Philanthropy is certainly not unheard of in India. However, the Companies Act 2013 is the first-known example of a corporate governance law in the country that enacts specific provisions to mandate and secure corporate spend on a set of socially desirable objectives laid down by the government.
The guiding principles stated in the proposed draft Corporate Social Responsibility Rules, under Section 135 of the act, define 'corporate social responsibility' as the process by which a business organisation evolves its relationships with stakeholders for the common good, demonstrating its commitment in this regard by adopting appropriate business processes and strategies. Thus, corporate social responsibility is not charity or mere donations; instead, it is a way of conducting business by which corporate entities visibly contribute to the good of society. Socially responsible companies do not limit themselves to using resources to engage in activities that increase only their profits, but use corporate social responsibility to integrate economic, environmental and social objectives with the company's operations and growth.
Under the act, as from April 1 2013 companies in India must undertake corporate social responsibility expenditure as mandated in Section 135, Schedule VII of the act and the draft rules. Any company incorporated under the act must ensure that it spends at least 2% of its average net profits for the three immediately preceding financial years on such matters, if the company has:
- a net worth of R50 billion;
- a turnover of R100 billion; or
- a net profit of R50 million.
If any one of the above criteria is achieved in any given financial year (ie, April 1 to March 31), the mandate to spend is triggered. The company must then ensure that it spends at least 2% of its average net profits on corporate social responsibility. For example, if the net profits were R100 million in 2013-2014, R80 million in 2012-2013 and R120 million in 2011-2012 (a total of R300 million), the company must determine the average net profit (ie, R100 million) and spend 2% of that figure (ie, R2 million) in the financial year in which the applicability of the law is triggered. Going forward, it must spend the mandated amount in every succeeding financial year. If there is a loss in all three years, no such spend need be incurred, as there would be no profit to start with.
i. CONSTITUTION OF COMMITTEE
Any company that meets the criteria for mandatory corporate social responsibility spending must set up a corporate social responsibility committee. The committee must comprise three directors, of which at least one must be an independent director. Such independent director must be appointed by the company for this purpose, even if it is not otherwise required to have an independent director on its board. Under the new act, the appointment of an independent director to the board of the company is mandatory only for public listed companies. However, Section 135 (as presently worded) would seem to impose this requirement on all companies to which the corporate social responsibility law applies. This anomaly may be addressed by the government in future.
ii. FORMULATION OF POLICY
The corporate social responsibility committee is mandated to formulate and recommend corporate social responsibility policy to the board. The draft rules specify in minute detail that this policy must:
- list the projects and programmes that the company plans to undertake for implementation during the year;
- spell out the modalities of execution; and
- detail the sectors or areas selected for implementation.
The company must then publish the implementation schedule for the policy. Rule 1 also states that the projects undertaken must focus their business models on the government's social and environmental priorities (possibly with the aim of directing companies to integrate their business models with government priorities). The policy must be reported to the government.
iii. DISPOSAL OF SURPLUS
Rule 1 further directs that the company must ensure that the surplus arising from any corporate social responsibility activity or project must not form part of the company's business profits. To this end, the policy must confirm that a company's corporate social responsibility funds will include:
- 2% of the average net profits;
- any income arising therefrom; and
- any surplus arising out of corporate social responsibility activities.
Although not explicitly stated so, it may be inferred that the amount of 2% year on year may be held or invested in income-earning securities until such time as the funds are actually deployed in projects or programmes. Conceivably, these funds could also be invested in the creation of capital assets that would be dedicated and used for the social sector activities. This appears to be the only logical conclusion, as large funds set aside for social sector programmes cannot be spent without considerable planning and research.
iv. DISCLOSURE AND REPORTS
Section 134(3)(o) of the act states that the board must prepare a report, to be attached to the company's financial statement and placed before the company in the general meeting, that sets out "the details about the policy developed and implemented by the company on corporate social responsibility initiatives taken during the year". The report by the board of directors must include the details mentioned in Section 134(3)(o).
Furthermore, the report must be approved by the board of directors before it is signed on behalf of the board by at least the chairperson of the company, if he or she is authorised to do so by the board or by two directors (of which one must be the managing director) and the chief executive officer (if he or she is a director in the company), the chief financial officer and the company secretary of the company.
The report must encompass:
- the details of the policy developed in relation to the initiatives chosen and implemented during the year;
- the composition of the corporate social responsibility committee;
- the amount of expenditure to be incurred for such activities, with reasons (if any) for allocating less than the minimum 2% spend required by the law;
- the monitoring mechanism established to monitor the implementation of the programmes;
- details of the initiatives that are to be undertaken in future and those that have already been undertaken by the company;
- the monitoring mechanism established to ensure use of the funds for the correct purpose.
The new act provides for the penalties for non-disclosure of the policy developed and implemented by the company during a financial year. Failure to make such disclosure will be punishable by a fine of between R50,000 and R250,000. Further, every officer that is in default will be punished with imprisonment of up to three years or with a fine of up to Rs 250,000.
The companies which fail to spend the entire 2% on CSR activities can also transfer the remaining amount to the Prime Minister's relief fund.
The government is planning to add more teeth to the Companies Act 2013 by introducing the penalty clause for companies that miss this target spending repeatedly. At present, non-compliance of CSR rule isn't penalized by the Companies Law, and those unable to spend the stipulated amount can get away with some justification.
According to CMA Sunil Singh, Past Chairman Institute of Cost Accountants of India, Lucknow Chapter, "Under the current law, there's no mandatory obligation on the company, but a responsibility is cast upon the board members. In case companies repeatedly fail to do so for two or more years, they should be penalized.”
Going forward, companies will have to work to increase their accountability for corporate social responsibility performance at board level. This will entail conscious policy decisions by the board as to how directors handle corporate social responsibility issues, as well as how the board manages itself and fulfils its responsibilities mandated by law. Companies will have to establish accountability norms for performance at a senior management level by creating a dedicated position responsible for the oversight of a company's corporate social responsibility activities.
Companies will also have to integrate accountability for corporate social responsibility performance with long-term planning for decision making with periodic reviews by:
- rethinking processes for establishing appropriate internal audit mechanisms;
- changing the practices used to hire, retain and reward resources; and
- creating a capacity building system to orient their stakeholders towards social sector delivery.
Corporate accountability will have to encompass policies, indicators, targets and processes to manage the relevant tasks and programmes. Such accountability will demand that companies report their social sector performance publicly, focusing on communication to both the government and stakeholders as a management tool that will progressively steer companies towards more effective implementation of such programmes.
It is still early days and the road is unlikely to be smooth, but it is hoped that companies will learn meet these new demands in time.
CMA Sunil Singh
The Institute of Cost Accountants of India, Lucknow Chapter
Tags :corporate law