Allowability of Corporate Social Responsibility (CSR) expenditure under the Income tax Act

Introduction of CSR under THE Companies Act, 2013
CSR
is a concept that has been discussed substantially in business and
professional circles. There could be two views on whether an expenditure
of this nature should be voluntary or be mandated by legislation.
However, the discussion would now be academic as provisions in relation
to CSR are now incorporated under the Companies Act, 2013 (‘2013 Act’)
and Rules thereof. The Central Government through Ministry of Corporate
Affairs (‘MCA’) in order to achieve the aforesaid objective has issued
back to back notifications dated 27th February 2014 prescribing
applicability from 1st April 2014 of relevant provisions, schedules and
rules thereof under the 2013 Act concerning CSR.

Section 135,
Schedule VII to the 2013 Act and CSR policy Rules, 2014 (‘CSRP Rules’)
[hereinafter they are together referred to as ‘CSR provisions’] govern,
operate and determine the scope of CSR initiative for the companies.
Before discussing the topic of the article, namely the allowability/
deductibility of CSR expenditure under the Income Tax Act 1961, it would
be appropriate to deal with the guiding principles of CSR, its
applicability, features and scope thereof as enshrined under the 2013
Act and rules thereof.

Guiding Principles of CSR
The
MCA has listed the following guiding principles concerning CSR, which
helps one to understand the intention of the Legislature as regard to
CSR activity:

• CSR is the process by which an organisation
thinks about and evolves its relationships with stakeholders for the
common good, and demonstrates its commitment in this regard by adoption
of appropriate business processes and strategies;

• CSR is not charity or mere donation;

• CSR is way of conducting business, by which corporate entities visibly contribute to the social good;

• CSR should be used to integrate economic, environmental and social objectives with the company’s operations and growth; and

•
CSR projects/ programmes of a company may also focus on integrating
business models of a company with social and environmental priorities
and processes in order to create shared value

Features and Scope of CSR activities under 2013 Act and rules thereof

• CSR activities does not include the activities undertaken in pursuance of normal course of business of a company;

• CSR activities as undertaken within India by a Company will only qualify as CSR under the 2013 Act and rules thereof;

• CSR activities will have to be undertaken with preference to the local area and areas from where the Company operates;

•
Projects or programmes of CSR as undertaken by a Company should include
activities and/or subjects as mentioned in Schedule VII to the 2013
Act;

• Only activities which are not exclusively for the benefit
of employees of the Company or their family members shall be considered
as CSR activity;

• The CSR activities can be undertaken by the
company either through itself and/or through a registered trust or a
registered society or a company established under Section 8 of 2013 Act
by itself, its holding or subsidiary company, or otherwise subject to
compliance of conditions mentioned therein and a cap of maximum 5 % of
total CSR expenditure of the Company in one financial year;
• CSR activities can also be undertaken in collaboration with other companies with compliance of conditions mentioned therein;
•
Contribution of any amount directly or indirectly to any political
party u/s. 182 of the 2013 Act, shall not be considered as CSR activity;
and
• Any surplus arising out of the CSR activity will not be part of the business profits of the Company.

 Applicability of CSR provisions under the 2013 Act and rules thereof

CSR
provisions are not applicable to all persons but are restricted to
companies. The provisions of Section 135 of the 2013 Act further
restrict the said applicability to only selected companies who fulfill
the following conditions:

• A Company having net worth of Rs. 500 crore or more during any financial year; or
• A Company having turnover of Rs. 1,000 crore or more during any financial year; or
• A company having net profit of Rs. 5 crore or more during any financial year;

The
CSRP Rules further provide that the CSR provisions are applicable to
all companies including a holding, subsidiary company and foreign
companies having project office or branch office in India, provided any
of the aforesaid conditions are fulfilled by the said companies. As
regard to applicability to foreign companies, the aforesaid conditions
viz, net worth, turnover and net profit will have to computed and
determined in light of the relevant provisions of 2013 Act.

So,
if a Company satisfies any of the aforesaid conditions in any of the
financial years, then the CSR provisions are applicable to the said
company and will have to be follow them year on year. However, the CSRP
rules relax the rigors of CSR provisions, if a company does not fulfill
any of the said conditions for a continuous period of 3 financial years.
The provisions will then apply once again in the year a company crosses
any one of the above thresholds.

