With the passage of Companies’ Act 2013 a mandatory responsibility under section 135 was cast on companies to spend 2% of the net profit as calculated under section 198 of the Companies Act on the activities listed therein and being social and charitable in nature.
A debate is going on whether companies incorporated under section 8 of the Company’s Act 2013 are also required to comply and expend on CSR activities or not. Section 8 companies being itself charitable in nature enjoy special status under various acts including acts related to various taxes. Section 8 of the Companies Act 2013 is silent on this subject and thus it applies to such companies also. But when we read the language of section 135 with section 198 of the company’s act 2013 it seems that the intention of the legislature is different thus provides a scope for the discussion on the subject.
The main conditions for applicability of section 135: Companies having net worth of rupees five hundred crore or more, or turnover of rupees one thousand crore or more or a net profit of rupees five crore or more during any financial year shall constitute a Corporate Social Responsibility Committee of the Board consisting of three or more directors, out of which at least one director shall be an independent director. This section does not speak about the exemption given to a class or classes of companies but is applicable to all the companies incorporated under the company’s act 2013 in India.
Reading section 135 of the company’s act 2013 along with section 198 of the said act which deals with the calculation of net profit – net profit here means profit as calculated after certain adjustments listed under section 198 of the company’s act 2013 but before adjustment of income tax. Thus 2% of net profit as calculated under section 198 of the Company’s Act 2013 is to be spend as the CSR on the approved activities listed under social and charitable activities.
Since section 135 of the company’s act 2013 is applicable to section 8 companies incorporated in India but the conditions listed under section 135 are such in nature that if interpreted in ordinary and constructive manner the intention of the legislature is that section 8 companies are exempt from CSR responsibilities till the time they are not treated as commercial entities.
Section 8 companies usually termed as charitable companies are not owner driven entities but are run by a group of people who constitute such companies with charitable mind set without any expectation to earn from the investments if any initially made by them. There is no provision to declare dividends or distribute profits in any manner whatsoever and cannot distribute assets or proceeds of the assets owned by such companies at the time of liquidation or closure due to whatever reason. These charitable companies are given tax exemption from paying income tax on surplus earned only with a condition that the activities of such companies will not be of commercial nature at all, surplus generated if any will not be distributed in any manner but will be set aside for future use for the attainment of objectives for which such companies have been created. The net assets after satisfying all the liabilities will be transferred to a company having similar objectives at the time of winding up or in default thereof by the High Court of judicature that has or may acquire jurisdiction in the matter.
Coming to the conditions laid down in section 135 of the company’s act 2013 for applicability of CSR. There are three main conditions:
Condition as to net worth: - Companies having net worth of rupees five hundred crore or more are covered under the CSR scheme.Net worth of a company is the available surplus by which the value of assets exceed liabilities. Technically speaking this is the worth of the company belonging to the shareholders. In case of winding up of a company net worth is the value of assets which gets distributed among the shareholders. But in the case of a company incorporated under section 8 of the Company’s Act the ownership lies with company at the same time the shareholders have no right to use or distribute these assets. Even if there is positive net worth it is only notional and not real. There is no provision under law to distribute the assets at the time of winding up of these charitable companies therefore the concept of net worth is meaningless and irrelevant as for as compliance of Section 8 companies are concerned.
Condition as to turnover: - Traditionally charitable institutions use to spend on the objectives for which they were created only after funds were collected form the donors. Since such organizations are not commercial in nature there is no means of raising funds from the financial institutions or banks in any form except loans or overdrafts against money instruments or properties. Presently there is a lot being done for social cause thus a lot of money comes to these charitable institutions through grants, donations, membership etc. be it from domestic sources or from abroad. But one thing is clear that the receipts of such organizations accrue as contribution in whatever name and not from the sale of goods produced or traded or services being offered in regular course of business as is the case with a commercial business entity. The aim of doing charitable activities are not focused to earn profits and multiplication of wealth.
Turnover under the Company’s Act 2013 means the aggregate value of the realisation of amount made from the sale, supply or distribution of goods or on account of services rendered, or both by the company during a financial year. As far as section 8 companies are concerned the inflow of money is treated as income and the outflow is treated as expenditure. With the final accounts an Income & Expenditure is drawn as per the requirements of law and not the profit and loss account. The idea behind is to ascertain the total income and the corresponding expenditure to know whether there is any surplus or deficit during a financial year. Thus income received by section 8 companies cannot technically be treated as turnover as defined by the Company’s Act 2013.
Condition as to Net Profit: The excess of income over expenditure in the case of section 8 companies is treated as surplus and not the profit. Any surplus generated cannot be distributed as dividend or otherwise as in the case of profit earned by commercial organizations. Surplus thus generated has to be carried forward and need to be used for the attainment of objectives for which the company was created under section 8. The requirement of section 135 of the Company’s Act 2013 is to spend 2% of the profit before taxes. Thus it is clear that the provision for money to be spend on CSR activities need to be out of profits which are subject to income tax. Surpluses generated by section 8 Companies are exempt from income tax. Usually tax exemption is allowed to all the charitable companies unless such companies violate the conditions based on which tax exemption was granted or where the authorities feel the activities of such companies are commercial in nature.
From the above the applicability of section 8 of the Company Act 2013 seems to be a debatable issue and has to be decided on case to case basis keeping in view both the Company’s Act as well as Income Tax Act.
DILIP K RAINA –Chartered Accountant:
B.Com; FCA (ICAI); PGDFM; PGDCA; DBM; Cert. IFRS (ICAEW); NCFM Capital Market (Dealers Module); Microsoft Certified IT Professional: Application for Microsoft Dynamics NAV (ERP) & AXAPTA (ERP)
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