companiess-act-2013

Notification of the rules for implementation of Sec 135 of the Companies Act

February 28th,2014

(This article is written by Mr.Krishnan Neelakantan – Managing Director, Samhita Social Ventures with inputs from Mr.Noshir Dadrawala –  Chief Executive, Centre for Advancement of Philanthropy and Mr.Pankaj Jain – Principal, Impact Law Ventures)

The government has notified the rules for implementation of Sec 135 of the Companies Act, which cover mandatory CSR obligations for companies. The notification specifies that the Act will take effect from 1st April, 2014. The final rules are broadly in line with the draft version put out for public comments in September 2013, though they do incorporate some amendments to Schedule VII of the Act.

The revisions to the definition of net profit and the flexibility arising from corpus funding is in favour of companies, though ambiguities persist in some key provisions –especially on the flexibility of boards to choose activities that can be considered in the CSR policy. Nevertheless, the notification is a big step forward since it formalizes a regulation that will significantly enhance resources available for addressing India’s social development challenges and guides companies on the framework within which they can engage in this effort from a regulatory point of view.

We present below our initial impressions on the rules, with particular focus on the changes from the draft rules and the primary issues that were raised by various stakeholders during our consultations with them over the past year.

Activities under Schedule VII

Schedule VII has been amended pursuant to government’s power under Section 467 of the Companies Act, 2013.  The amendment has led to addition of new focus areas, removal of a few activities and expansion or restriction in the scope of others.

For example, social business projects have been deleted from the list but there is no restriction on using for-profit entities for implementation of CSR activities. Any surplus earned through CSR activities (or interest earned on corpus funding) will, however, need to be ploughed back as additional CSR spend.

Some activities have been added, for instance, protection of national heritage, art and culture including restoration of buildings and sites of historical importance and works of art;promotion of sports, contribution to technology incubators within academic institutes and rural development projects. The Schedule also includes permits measures for the benefit of armed forces veterans, war widows and their dependents.

For some of the activities, the scope has been expanded. For instance, promotion of education has been expanded to include special education especially among children, women, elderly and the differently-abled and livelihood enhancement. But it also limits health related interventions to reducing malnutrition and promoting preventive health care projects.

There is some ambiguity around Board’s flexibility to choose CSR activities outside of Schedule VII. The wording in clause 2 (c) under “Definitions”, as given below, suggests that there may be flexibility to the Board to include activities beyond those mentioned in Schedule VII. However, subsequent clauses reiterate that activities should be restricted to those covered under Schedule VII.

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Distinction to be made with activities undertaken in the normal course of business
The rules mention that CSR activities will exclude those activities undertaken in the normal course of business of the company. Some more clarity on what ‘CSR activities’ could be deemed part of normal business would be useful, since some training, literacy related initiatives that are closely linked to companies’ businesses could be construed to fall in this category. The rules re-iterate that activities exclusively for the company’s employees will not be counted as CSR.

CSR as contributions towards politics and company employees

It is noteworthy that the rules offer clarity that political contribution shall not be considered as CSR activity. The rules re-iterate that activities exclusively for the benefit of company’s employees will not be counted as CSR.

Employee Volunteering

The expectation of the industry to permit the time-value of the contribution of personnel towards CSR has not been permitted. This means that actual spending by the company will only be considered as CSR and the value of service contributed will not be considered as a CSR activity.

2% applied on profit after tax (PAT)

The draft rules had considered PBT, whereas the final rules clarify that the calculation is based on PAT, offering relief to companies on the quantum of spend required (this could also be recognition of the reality that there will be no tax break on such spending). The rules allow for adjustment for foreign branch profits, dividend from local companies, which is a relief for large groups and companies for substantial foreign operations. It appears that profits for past years (until FY2013-14) will, however, not be subject to these adjustments.

Foreign companies – branch/project offices covered as well

Foreign companies having a branch office or project office in India will also need to comply with the CSR requirements if they fall within the criteria under Section 135.This may result in a larger number of entities being covered under the CSR law.

Compliance requirement even in years when financial thresholds are not met

Beyond FY2014-15, even if a company falls below financial criteria for compliance with Sec 135 in a particular year, it will be exempt from the provisions of Sec 135 only if it is out of the bracket for three consecutive years.

CSR policy may need to be more detailed and specific

As per the rules, the company’s CSR Policy requires modalities of utilisation of funds and monitoring & reporting mechanism to be spelt out. There is some relief for private/unlisted companies that do not have independent directors on their Board, since they are now allowed to form CSR Committees with just two non-independent directors.

No specific cap on overheads within spending

The reporting template requires a breakdown of direct expenditure on the program versus overheads. It is not clear if consultants’ fees could be included within the program or will be treated as overhead. As of now, there is no limit set for overheads.

Cap on capacity building related expenditure

A cap of 5% of annual CSR expenditure for capacity building of personnel/implementing agencies by intermediaries has been set. Our impression is that this might cover activities such as training rather than implementation, M&E support, etc. There is a requirement for a three year track record for intermediaries and one would expect a significantly higher involvement of intermediaries in the initial years as the CSR program is being built-up.

Corpus funding: a relief for timeframes for rollout of programs.

CSR expenditure will include contribution to the corpus, so companies that operate through their foundations will not feel the pressure to scale-up their programs until they are convinced about the absorptive capacity in the system. Companies looking to implement through NGOs will, however, need to figure out the right partners early enough even if they would like to contribute to a corpus.

Non-compliance of CSR

The provision of ‘comply or explain’ in regards to the spending requirement remains unchanged.

With the notification of these Rules, it is hoped that companies will be better positioned to make strategic and program commitments for their CSR activities. Please write to us at [email protected] for any specific queries or to set up a conversation on the same.