After a considerable period of "wait and watch" MCA has through a slew of notifications issued on January 22, 2021, giving effect to some of the amendments made to the Companies Act, 2013 (hereinafter the "Act") through the Amendment Act, 2020 which encapsulated substantially the recommendations made by the high powered committee set up in the year 2019 by the Govt. In this exposition, we shall examine the implications of some of the amendments notified in relation to Section 135 of the Act, relating to CSR and more importantly, the widespread overhaul made to the CSR rules which hold out serious ramifications for Corporate Inc.
To read the official rules released, click here
Amendments notified to Section 135
What is heartening to note is that although the Companies Amendment Act, 2019 proposed several changes under Section 135, some of which led to hostile reactions from the corporate world as being retrograde , only the changes which are benevolent to companies have been given effect to, suggesting therefore that the rest of the changes that had been contemplated have perhaps been put into the backburner for future introspection.
The following amendments to the Section alone have been notified:
Provision for set off in future against excess spends
1) After the second proviso to Section 135(5), a third proviso has been notified which stipulates that where a company has spent in excess of its obligations in respect of a financial year, the excess amount shall be allowed to be set off against its obligation to incur spends for future years in the manner provided in Rule 7(3) of the Companies (Corporate Social Responsibility)Amendment Rules, 2021 which have been notified simultaneously with effect from January 22, 2021.The above sub-rule allows the carry forward of the excess amount to the next three financial years, subject to the following conditions:
a) the excess amount to be utilized in the future shall not include any surplus i.e. excess of income over expenditure arising out of any CSR project implemented by the company.
b) The board of directors shall pass a resolution to take note that the excess amount available is being put to use for its CSR initiatives and that the same does not include any surplus that has been generated out of any approved CSR activity.
The notification of the above amendment is welcome in that it will lessen the burden of the company to make spends in the next three financial years in particular in a lean year, where the Company’s coffers may not exactly be brimming with activity.
Penalty for non-compliance with sub-sections (5) and(6)
2) Sub-section (7) as substituted postulates that the company shall be liable to a penalty which shall be twice the amount required to be transferred by the company to the fund specified in Schedule VII or to the unspent CSR Account as the case may be or one crore rupees whichever is lower. Apart from the above, the officers of the company responsible for the non-compliance shall be liable to penalty which may extend to one-tenth of the amount required to be transferred to the funds referred to above or rupees two lacs whichever is lower.
It is pertinent to note that the Companies Amendment Act 2019 proposed that the non- compliance of the above sub-sections would also lead to punishment by way of imprisonment for a term which could extend to three years or with a fine which could extend up to rupees fifty thousand or with both. In the wake of the emphatic recommendations made by the high powered committee on company law to decriminalize most of the technical offences under the Act, the sting in the above sub-section was diluted substantially by the Amendment Act 2020 resulting in the obliteration of the provision relating to punishment by way of imprisonment. The fact that the amendment given effect to by the notification dated January 22, 2021 does not contemplate imprisonment will hopefully usher in an era of voluntary compliance of the provisions relating to CSR.
No requirement of CSR Committee if spends do not exceed rupees fifty lacs.
3) Subsection (9) of section 135 as notified stipulates that if the amount to be spent on CSR in a financial year does not exceed rupees fifty lacs, the CSR committee of the Board can be disbanded and the responsibility of steering the CSR initiatives will pass on directly to the Board. This change too is also salutary. However, it is not clear what would be the situation if the mandatory spend in a year goes beyond the threshold of rupees fifty lacs. Would it be in such circumstances, necessary to reinstate the Committee is a question that will confront the stakeholders which needs to be clarified. The need to have a committee should not oscillate depending upon the quantum of the CSR spend.
Amendments to the CSR Rules
Of much greater significance than the amendments administered to Section 135 elaborated above are the changes brought about to the CSR Rules through the introduction of the Companies (CSR Policy)Amendment Rules 2021. The amended rules have become applicable from the date of their notification.
