June 12, 2020
Impact of Proposed Amendment to Corporate Social Responsibility Norms
The Draft CSR Rules propose to develop and expand the available mechanisms for corporate participation in addressing societal issues, thereby strengthening the corporate social responsibility regime in India…
Development of Corporate Social Responsibility in India
Historical Overview
Corporate social responsibility is based on the concept that corporations act as partners in the social development process of the country. The idea of Corporate Social Responsibility (“CSR”) developed in India during economic liberalization and increased in popularity during the early 2000s, when multi- national companies set up business in India.1 The Indian Ministry of Corporate Affairs (“MCA”), took initial regulatory steps to promote CSR by drafting the Corporate Social Responsibility Voluntary Guidelines, 20092, and National Voluntary Guidelines on Social, Environmental, and Economic Responsibilities of Business, 20113 (“Guidelines”). The Guidelines inter alia provided that companies should undertake activities for economic and social development of communities and geographical areas, particularly in the vicinity of their operations. However, the Guidelines were voluntary, and saw limited implementation. Subsequently, CSR was made a mandatory obligation under the Companies Act, 2013 (“Act”), to make it an integral part of business philosophy.
Present Framework
At present, CSR is governed by Section 135 of the Act read with the Companies (Corporate Social Responsibility Policy) Rules, 2014 (“Rules”), as amended from time to time (together, the “Framework”). Under the Framework, companies which meet certain thresholds4 must mandatorily spend a prescribed amount towards CSR, in accordance with a clearly formulated CSR Policy. The funds are required to be spent in certain focus areas specified in Schedule VII to the Act, including, inter alia, eradication of hunger, promotion of education, protection of national heritage, and rural development.
Proposed Reforms
In order to further capture the essence of CSR, a High Level Committee on Corporate Social Responsibility submitted its Report on CSR (“Report”) to the Union Minister of Finance and Corporate Affairs on August 7, 2019. The Report made recommendations for improvement of efficacy and accountability of CSR activities. Following the release of the Report, the MCA had recently released the draft Companies (Corporate Social Responsibility Policy) Amendment Rules, 2020 (“Draft Rules”) for public comments.5 The Draft Rules, based partially on the Report, are intended to operationalize the provisions governing corporate social responsibility (“CSR”) under the Companies (Amendment) Act, 2019 (“2019 Act”)6. This article examines the major changes proposed by the Draft Rules and analyzes their impact on CSR in India.
Overview of the Draft Rules:
It has been welcome to note the revised definition of CSR which is more progressive and inclusive but at the same time it also permits CSR spend by the Companies on the projects exclusively to the benefit on certain percentage of its employees which is indeed debatable (discussed in detail later). The focus of the Draft Rules is to improve accountability of companies, streamline implementation of CSR activities, improve board oversight in CSR spending, and provide greater flexibility for deployment of funds towards CSR activities. The key amendments proposed by the Draft Rules are as follows:
- Changing the entities which can be implementing agencies for CSR–Registered trusts and societies will no longer be considered eligible implementing agencies for CSR activities, and only a company established under Section 8 of the Act or an entity established under an Act of Parliament or a State legislature, may be an eligible implementing agency for CSR.
- Introduction of International Organizations – Companies may now engage International Organisations7 for designing, monitoring, and evaluation for CSR projects, as well as capacity building of a company’s personnel for CSR; further, international organizations will also be allowed as implementing agencies, subject to prior Central Government approval.
- Introducing the concept of ongoing projects and enabling flexible funding – Companies may now engage in multi-year CSR projects, known as ongoing projects, and can fund them in the manner prescribed in the Draft Rules. There was no provision for the same in the Framework.
- National Unspent Corporate Social Responsibility Fund – The Central Government will create a National Unspent CSR Fund, into which companies will need to mandatorily deposit the unspent funds earmarked for CSR, within timelines prescribed under Section135.
- Increasing board engagement – The board will now have a more active role in overseeing usage of funds disbursed for CSR. It will now have to satisfy itself that the funds disbursed for CSR are being utilized as directed, and the CFO or person responsible for financial management will have to certify to this effect.