Consequences upon applicability of the CSR provisions

•
The Board of Directors (‘Board’) of the concerned Company will have to
form from amongst themselves a Corporate Social Responsibility Committee
(‘CSRC’) containing at least 3 directors [including 1 independent
director];

This requirement is relaxed by the CSRP Rules, to
take care of specific situations, namely, non-requirement of independent
directors in regard to particular companies, applicability of
provisions to private company, foreign company, etc

• The CSRC
shall formulate a framework containing Corporate Social Responsibility
Policy (CSRP) of the Company, amount to be spent qua the CSR activities,
monitoring and transparency in implementation of the said activities,
etc; and give recommendations to the Board accordingly;

• The
Board is required to approve the CSRP of the Company alongwith ensuring
that the activities under the CSRP are undertaken accordingly;

•
In addition, the Board will be required to ensure that at least 2% of
average net profits of the concerned Company during the immediately 3
financial years shall be spent as per the CSRP approved by the Board of
the Company; and

• The Board’ Report should contain disclosure
of composition of the CSRC, details of CSRP [should also be published on
website of the company], alongwith reporting of other details in the
format as prescribed under the CSRP Rules including the amount of money
which was not spent as per the requirements of CSR provisions on CSRP
with reasons thereof.

Schedule VII to the 2013 Act duly amended
prescribes list of 10 specific subjects and/or projects of CSR,
recognised as CSR activities, which a Company needs to consider under
its CSRP. The said CSR activities are explained in detail in the ensuing
paragraphs during the course of discussion of allowability of CSR
expenditure under the Income-tax Act, 1961

Allowability of CSR expenditure under the Income-tax Act, 1961

With aforesaid background in place, it would be appropriate to discuss the allowability of CSr expenditure under the income-tax act, 1961.
The MCA mentions that tax treatment of CSR spends will be in accordance with the income-tax act, 1961 (‘the act’) as may be notified by the Central Board of Direct Taxes [‘CBDT’]. The CBDT till date of writing of this article has not notified any tax treatment as regard to allowability of CSr expenditure under the act. the newspaper articles and reports also are highlighting concerns for allowabil- ity of CSr expenditure under the income-tax act, on the ground that said expenditure may not be allowed to the Companies, since it is not wholly and exclusively for the purposes of the business of the assessee companies.

An issue which then requires to be analysed is, when the MCA requires for specific tax treatment on CSR spends, there seems to be an underlying assumption and/or un- derstanding that the present provisions of the act do not provide for allowability of said CSr expenditure under the act. however, on proper perusal of the provisions of the Act, one may find that CBDT may not be required to notify separate tax treatment for CSR spends, since the present provisions provide for allowability of said spending under various provisions of the act irrespective of whether the said expenditure is incurred wholly and exclusively for the purpose of business of assessee companies.

A chart explaining the specific CSR activities as prescribed under Schedule VII to the 2013 Act and simultaneous provisions of the income-tax act, 1961 which provide for allowability of expenditure qua the specific CSR activities are tabulated below:

Section 372A of the Companies Act, 1956 contained several exemptions which have been done away with by section 186 of the act. the differences in the exemptions are as follows:

With the onset of the CSR provisions under the 2013 Act, the aforesaid provision now will have greater applicability in computation of profits and gains from business of the assessee companies under the provisions of the act, unless otherwise prescribed by CBdt.

A brief overview of the aforesaid provisions of the act alongwith relevant rules under the 1962 rules are dis- cussed herein below:

Section 35AC of the Act provides for deduction of expenditure incurred by way of payment by an assessee of any sum to a public sector company or a local authority or   to an association or institution approved by the national Committee for carrying out any eligible project or scheme. the said provision further provides that the assessee may either make payment aforesaid to the entities referred in above or either directly make payment of any sum to the eligible project or schemes. in other words, the provisions of section 35AC recognise the features of CSR provisions i.e., of allowing the Company to either make contribution to the eligible organisations/entities that undertake eligible projects or schemes and/or incur expenditure directly by itself on eligible projects or schemes. the eligible projects or schemes as referred in section 35AC are recommended under Rule 11K of the 1962 Rules. On perusal of Rule 11K, one may find that the significant guidelines of activities as recommended are in consonance to the subjects as prescribed under Schedule VII to the 2013 Act. the aforesaid chart tabulating the activities as prescribed under Schedule VII to the 2013 Act and the allowability of expenditure incurred on the said activities under the act confirms the said understanding.

