On January 22, 2021, the Ministry of Corporate Affairs (“MCA”) notified the amendments made to Section 135 of the Companies Act, 2013 (“the Act”), along with the Companies (Corporate Social Responsibility Policy) Amendment Rules, 2021 (“Amendment Rules”), which substantially revamped the CSR Rules, 2014. While the notification of the amendments made to Section 135 [by the Companies (Amendment) Act, 2019, and the Companies (Amendment) Act, 2020] was always on the cards, the onerous obligations imposed by the Amendment Rules was like a bolt from the blue for India Inc.
The shift from ‘comply or explain’ to mandatory CSR, coupled with the onerous obligations imposed under the Amendment Rules significantly increased the compliance burden on India Inc, amid the challenges brought about by the Covid-19 pandemic. As multiple provisions of the new CSR regime gave rise to interpretative challenges and practical difficulties, multiple representations were made to the MCA for issuing clarifications, and for liberalising some of the stringent compliance obligations.
After an anxious wait of seven months, on August 25, 2021, the MCA finally issued its FAQs[1] on CSR, which provides responses to various queries raised by the industry. In this article, the authors’ will examine some of the key clarifications provided by the MCA, along with their implications from a compliance perspective.
‘Utilisation’ of CSR grants by implementing partners
Undertaking CSR activities by disbursing grants to implementing agencies (“IAs”) has been convenient and cost-effective for companies, as IAs have expertise in executing projects in fields such as education, healthcare, etc. The Report of the High-Level Committee on CSR (“CSR HLC”) notes that more than 50% of the CSR expenditure incurred in FY 2017-18 was through IAs.[2]
Along with noting the prominent role played by IAs, the CSR HLC expressed concern with the fact that mere disbursal of CSR grants to IAs was being construed by companies as ‘CSR spending’ – which defeated the rationale of having a ‘Board-driven CSR regime’. It recommended that a clarification must be issued stating that mere disbursal of grants to IAs does not amount to ‘CSR spending’, and the grants should be ‘duly spent’ by the IAs.
While this aspect is not expressly clarified in the Amendment Rules, Rule 4(5) provides that the Board of the company shall satisfy itself that the funds disbursed have been utilised for the purposes approved and requires the CFO to certify the same.
In FY 2020-21, due to the Covid-19 pandemic, many IAs could not utilise the full portion of the CSR grant disbursed by a company. This resulted in ambiguity regarding whether a company would have fulfilled its CSR obligation, once it had disbursed its 2% CSR budget to one or more IAs by the last date of the FY.
The MCA has now clarified that mere disbursal of funds to IAs does not amount to “spending”, unless the IA utilises the whole amount.[3] Hence, even if a fractional portion of the grant is unutilised by the last date of the FY, this unutilised portion of the grant will be accounted as ‘Unspent CSR’.
‘Unspent CSR Account’
Perhaps the most contentious provision of the new CSR regime is Section 135(6), which mandates that any unspent CSR amount relating to an ‘ongoing CSR project’ shall be transferred to the ‘Unspent CSR Account’ to be opened by the company. As IAs were unable to fully utilise CSR grants disbursed for FY 2020-21, there was no clarity as to whether a company would, in such situations, have an obligation to transfer the unutilised CSR grant to the ‘Unspent CSR Account’.
This ambiguity arose as there is no provision in Section 135 of the Act and the CSR Rules, which requires a company to claw back the funds that it has already disbursed to IAs. The provisions also do not clarify whether the IA can directly transfer the unutilised funds to the Unspent CSR Account of the company.
The MCA’s clarification relating to ‘utilisation’ of grants by IAs indicates that mere disbursal of the full CSR amount to an IA will not exempt the company from complying with Section 135(6). However, the FAQs are silent on whether the company would be obligated to claw back the unutilised funds from IAs, or if any other mechanism can be adopted for complying with Section 135(6), in situations where the company has already disbursed the grant to IAs.
Dichotomy between Section 135(6) and the Foreign Contribution (Regulation) Act, 2010
The FAQs are also silent on the potential conflict between Section 135(6) of the Act, and the Foreign Contribution (Regulation) Act, 2010 (“FCRA”). With respect to foreign companies that are required to comply with the FCRA while disbursing their CSR grants to NGOs, there is no clarity on whether the ‘Unspent CSR Account’ should also be an FCRA-compliant account (to be opened at the New Delhi Main Branch of the SBI), as the FCRA is a special legislation that may override the general provisions of the Act.
Further, the FCRA does not permit a foreign company from getting a refund of the ‘foreign contribution’ provided to an NGO. Hence, foreign companies may not be permitted to exercise the option of clawing back the unutilised CSR grants from IAs, for transfer to the Unspent CSR Account.
Activities benefitting employees of the company
The CSR Rules provide that “activities benefitting employees of the company” shall not be considered as CSR activity.[4] Prior to January 22, 2021, “activities that benefit only the employees of the company” could not be construed as ‘CSR’.
As the word “only” has now been omitted, one question that arises is whether CSR programmes that envisage the employees as one among several beneficiaries can be considered as ‘CSR’. The FAQs provide that any activity designed exclusively for the benefit of employees will not qualify as ‘CSR expenditure’.[5] Further, if the employees are incidental beneficiaries only, then such activities will qualify as ‘CSR expenditure’.[6]
This is a step in the right direction, as employees and their families may incidentally benefit from the CSR activities undertaken by the company in fields such as education, healthcare, sanitation, etc., which may be targeted towards the public at large.