- Introduction of Impact Assessment–It is proposed that now, companies with CSR spending above a particular threshold, will be required to carry out impact assessment of their CSR activities and disclose details of the same in their Annual Report on CSR.
- Changes in modalities of CSR expenditure– The assets acquired or created by companies in pursuance of CSR, can no longer be held by such companies, and must be transferred to companies established under section 8 of the Act having charitable objects or a public authority8, within the prescribed timelines.
- Changed definition of CSR – The earlier definition of CSR stated that activities carried out solely for the benefit of a company’s employees and their families, would not be considered CSR. However, it is now proposed that if such activities have less than 25% (twenty-five percent) employees as its beneficiaries, then it would constitute CSR.
Analysis of the Proposed Amendments
This article thematically analyzes the amendments proposed under the Draft Rules, and their impact on the CSR Framework in India, under three broad heads, namely: (i) Implementation; (ii) Accountability; and (iii) Funding. The article also analyses the implications of the change in the definition of CSR.
Implementation
In India, most companies did not (and still do not) have the financial wherewithal to undertake CSR activities on a standalone basis. Therefore, when the Framework was initially implemented in 2014, it was permitted for companies to either jointly or singly, undertake CSR activities on their own or with the aid of certain implementing agencies.
Under the Framework, implementing agencies could be registered societies/trusts or a company with charitable objects (“Section 8 Company”), whether established by the company(ies) themselves or established by the Central/State Government or through an entity established under an act of Parliament or State legislature (each an “Eligible IA(s)”). The Draft Rules retain the concept of Eligible IAs in CSR, with some important changes. The Draft Rules propose that registered trusts and societies be removed from the list of Eligible IAs, and that International Organizations be included as Eligible IAs, subject to prior government approval.9
The reasons for removal of registered societies/trusts from the list of Eligible IAs arise from the Report, which noted that there is no direct mechanism to cross-check CSR activities carried out by registered trusts and registered societies, as they fall outside the regulatory purview of the Companies Act, 2013. However, these changes are prospective in nature, and would not affect programmes that were approved prior to the Draft Rules coming into force.
Additionally, the Draft Rules also propose to allow International Organisations, to monitor, design and evaluate CSR programmes. Accordingly, all implementing agencies would henceforth be organized either as a Section 8 Company or entity established under an Act of Parliament or a State legislature.
The proposed amendments under the Draft Rules, would increase the checks and balances in an under- regulated sector. Further, the inclusion of International Organizations will also bring best practices to CSR, as well as an international footprint and proven record of delivery to thesector.10
However, the Draft Rules have also deleted a provision which allowed companies to undertake CSR through societies/trusts or companies with charitable objects, even other than Eligible IAs, if these trusts, societies or Section 8 companies had a previous track record of at least three (3) years in similar programmes or projects [emphasis supplied].
The removal of the track record requirement is likely to have a mixed impact, and it appears that this removal has been effected to accommodate existing societies and trusts which will convert to newly incorporated Section 8 Companies, so that they remain Eligible IAs pursuant to the Draft Rules. The number of new implementing agencies in the CSR sector will see a decided increase. However, since new implementing agencies no longer need to have a track record, the quality of services provided by these new entrants will have to be carefully scrutinized by companies, before appointing them as an Eligible IA.
Accountability
Since the Framework was fairly recently enacted in 2014, the requirements for companies were, by design, less onerous to encourage the adoption of CSR in India. Under the Framework, each company which was required to undertake CSR had to constitute a CSR Committee whose role was, inter alia, to prepare a transparent monitoring mechanism for the projects undertaken by the company. However, the Report recommended that with the maturing of CSR in India, the role of the CSR Committee and the board be expanded. Accordingly, the Draft Rules have proposed to make Rule 4 (CSR Activities) & 5 (CSR Committees) of the Rules, wider in scope; and omit Rule 6 (CSR Policy).