The following changes have been made to Rule 2 of the above Rules:
A. Administrative overheads-defined
The above term has been defined to mean the expenses incurred by the company for "general management and administration" of the CSR functions in the company shall not include expenses that are directly incurred for designing, implementing, monitoring and evaluation of a CSR Project or programme. The above expression was never defined before and it follows from the above that the company can incur expenditure towards administration cost of a CSR project and the expenditure cannot be something which is directly related to the cost of the project or its implementation. The claim for administrative cost will hold water only in respect of projects being implemented directly by the company and not through an intermediary such as a Trust or a Section 8 company.
B. CSR-Scope of activities widened
The amplitude of the term "CSR" is being widened to cover certain new activities as explained below .At the same time , Rule 2(1)(d) provides that activities undertaken in pursuance of normal course of business will not come within the ambit of the term. What represents activities which are in the "normal course of business" is something which has to be determined having regard to the meaning given to the expression in common parlance in the absence of a definition thereto.
Apart from activities already covered under Schedule VII of the Act, the following activities will be considered as a CSR activity:
a) In respect of a company which is engaged in research and development activity of new vaccine, drugs and medical devices in the normal course of business may undertake research and development of new vaccine , drugs and medical devices related to COVID-19 for the financial years 2020-21, 2021-22 and 2022-23 subject to the following conditions:
i) the research and development activities shall be carried out in collaboration with any of the Institutes or organizations referred to item (ix) under Schedule VII. Item (ix) in the above Schedule refers to technology incubators which are located within academic institutions which have been approved by the Central Govt.
R&D activity carried on a standalone basis in relation to the COVID pandemic without the activity being collaborative will not fall within the ambit of CSR. Another aspect that has to be borne in mind is that the extended connotation to CSR will be applicable only for the next three years, the assumption being that the threat provided by COVID would haunt the country only over the next three years.
ii)If and where the company is involved in R&D related to COVID in a collaborative manner the fact that the company is so involved will have to be reported by the Board to the members.
b) any activity undertaken outside India shall not be CSR unless it is undertaken for the training of Indian Sportspersons representing any State or Union territory at the national level or the Country at the international level. Sponsoring Indian sportsmen and thereby drawing marketing mileage would not be covered under the above. This is a laudatory step which will give an impetus to deserving sportsmen for sharpening their skills..
c) contributions made either directly or surreptitiously to a political party would not be CSR.
d) activities benefiting employees of the company as defined in Section 2(k) of the Code on Wages 2019. This implies that provision of COVID vaccination shots to employees would not be a CSR activity as has been clarified earlier by MCA.
e) activities involving sponsorship to derive marketing advantage would not be covered.
f) activities which are in fulfillment of any statutory obligations. This is a reiteration of the stand taken by the MCA in earlier circulars on CSR.
C. CSR Policy
The above expression has been defined in the Rules to mean a statement which articulates on the approach and direction given by the Board after considering the recommendations made by the CSR Committee and covers the guiding principles leading up to the selection, implementation and monitoring of activities as also the formulation of the action plan and includes a statement containing the approach and direction given by the board of a company, taking into account the recommendations of its CSR Committee, and covers the guiding principles for selection, implementation and monitoring of activities as well as formulation of the annual action plan.
D. Definition of Net Profit
The definition to the above term as existing under the original rules has been retained except for the removal of a proviso which stated that the net profit calculated for any financial year in accordance with the provisions of the Companies Act, 1956 need not be recomputed .This was a transitory provision and given that the new Act has now been operational for over six years, the above proviso has been correctly dropped.
E. Ongoing Project
The above term has been defined to facilitate implementation of CSR projects which are of a long term nature with a gestation period extending beyond a financial year.The project shall be subject to completion in a time frame of three financial years excluding the year in which it is commenced .It will also include a project which was originally not approved as a multi-year project but whose duration has been extended by the Board for justifiable reasons.