Stamp duty on transfer of capital assets
Rule 7(4) provides that capital assets ‘created or acquired’ out of CSR funds cannot be held by the company, and should be held by the entities prescribed under Rule 7(4)(a) to 7(4)(c), which includes a Section 8 company, registered public trust, etc. The proviso to Rule 7(4) makes it applicable with retrospective effect, and states that any capital asset ‘created or acquired’ out of CSR funds, prior to January 22, 2021, should also be transferred.
While transferring capital assets such as land or buildings, companies will have to pay stamp duty and registration fees, in accordance with the applicable provisions of the State where the capital asset is located. The FAQs have now clarified that expenses incurred on stamp duty and registration fees will qualify as a ‘CSR expenditure’ in the year of transfer.[7]
The rationale behind this is doubtful, as the expenses incurred towards stamp duty and registration fees will be deposited in the treasury of the State Government, and will not be utilised for a CSR project/programme. This expenditure is also pursuant to a statutory obligation, and the CSR Rules[8] expressly provide that expenses incurred towards fulfilment of a statutory obligation cannot be construed as ‘CSR’. It is doubtful whether FAQs issued by the MCA can dilute the law passed by the Parliament.
Corpus contributions
Previously, the MCA had clarified that contributions to the corpus of a trust/ society/ Section 8 company will qualify as ‘CSR expenditure’, if the entity is exclusively created for undertaking CSR activities, or if the corpus is created exclusively for a purpose relatable to Schedule VII of the Act.[9]
The FAQs have now clarified that w.e.f. January 22, 2021, corpus contributions will not qualify as ‘CSR expenditure’.[10] The rationale is that the new CSR regime imposes an obligation to undertake CSR activities in ‘project’ or ‘programme’ mode, and a mere corpus contribution may not be directly utilised in favor of the targeted beneficiaries of a CSR project/programme.
CSR obligations of a Section 8 company
The FAQs provide that as Section 135(1) begins with the words “Every company…”, the CSR provisions will also be applicable to a Section 8 company.[11] A Section 8 company, which satisfies the requirements of Section 135(1), read with Section 135(5) must accordingly comply with the new CSR regime.
While the MCA has taken a similar stance in its earlier clarifications[12], it is pertinent to note that a Section 8 Company is in any case incorporated with charitable objects and may also be engaged as an IA by one or more companies. A Section 8 company is obligated to apply its profits for promoting its charitable objects only and is prohibited from declaring any dividend. Hence, imposing an independent CSR obligation on such companies sounds counter-intuitive.
Ongoing Projects
In accordance with Rule 2(1)(i), the FAQs have clarified that an ‘ongoing CSR project’ can have a maximum duration of three FYs, excluding the FY in which it was commenced. Further, the MCA has clarified that the duration of an ‘ongoing project’ cannot be extended beyond the maximum permissible time-period.
Instead of adopting a prescriptive approach, the FAQs could have conferred the Board / CSR Committee with the authority to extend this duration further, after evaluating the nature of a CSR project. Prescribing a stringent time-period may impact long-gestation projects in fields such as healthcare and education, which require access to funding on a long-term basis.
Concluding Thoughts
The FAQs and the new CSR regime give a prima facie impression that the functions of the CSR Committee have been diluted, as the Board now has onerous obligations to monitor fund utilisation, approve ‘ongoing projects’, etc. However, given that the MCA has envisaged a ‘Board-driven CSR regime’, the spirit of the law is not to dilute the functions of the CSR Committee, but to enhance the obligations of the Board, and ensure that the Board collectively fulfils its supervisory responsibilities.
Along with the Board, the CSR Committee will continue to perform an integral role in formulating the Annual Action Plan, monitoring the implementation of CSR projects by IAs, ensuring adherence to project timelines, etc.
Further, pursuant to the amendment made to Section 37(1) of the Income Tax Act, 1961, by the Finance Act 2014, the MCA has reiterated its view that CSR expenditure is not tax-deductible. This is grossly unfair, given that CSR expenditure is now mandatory, and expenditure incurred on activities relatable to Schedule VII of the Act had always been tax deductible under different provisions of the Income Tax Act, prior to the amendments to Section 37(1).
Lastly, although the FAQs were eagerly awaited, one must not lose sight of the fact that some of the FAQs militate against the substantive provisions of Section 135 and the CSR Rules. This practice of altering the provisions of the Act (read with the Rules framed thereunder) by issuing clarificatory circulars is of doubtful legal validity, as a delegated legislation cannot override the parent statute. Hence, from a strictly legal standpoint, it would be better if future changes to the CSR regime are brought about by suitable amendments to Section 135 and the CSR Rules.
[1] Frequently Asked Questions (FAQs) on Corporate Social Responsibility (CSR), Ministry of Corporate Affairs, General Circular No. 14/2021, dated August 25, 2021 (“August 25 Circular”)
[2] Report of the High-Level Committee on Corporate Social Responsibility, submitted to the Ministry of Corporate Affairs on August 7, 2019, at Para 2.7.1 and Table 2.8.
[3] FAQ 7.4, August 25 Circular.
[4] Rule 2(1)(d)(iv) of the CSR Rules, 2014 (as amended on January 22, 2021).
[5] FAQ 4.2, August 25 Circular.
[6] FAQ 4.2, August 25 Circular.
[7] FAQ 3.6, August 25 Circular.
[8] Rule 2(1)(d)(vi), CSR Rules, 2014 (as amended on January 22, 2021).
[9] Ministry of Corporate Affairs, General Circular No. 21/2014, dated June 18, 2014.
[10] FAQ 3.5, August 25 Circular.
[11] FAQ 1.3, August 25 Circular.
[12]Ministry of Corporate Affairs, FAQs on CSR Cell, available at https://www.mca.gov.in/MinistryV2/faq+on+csr+cell.html.