Under the proposed amendments, the CSR Committee will not only be required to constitute a transparent monitoring mechanism, but also recommend a comprehensive action plan to the board, pursuant to the CSR Policy. The action plan would include, inter alia, the list of projects, their manner of execution, the modalities of fund utilization and implementation schedules, monitoring mechanism, and details of impact assessment, if required.11
The board has been given a greater role under the Draft Rules12. The board would now need to satisfy itself that the funds disbursed for CSR have been duly utilized as it was intended, and will also have the authority to make modifications to ongoing projects (refer to Funding below), for their smooth implementation. The proposed provisions additionally require the CFO or a person responsible for financial management to certify the usage of funds. The Draft Rules also highlight that for companies with a CSR spend of over INR 5 Crore (approx. USD 660,000) on average over the past three financial years, a detailed impact assessment would be mandatory. The Draft Rules propose that a company which is required to do an impact assessment can spend upto 10% (ten percent) of the total CSR expenditure in a financial year as administrative overheads, as compared to other companies, which may spend only up to 5% (five percent) of the CSR expenditure as overheads.
The focus of the government has clearly shifted from increasing the adoption of CSR by companies, to now ensuring its impact on the beneficiaries. The proposed requirement of certification by CFO will increase scrutiny and reduce the probability of leakages. Further, the need for an impact assessment for large CSR projects, will ensure that actual value addition is being delivered as a part of the projects.
Further, the Draft Rules propose, that if a company develops a capital asset during the course of CSR activities, then such asset shall be held not by the company itself, but by a Section 8 company or a public authority. The Draft Rules give existing companies a period of 180 (one hundred and eighty) days, extendable for a further 90 (ninety) days subject to reasonable justification, from the commencement of the Draft Rules to comply with the requirement.
The requirement of having a Section 8 company hold such a capital asset, is a positive step from a corporate governance perspective and will reduce the chance of the company misusing such capital assets. All of these operational improvements will minimize the chances of funds or assets relating to CSR, being diverted for other purposes.
Funding
The Framework as it exists now, features a comply-or-explain model for failure to spend CSR funds. Under the Framework, if a company fails to spend the funds earmarked for CSR in a particular financial year, an explanation would have to be made in the board’s report to the shareholders, specifying the reason for such failure.
However, the Report analyzed CSR trends since their introduction, and suggested that there was a greater need to allow flexibility in spending on CSR projects. The Report observed that this flexibility
was important to increase the impact of CSR on beneficiaries. Accordingly, the Draft Rules read along with amendments to Section 135 made pursuant to the 2019 Act, make significant changes to the funding mechanisms and permissible duration for CSR activities.
A major change is the proposed insertion of subsections (6), (7) and (8) to Section 13513 and of Rule 10 to the Rules, which provides for differential treatment CSR funds earmarked for short term (i.e., limited to one financial year) and ‘on-going’ activities.
The 2019 Act proposes that if the funds earmarked for CSR activities remain unspent, then they shall be transferred to a fund specified under Schedule VII to the Act, within six months from the expiry of the financial year for which the funds were earmarked.14
However, it makes a special provision for an ‘ongoing project’, that is, a multi-year project, not exceeding three years, excluding the financial year in which it was commenced. In case of ongoing projects, unspent funds earmarked for one financial year must be transferred to an ‘Unspent Corporate Social Responsibility Account’, to be opened by the company with a scheduled bank, within thirty days from the end of the financial year. If such funds remain unspent for three financial years from the date of transfer, they shall be transferred to a fund specified under Schedule VII to the Act, within thirty days from the end of the third financial year, until the Central Government establishes an exclusive fund for this purpose, to be called the ‘National Unspent Corporate Social Responsibility Fund’. Further, the Draft Rules now expressly state that surplus from a CSR project will be ploughed back into the same project or be transferred to the Unspent Corporate Social Responsibility Account, and spent in accordance with the action plan of the company.