F. Implementation of CSR Projects - Mode of Implementation - Rule 4
Rule 4 sets out the manner in which a CSR project can be implemented by a company.
The following may be noted:
i) The project can be implemented either directly by the company or through a company set up under Section 8 of the Act or by a registered public trust or Society which has obtained registration under Section 12AA or Section 80 G of the Income Tax Act, 1961 .The entity set up under Section 8 or as a society may be set up either by the company itself or in collaboration with another company or .
ii) through a Section 8 company or a registered Trust or Society set up by the Central Govt. or State Govt.or
iii)through a company established under section 8 of the Act, or a registered public trust or a registered society, registered under section 12A and 80G of the Income Tax Act, 1961, which has an established track record of at least three years in undertaking similar activities.
G. Registration of Entity through which CSR Projects are proposed to be implemented
Rule 4(2) sets out that every entity through whom the CSR Projects are proposed to be carried out shall register itself with the Central Govt. For this purpose it has to file Form CSR-1 electronically with effect from April, 1, 2021.
To enable entities which are already in the process of carrying on activities to continue undeterred it is provided that the projects undertaken prior to April,1,2021 shall not be affected by the requirement of obtaining registration.
Upon submission of the form CSR 1 ,a unique CSR Registration Number shall be generated automatically.
H. Capacity building through International Organizations
Rule 4(3) envisages that a company may engage international organizations for designing , monitoring and evaluation of its CSR projects as also for capacity building of its own personnel for the CSR Projects.
I) Taking up CSR Projects in collaboration with other companies
Under Rule 4(4) a company may carry out CSR Projects in collaboration with other companies .this should be done in a manner which enables each of the companies to report on such projects to the Board/Committee as per the rules.
J. Board to satisfy itself as to end-use of CSR funds
It shall be the responsibility of the Board to satisfy itself that the funds disbursed for the CSR initiatives have been used up properly in line with the approval granted by it. The CFO of the company will have to provide an assurance to the Board as to end use of the resources.
By way of good secretarial practice it is recommended that such assurances be provided to the Board/Committee once in every six months.
K. Monitoring of ongoing projects
Rule 4(6) provides that the board shall monitor the progress of the ongoing projects, ensure that the approved timelines are being maintained and the funds properly used vis-à-vis yearly allocations. Where necessary , the Board shall be competent to make modifications to the project to ensure smooth implementation of the projects within the overall approved time lines.
L. Responsibilities of the CSR Committee
Rule 5 of the amended Rules provide that the CSR Committee shall shoulder the following responsibilities:
i) Formulate and recommend to the Board an annual action plan in terms of its CSR Policy which shall consider the following aspects:
· List of the projects or programmes that are approved to be undertaken in areas or subjects specified in Schedule VII.
· The manner of execution of such projects or programmes.
· The modalities for utilization of funds and implementation Schedules for the projects or programmes.
· The monitoring and reporting mechanism which has to be followed in respect of the various projects or programmes.
· The details of the need and impact assessment , if any, in respect of any of the projects undertaken.
· Based on the recommendations made by the CSR Committee, the Board shall alter the plans in respect of any of the activities with a proper justification therefor.
M) Omission of rule 6 in the existing rules
Rule 6 in the erstwhile rules which provided for the inclusion of specific contents in the CSR Policy has been omitted in as much as the requirements of the said Rule have been dove-tailed into the other rules as enumerated above.
