Corporate social responsibility, or CSR, which is currently voluntary, is likely to become mandatory once Companies Bill 2012 comes into force. Any company with net worth of Rs 500 crore or more, turnover of Rs 1,000 crore or more, or net profit of Rs 5 crore or more during a financial year will have to constitute a CSR committee.

The committee will formulate and recommend CSR policies to the board and monitor compliance. It appears that the low threshold on profit is deliberate, to ensure more companies contribute to CSR.

Companies Bill requires the board to ensure that in each financial year the company spends at least 2 per cent of the average net profit earned during the three preceding financial years. The average net profit will be calculated in accordance with clause 198. Interestingly, the Bill does not prescribe any specific penalty for non-compliance. Instead, the board is required to specify in its report the reasons for not spending the recommended amount. Details of penalty, if any, will be clear once the rules are notified. For public sector companies, the Guidelines on CSR for Central Public Sector Enterprises require rolling over the unspent amount to the next year.

Tax deductibility of CSR expenditure is an important issue. One argument is that the expenditure is in the nature of allocation of profit and, therefore, not deductible.

The counter-argument is that the company has a legal obligation to incur the expense, even though it is a percentage of net profit. Hence, it is not akin to distribution of profit, and should be allowed as deduction.

The Central Board of Direct Taxes should clarify on this.

From a financial reporting perspective, CSR expenditure will be treated as expense and not distribution of profit. However, it is not clear whether a company should create a provision in the financial statement if it fails to spend 2 per cent of profit on CSR in a certain year. The resolution of this issue may depend on the legal/ other consequences. For example, if a company can get away with an explanation in the board’s report, and need not make good the shortfall in future, there may be no need to create a provision. However, if the company has to incur the unspent amount in future, a provision in accordance with AS-29 may be needed.

Under Companies Bill, the CSR committee will comprise three or more directors, including at least one independent director. This applies irrespective of whether the company is a public or private entity. In contrast, the Companies Bill mandates only public companies, whether listed or in other prescribed class, to have independent directors.

A reading of both requirements suggests that though clause 149 does not require private companies to have independent directors, they may be required to have an independent director if they are covered under CSR requirements. The Ministry of Corporate Affairs should clarify this among other unresolved issues.

Vishal Bansal is a senior professional in a member firm of Ernst & Young Global

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