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Penal Provisions for Defaults in CSR Compliance

CSR Compliance

Penal Provisions for Defaults in CSR Compliance

Parliament recently approved and passed the Companies (Amendment) Bill, 2019, which was meant to amend the 2013 Companies Act. This Act comprised of a variety of provisions and guidelines, which included, among other things, the laws associated with CSR or Corporate Social Responsibility.

Any company which met any of the following criteria would fall within the ambit of CSR. Some of these criteria have been listed below:

  • The company must have a net worth of at least ₹500 crore.
  • It must alternatively have a turnover of more than ₹1,000 crore.
  • It must have a net profit per year of ₹5 crore or more.

A company which met one or more of these benchmarks would have to contribute a minimum of two percent of the net profit earned in the three preceding financial years to activities deemed “socially important” under the Companies Act.

The new 2019 Amendment Bill has fundamentally altered the nature of CSR in this country. The amendments have also ensured that companies that refuse to abide by CSR regulations risk criminal charges and the associated liability.

Broadening the Base for CSR in India

Section 135 of the Companies Act mandates that any company that meets the basic criteria to fall within the ambit of CSR must constitute an internal CSR Committee, which would be responsible for ensuring that the business has done everything in its power to honourably discharge its duties under CSR in accordance with the provisions of the Companies Act.

The CSR Committee constituted by the company must also choose any of the activities prescribed by the government in the Companies Act (Schedule VII). The average net profits earned in the three preceding financial years would be used to calculate the minimum amount of money to be spent on CSR activities by the business.

This provision was often a cause for dispute, in cases when a company which had not yet completed three whole years in the market, could nonetheless be qualified as a CSR company due to metrics such as turnover or net worth.

The amendment brought about by the new Bill has tried to resolve this problem by creating a separate provision for companies which qualify via some metrics to undertake CSR activities but are yet to complete three financial years of existence. In such cases, the amount to be spent on CSR activities by the company will be calculated on the basis of profits earned in the last financial year/years.

Hence, if a company that has only existed for two years crosses the minimum threshold for CSR spending, then the amount it needs to spend will be calculated on the basis of profits earned during the last two financial years. If the company had existed just for a single year at the time of triggering the CSR thresholds, then the amount would be calculated on the basis of profits earned during that first year itself.

Financial Outflow for CSR

According to the original law, if a company was unable to spend the entire amount allotted during a single year for CSR (approx. 2 percent of profits), then the remaining sum of money would have to be carried forward into the next year for similar, socially beneficial activities.

However, such carrying forward was not considered to be mandatory, as companies were not bound by law to spend the entire CSR amount, as long as they declared in their annual report exactly why they had failed to wholly spend the money allocated for CSR.

Under the newly amended Companies Act, a company which has failed to spend the whole CSR amount within a particular financial year will have to transfer the leftover money to a fund within six months of the next financial year. The functions of this fund have been specified under Schedule VII of the Act.

If, on the other hand, the unspent amount was set aside for an ongoing CSR project, then that leftover money will have to be relocated to the ‘Unspent Corporate Social Responsibility Account’, instead.

The definition of an ongoing project – and what can be classified as such – will be decided by the central government. The money in this account cannot sit idle, however, as it will have to be used for the ongoing CSR project within three years or less from the time of the transfer.

Carrying Forward Leftover CSR Funds

If there’s still any leftover money in the Unspent CSR Account after three financial years, then this money will be transferred to the Fund. The government can, of course, pressurize a company to increase its spending by raising the bar for what qualifies as an ongoing CSR project, thus preventing the transfer of funds to the Unspent CSR Account.

The flexibility that companies formerly enjoyed in terms of carrying forward any unspent CSR money have now been curbed to a significant extent. Moreover, companies that could have avoided CSR spending altogether (or to a great extent) by explaining in their annual reports the reason for such avoidance, can no longer take recourse to this provision. As a result, defaulting on CSR obligations has become much more difficult and risky for Indian companies.

CSR Compliance and Criminal Liability

No penalties had previously been imposed on companies for non-compliance in the matter of CSR allocations or projects, just so long as the business was able to cite reasons for its failure to comply. This, however, will no longer be the case after the implementation of the new Amendment Bill.

The Companies (Amendment) Bill, 2019, has brought into being a new provision under which a company can incur a monetary penalty in cases of non-compliance. The penalty will apply if:

  • The company fails to spend the stipulated CSR amount within one financial year
  • Does not transfer the unspent amount of money to a Fund under Schedule VII
  • Does not transfer it to the special ‘Unspent CSR Account’ for ongoing projects

If any or all of the above-mentioned events come to pass, then the company or business may incur a penalty of between ₹25 thousand (minimum) and ₹25 lakh (maximum).

Moreover, all officers of the company responsible for the default may have to face similar penalties. The officers may have to face imprisonment of up to three years, a fine of any amount between ₹50 thousand and ₹5 lakh, or both. The exact penalty will be decided depending on the particularities of the case in question.

This amendment constitutes a major shift in the stance of the government and the law vis-à-vis CSR for business entities. Earlier, companies had a choice between spending their allocated CSR amount or disclosing the reason for their failure to do so in the annual report. Now, the choice they face is much direr – they can either spend the amount or face legal penalties and repercussions.

Statistics Show Improved CSR Compliance

According to the new amendment, the government also has the right to ensure CSR compliance by issuing special (or general) directions to businesses and corporations. Statistics show, however, that over time, the CSR spending record of several companies has been improving.

The data also demonstrates that over the last five years, companies have gradually increased their CSR-related expenditure from seventy to ninety percent. 92 percent of the mandated CSR expenditure was spent by businesses and corporate bodies in 2018-19 alone.

For the longest time, the role of CSR was understood as being a voluntary social obligation undertaken by companies to enhance their ‘reputation capital’ in the market. The long-term impact of this stricter approach to the CSR policy is, therefore, yet to be seen.