Introduction
1.1.1 The Finance Act, 2014 has brought a very radical & far reaching amendment, as far as CSR expenditures are concerned.
1.1.2 There was a lot of expectation that as a corollary to the CSR related amendment in the Companies Act there will be a corresponding amendment in the Income Tax Act, 1961 allowing CSR expenditures as deductions under section 37.
1.1.3 On the contrary the Finance Act has proposed that CSR expenditure shall not be allowed as expenditure under section 37 of Income Tax Act, 1961. However, any CSR expenditure which is allowed as deduction under other sections such as section 30, 32, 35, 35AC, 80G etc. is permissible.
1.1.4 Now the tax treatment will be different for various types of permissible CSR activities. If the company directly undertakes CSR expenditures there will be no tax benefit, therefore, to spend 2% of CSR the company may lose the tax benef its available otherwise.
1.1.5 If the company undertakes CSR expenditures through 80G registered NGOs (including its own foundation) then to spend 2% of CSR the company shall have some tax benef it as such contribution provide 50% tax benef it.
1.1.6 Further, if a corporate undertakes CSR activities thr0ugh Institutions registered under sections 35CCA, 35AC, 35CCC, 35CCD of the Income Tax Act, 1961 or through funds like Prime Minister Relief Fund, National Defence Fund having 100% tax benef it under section 80G then it will get 100% tax advantage therefore, Corporates would be more inclined to fund through such mode.
1.1.7 Further, if a corporate undertakes CSR activities thr0ugh Institutions registered under sections 35 for scientif ic research or social research then it may get 125% to 175% tax advantage and will be most advantages for CSR, but the choice of activities will be reduced and the money will go towards research and not towards direct f ield level programmes.
Status Before Companies Act, 2013 & Finance Act, 2014
1.2.1 Before Companies Act, 2013 and Finance Act, 2014, the expenditure on CSR was not mandatory and there was no direct provision under Income Tax Act dealing with CSR expenditure.
1.2.2 Therefore all the voluntary expenditures incurred on CSR were claimed either u/s. 35(2AA) or 35AC or under Section 80G of the Income Tax Act and in most of the cases the CSR expenditures were claimed to be allowed u/s. 37(1) of the Income Tax Act, 1961.
1.2.3 However after Companies act 2013 CSR expenditure became mandatory and the tax treatment of CSR spends became contingent upon the Income Tax Act, 1961 and amendments thereof.
1.2.4 Hence, there was a lot of expectations from the Finance Act, 2014 and everybody expected that the CSR expenditure shall be allowed fully as it becomes a legal obligation/charge against income because of being mandatory in nature.
Section 37 and CSR Expenditures After Finance Act, 2014
1.3.1 On the contrary the Finance Act, 2014, instead of providing for a separate section for allowability of CSR expenditure, proposed that CSR expenditure shall not be allowed as expenditure under section 37 of Income Tax Act, 1961. However, any CSR expenditure which is allowable as deduction under other sections such as section 30, 32, 35, 35AC, 80G etc. is permissible.
1.3.2 The Finance Act, 2014 inserted a new Explanation in sub-section (1) of section 37 clarifying that for the purposes of sub-section (1) of the said section, any expenditure incurred by an assessee on the activities relating to Corporate Social Responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession. This amendment will take effect from 1st April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent years. The amended provisions are as under:
13. In section 37 of the Income-tax Act, in sub-section (1), the Explanation shall be numbered as Explanation 1 thereof and after Explanation 1 as so numbered, the following
Explanation shall be inserted with effect from the 1st day of April, 2015, namely:—
“Explanation 2.—For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.”.
1.3.3 This amendment is a great set back and may defeat the real purpose of bringing CSR related amendments in the Companies Act, 2013. A corporate will now be motivated to contribute to those statutory funds where 100% deduction is available or to organisations registered under section 35 or 35AC of the Income Tax Act.
