certain projects with large outlays, to identify areas where intervention is required for the benefit of marginalised communities.
This “impact assessment” obligation is a separate reporting requirement, that is distinct from the Board’s general obligation of monitoring and evaluating implementation of CSR projects. Under Rule 8(3)(c), the expenses incurred towards impact assessment should not exceed 5% of total CSR expenditure, or INR 50 Lakhs, whichever is lower. As Rule 8(3)(c) imposes a specific cap on expenses incurred towards impact assessment, such expenses shall not be covered under the “administrative overhead” expenses defined under Rule 2(1)(d).
Along with Section 135 of the Act, the new CSR Rules create a stringent regulatory architecture for carrying out CSR activities in India. For ensuring compliance with the new legal framework, companies must preserve detailed records of CSR Committee meetings, CSR fund allocations, and projects undertaken through implementing partners.
The CSR mandate under Section 135 was originally founded on the ‘comply, or explain’ principle, where a company could either undertake CSR activities, or disclose reasons for failing to spend the CSR amount. Compliance with Section 135 was envisaged by Parliament to be voluntary, and not mandatory.
Within a short span of seven years, there has been a complete departure from this original intention. With the notification of the new CSR Rules, the departure from the ‘comply, or explain’ regime is now complete. There is a strong feeling in the corporate world that the new regime has become rather too prescriptive. Corporates need more flexibility to implement their CSR programmes.
 Report of the High-Level Committee on Corporate Social Responsibility, submitted on August 7, 2019, Pg. 64.
 Report of the High-Level Committee on Corporate Social Responsibility, submitted on August 7, 2019, Pg. 70.