N. CSR Expenditure.
Rule 7 in the existing rules has been substituted to consider the following aspects:
i) The Board shall ensure that administrative overheads as defined in the Rules and elucidated above is capped to a limit of five percent of the CSR expenditure for the year.
ii) CSR projects of a company may sometimes yield surpluses such as sale of rural artifacts,handicrafts etc.If the income earned from such activities yield a surplus over the expenditure incurred, the surplus thereof shall not form a part of the business profits of the financial year and shall have to be ploughed back into the same project or transferred to the unspent CSR Account and spent in accordance with the CSR policy. If none of the above is done , the surplus can be transferred to the fund specified in Schedule VII and such transfer shall be made within six months from the close of a financial year.
iii) Provision for Set off against excess spends
By far this provision is the biggest takeaway for Corporate Inc, arising from the amendments made.We have articulated on the above elsewhere in this exposition and for the sake of brevity would not like to reiterate the submission-brevity being the soul of the wit.
iv) Creation/Acquisition of Capital assets
The CSR funds maybe used by the company for the creation or acquisition of a capital assets. Such assets maybe held by the company set up under Section 8 of the Act or the Registered public Trust or Registered Society which is the launch vehicle of the company in respect of its CSR initiatives.The entities stated above should possess a CSR Registration number
The capital assets can also be held by the beneficiaries of the project in the form of self- help groups, collectives and other entities.
The assets can also be held by a public authority.
Where it comes to capital assets which have been acquired prior to the coming into force of these Rules, these shall be transferred to the Entities referred to above within a period of 180 days from the date of commencement of these Rules. If such transfer is not possible within the stipulated timeline, an extension of ninety days shall be provided within which the transfer shall be effectuated with the approval of the Board based on reasonable justification.
O. CSR Reporting
Rule 8 as substituted provides for the following:
· The Board’s Report for any financial year shall contain an Annual Report on CSR incorporating particulars as laid down in Annexure I or Annexure II as the case maybe, to the rules.
· As a foreign company also comes within the ambit of Section 135 subject to it meeting the thresholds prescribed, the Balance Sheet filed by the company pursuant to Section 381 of the Act shall contain an Annual Report on CSR incorporating the information set out in Annexure I or Annexure II as the case maybe.
· Impact assessment of CSR Projects
Rule 8(3) sets out a new requirement in terms of which those companies which have an average CSR obligation of rupees ten crore or more based on the immediately preceding three financial years should carry out through an independent agency an impact assessment of its CSR Projects which have an outlay of Rupees one crore or more and such study should be undertaken in respect of those projects which have been completed not less than one year before undertaking the study. The Reports of such assessments shall be placed as an annexure to the Board's Report on CSR for the year.
Where a company has undertaken such an impact assessment, it shall be allowed to book an expenditure towards CSR for that financial year which shall not exceed five percent of the total CSR expenditure for that year or rupees fifty lacs whichever is lower.
P. Display of CSR activities on the company’s website
Rule 9 as substituted places the onus on the Board of the company to mandatorily display on its website the following information:
i) Composition of the CSR Committee.
ii) The CSR policy as approved by the board
iii) Projects as approved by the Board.
Public access shall be provided in respect of the above information.
Q. Transfer of unspent CSR Amount
Rule 10 as substituted provides that the unspent amount towards CSR shall be transferred where the amount is not being used for any specific project to a fund specified in Schedule VII. Until such time a dedicated fund is set up , the unspent amount can be transferred to any of the funds as stated in the Schedule.
We have covered the entire gamut of changes that have been brought about to the CSR provisions as also through the amended rules in this exposition. What is conspicuous in the changes is the fact that there shall be greater transparency in so far as reporting on CSR is concerned. The provision of the facility of set-off against excess funds is a welcome measure. The need for carrying out an impact assessment is most relevant , given the fact that a company ought to know the impact of its projects on the targeted population and the areas covered. As they say, "the proof of the pudding lies in its eating".
Yet another submission that shall be worthwhile is that now that the entire canvass of the subject has been revisited with newer avenues being carved out, it is expected that the MCA shall not tinker with the provisions, at the drop of a hat as it has been the case in the past. The removal of the provisions relating to prosecution for non-compliances is yet another watershed towards creating an environment which is conducive towards encouraging voluntary compliance.
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