Clarification regarding Expenses under Other Sections
1.4.1 The amendment to section 37 by Finance Act, 2014 has been supported by an explanatory circular which clarif ies that expenditures under other sections i.e. section 30 to 36 of the Income Tax Act shall be permissible. The text of the circular is provided in Annexure 1. The relevant portion of the circular is as under:
CIRCULAR NO.1/2015 [F.NO.142/13/2014-TPL], DATED 21-1-2015
13. Corporate Social Responsibility (CSR)
13.1 Under the Companies Act, 2013 certain companies (which have net worth of Rs.500 crore or more, or turnover of Rs.1000 crore or more, or a net prof it of Rs.5 crore or more during any f inancial year) are required to spend certain percentage of their prof it on activities relating to Corporate Social Responsibility (CSR). Under the existing provisions of the Income-tax Act, expenditure incurred wholly and exclusively for the purposes of the business is only allowed as a deduction for computing taxable business income.
13.2 CSR expenditure, being an application of income, is not incurred wholly and exclusively for the purposes of carrying on business. As the application of income is not allowed as deduction for the purposes of computing taxable income of a company, amount spent on CSR cannot be allowed as deduction for computing the taxable income of the company. Moreover, the objective of CSR is to share burden of the Government in providing social services by companies having net worth/turnover/prof it above a threshold. If such expenses are allowed as tax deduction, this would result in subsidizing of around one-third of such expenses by the Government by way of tax expenditure.
13.3 The provisions of section 37(1) of the Income-tax Act provide that deduction for any expenditure, which is not mentioned specif ically in section 30 to section 36 of the Income-tax Act, shall be allowed if the same is incurred wholly and exclusively for the purposes of carrying on business or profession. As the CSR expenditure (being an application of income) is not incurred for the purposes of carrying on business, such expenditures cannot be allowed under the provisions of section 37 of the Income-tax Act. Therefore, in order to provide certainty on this issue, said section 37 has been amended to clarify that for the purposes of sub-section (1) of section 37 any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to have been incurred for the purpose of business and hence shall not be allowed as deduction under said section 37. However, the CSR expenditure which is of the nature described in section 30 to section 36 of the Income-tax Act shall be allowed as deduction under those sections subject to fulfillment of conditions, if any, specif ied therein.
13.4 Applicability:—This amendment takes effect from 1st April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent years.
Overview of the Tax Implications of CSR expenditure after Finance Act, 2014
1.5.1 The only impact due amendment in Finance Act is specif ically providing for that the CSR expenditure will not be allowed u/s. 37(1) of the Income Tax Act though CSR expenditure can be claimed as deduction in other sections like section 30, 31 32 of the Income Tax Act or u/s. 80G.
1.5.2 The basis of allowability of CSR expenditure u/s. 37(1) of the Income Tax Act, 1961 before Finance Act, 2014 : Historically it is well established by various judicial pronouncement that the CSR expenditures were allowed u/s 37 (1) of the Income tax act, 1961, only on the background that these expenditures were considered to be for the purpose of business or for advancement of the business of the assessee.
However Rule 4 of CSR Rule specifically provides that CSR activities will not include any activities undertaken in pursuance of normal course of business and therefore, to constitute a valid CSR expenditure, the expenditure cannot be in relation to or for advancement of businsess of the company.
Under this background the amendment in the Finance Act, 2014 seems to be clarif icatory in nature as expenditure can be allowed to be deducted u/s. 37(1) only when it is incurred for the purpose of business.
1.5.3 Priority may shift to tax saving rather than need based CSR expenditure : CSR being a statutory requirement should have been treated as a valid charitable expenditure, otherwise it would be big disincentive to the Companies. Moreover, if the Income Tax regulations don’t provide similar tax treatment to the various types of CSR expenditures or various modes of CSR expenditures, then the company would be motivated to undertake only those CSR activities or undertake CSR through modes under which they get maximum Tax benef its. For instance, Prime Minister Relief Fund, National Defence Fund or organisations notif ied under Section 35 or 35AC or 80G. Such organisations provide 100% tax benef it. It may be noted that only few organisations such as Prime Minister Relief Fund, National Defence Fund provide 100% benefit under Section 80G however, only 50% benefit is available to the donor in case of other NGOs registered under section 80G. Hence the present tax provisions of differential tax statement of CSR expenditure may shift focus of the company to have a CSR policy on the basis of tax eff iciency rather than need based CSR policy.
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