The national Committee as referred in above is the nodal agency to provide approval to the organisation/entities who undertake eligible projects or schemes and/or to the eligible projects or schemes. the complete procedure as regard to composition of national Committee, its place of operation, functions of the said committee, guidelines for approval of organisation/entities and/or eligible project or schemes, application forms, audit reports for verification and procedure to be followed by the national Committee in granting approvals are documented in rule 11f to rule 11o of the 1962 rules and forms prescribed thereof. One may want to refer the said provisions and rules thereof for better understanding of the subject.

Similarly, the provisions of section 35(2AA), section 35CCA and section 80G alongwith relevant rules pre- scribed thereof may be looked into for further and better understanding of the subject.

In light of above, one may find that provisions of the Act have  long  recognised  the  CSR  initiative  and  provided benefits accordingly by allowing expenditure in computa- tion of income from business of the assessees or deduction otherwise. however, considering the said initiative was not mandatory in nature until CSR provisions under the 2013 Act, therefore, one may not have had contribu- tions made by the corporate sector to the subject.

Allowability of CSr Expenditure u/s. 37(1) of the Act

A question which requires further consideration, is in case if the specific CSR activities as covered under Schedule VII to the 2013 Act are not allowable under the provisions of the act as referred in above, then can the said CSR expenditure could be allowed u/s. 37(1) of the Act.

On perusal of features of CSr provisions as reproduced in earlier paragraphs, one may find that the said provisions allow for activities to be undertaken  which are in furtherance of business activities of the assessee company, however with limitations that said activity should neither be undertaken in normal course of business of the Company nor exclusively for employees of the Company and their family members. the said CSr provisions also mention that such expenditure should not be a charity and/or donation.

Recently, the Karnataka High Court in the case of CIT and Anr. vs. Infosys Technologies Ltd. (2014)(360 ITR 714), has opined that CSr expenditure which facilitates the business of the assessee is allowable u/s. 37(1) of the act. the relevant facts of the said decision are as under:

infosys technologies ltd (‘infosys’) has an establishment in Bannerghata Circle in Karnataka, where nearly 500 em- ployees are working. There was severe traffic congestion near the said establishment and therefore, the employees including the general public had to wait for a long time. the  said  congestion  seriously  affected  the  free  movement of public including employees of infosys. infosys as  a  Corporate  Social  responsibility  initiative  installed traffic signal near the establishment which otherwise was responsibility of the State. a question arose as regard to allowability of said expenditure u/s. 37(1) of the Act. The high Court held that the said CSr expenditure incurred by infosys could be said to be laid out or expended wholly and exclusively for the business u/s. 37(1) of the Act and therefore, is allowable, for want of following reasons:

•    The said expenditure facilitates the employees of Infosys for free movement and allows them to reach the office in time, which otherwise was affecting the business of Infosys on account of delay in reaching office and thereby resulting in delay in completing projects; and

•    The Court further noted that just because the general public other than Infosys was also benefited by the said expenditure shall not come in way of deduction of said expenditure u/s. 37(1).

In view of the above decision, one may find that the if the CSr activity is undertaken in advancement of business of the assessee, then the said expenditure could be allowed u/s. 37(1) of the Act.

in addition to above, reliance could be placed on the fol- lowing decisions, wherein Courts have time and again held that contribution made by the assessee company in public welfare funds which are directly connected or related with the carrying on the business or which results in benefit to the business has to be regarded as allowable deduction u/s. 37(1) of the Act:

•    Sri Venkata Satyanarayna Rice Mills Contractors Co. vs. CIT (223 ITR 101) (SC);

•    Addl. CIT vs. Rajasthan Spinning and Weaving Ltd.
(274 ITR 463)(Raj);

•    Mehsana District Co-operative Milk Producer’s Union Ltd. (203 ITR 601)(Guj);

•    CIT vs. Kaira District Co-operative Milk Producers Union Ltd. (247 ITR 314)(Guj.);

•    Krishna Sahakari Sakhar Karkhana Ltd vs. CIT (229 itr 577); and

•    Surat Electricity Co. Ltd. vs. ACIT (125 itd 227)(ahd) in the same vein and for the sake of completeness,    it would also be necessary to mention that in the following decisions, the Courts have either held against and/or remanded the matter on expenditure similar to CSR activity claimed for deduction u/s. 37(1) of the Act:

•    CIT vs. Madras Refineries Ltd. (313 ITR 334)(SC) – The Supreme Court was hearing a plea for allowability of ex- penditure u/s. 37(1) of the Act on the CSR activity of providing drinking water and sanitation to residents in the vicinity of factory of the Company. the apex Court remanded the matter to the tribunal for denovo consideration as it was found that neither the madras high Court nor the Tribunal concerned had given specific finding to the effect that said CSr expenditure is allowable as business expenditure.

The madras high Court had earlier allowed for deduction of aforesaid CSr expenditure with the following relevant findings:

“The concept of business was not static. It has evolved over a period of time to include within  its fold the concrete expression of care and concern for the society at large and the people   of the locality in which the business is located,  in particular. Being known as a good corporate citizen brings goodwill of the local community,   as also with the regulatory agencies and the society at large, thereby creating an atmosphere in which the business can succeed in a greater measurewith the aid of such goodwill.”

•    CIT and Anr. vs. Wipro Ltd. (360 ITR 658)(Kar) – Wipro ltd (‘Wipro’) had incurred expenditure on community development near its factory which was located in backward area and claimed as business expenditure. The Court specifically found that Wipro was not able to provide any supporting documents to substantiate its claim for community development which was claimed to be in the nature of religious funds, charitable institutions, social clubs or charity, etc. the Court held that for want of limitation of documents, the expenditure on community do not stand to test of commercial expedi- ency and therefore, said expenditure will not be allow- able u/s. 37(1) of the Act.

The relevance of documentation in allowability of expen- diture u/s. 37(1) of the Act was succinctly brought in the decision of apex Court in the case of CIT vs. Imperial Chemical Industries Ltd. (74 itr 17). the Supreme Court held that burden of proving that particular expenditure has been laid out or incurred wholly and exclusively for purpose of business is entirely on assessee.

Based on the above decisions, one may find that it is too early to carve out specific rules determining allowability of CSR expenditure u/s. 37(1) of the Act and the facts and circumstances of the respective cases shall determine the deductibility of said expenditure.

Lastly, it would also necessary to highlight that on perus- al of the CSR provisions of the 2013 Act, one also finds that during the course of implementation one may find that there are still some bottlenecks in its implementation with following questions remaining unanswered and/or no clarifications provided by the MCA on the said issues, which are as under:

•    Whether, contribution of at least 2% of average net profit as prescribed under CSR provisions, is mandatory? the CSr provisions do not provide any advisory to that effect except for requiring a mere disclosure alongwith  reasons  thereof  for  non-spending  of  CSr expenditure in the Board’s report;

•    Further, the definition of ‘average net profit’ is referred to in 2013 Act, whereas the CSRP Rules prescribes definition of ‘net profit’, which is not in consonance with the definition as referred in 2013 Act. One may recon- cile the said differences in definition with interpreting the ‘net profit’ definition only relevant to determine the applicability of CSr provisions, whereas ‘average net profit’ definition is relevant to determine the amount of CSR expenditure by a Company;

•    In addition, the guiding principles to CSR provide for not  considering  the  CSR  expenditure  as  donation  or charity, whereas Schedule VII to the 2013 Act itself provides for activities viz, contribution to PM National relief fund, contribution to technology incubators, etc, which supports the concept of donations given to said institutions; etc

It appears that it is possible to take view that the expenditure incurred on CSR activities as prescribed under the 2013 Act and Rules thereof may be allowed under the present provisions of the act and the CBDT may not be required to prescribe any separate tax treatment.