Now, for ongoing projects, the board can simply deposit unspent CSR funds in the ‘Unspent Corporate Social Responsibility Account’, and disburse those funds in a need based manner within three financial years from the date of such transfer, as described above. This provision will allow flexibility of funding of ongoing projects, minimize front-loading or back-loading of ongoing projects, and ensure consistent financial support during the project life-cycle. Overall, this would increase the diversity of projects that can be undertaken by companies and create long term value for stakeholders. It will also change the nature of general CSR programs that companies undertake, and together with the introduction of International Organizations as implementing agencies, will introduce diversity in the CSR activities undertaken by Indian corporates. However, given the regulatory and logistical hurdles to project execution in India, and the beneficial intent of the Draft Rules, it may be advantageous to extend the timeframe of ‘ongoing projects’ beyond the proposed three years, and grant authority to the companies to determine the timeframe, in accordance with their financial capacity.
Changing the Definition of CSR: A possible misstep?
While most of the proposed amendments signify a maturing environment for CSR in India, but certain proposed changes as stipulated in Draft Rules should be scrutinized from the practical perspective prior to notifying.
One such change is to the definition of ‘corporate social responsibility’. This definition was quite wide earlier, and continues to be so, even under the Draft Rules. However, the earlier definition, prescribed that inter alia, activities that benefit solely the employees of the company and their families would not be considered corporate social responsibility for the purpose of Section 135 of the Act. Now, the Draft Rules proposes that any activity having less than twenty five percent employees as its beneficiary15, shall be considered corporate social responsibility.
The reason for this change is unclear, as this was not a recommendation of the Report. Additionally, the rationale behind a cap of 25% (twenty-five percent) is also not provided for. Further, employee related welfare measures can be regulated under labour laws, or through contract and capturing them again under CSR is debatable.
The aforementioned issues can potentially raise questions on real objective of CSR i.e. to achieve social objective or tilted towards the welfare of its employees.
Conclusion
It has been witnessed that any new legislation with time and after gathering experience has gone through different phases of evolution. The same has happened to CSR where it has grown from a voluntary guideline in 2009 to a mandatory obligation in 2014 but not fully matured. It has also been very encouraging to see the increasing level of maturity of the bankruptcy code16 since its inception.
Barring certain deficiencies, the Draft Rules largely are a step in the right direction for CSR in India. The increase of the board’s engagement, rationalized ownership regime of assets developed pursuant to CSR, and mandatory creation of an Unspent CSR Account, will all provide for greater accountability. The increased monitoring of Eligible IAs and mandatory impact assessment for companies with large CSR spend will likely improve governance and provide a welcome databank which will be instrumental for future policy formation. The inclusion of ongoing projects and flexible funding options made available to companies will help widen the CSR activities that may be undertaken by companies. The Draft Rules propose to develop and expand the available mechanisms for corporate participation in addressing societal issues, thereby strengthening the corporate social responsibility regime in India.
It can be reasonably assumed that numerous individuals and organizations would have offered their meaningful comments on Draft Rules and included the deficiencies indicated in this article. We are hopeful that government will continue to enable the concept of CSR evolve further by notifying theoretically and practically feasible rules governing CSR.
Authored by Amit Kumar, Partner and Aayush Sood, Associate, Shardul Amarchand Mangaldas & Co.
Disclaimer: The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Further, the views in this article are the personal views of the author.
1 Report of the High Level Committee on Corporate Social Responsibility dated August 7, 2019.
2 Available at https://www.mca.gov.in/Ministry/latestnews/CSR_Voluntary_Guidelines_24dec2009.pdf
3 Available at https://www.mca.gov.in/Ministry/latestnews/National_Voluntary_Guidelines_2011_12jul2011.pdf
4 Section 135 (1) & (5) of the Act provides that the board of every company having net worth of rupees five hundred crore or more, or turnover of rupees one thousand crore or more or a net profit of rupees five crore or more during the immediately preceding financial year, shall ensure that the company spends, in every financial year, atleast two percent, of the average net profits of the company made during the three immediately preceding financial years.
5 Available at http://feedapp.mca.gov.in/csr/pdf/draftrules.pdf
6 The Companies (Amendment) Act, 2019 was partially notified on July 31, 2019. However, certain provisions, including those which proposed changes to Section 135 of the Act, were yet to be notified.
7 “International Organization” means an organization notified by the Central Government as an international organization under section 3 of the United Nations (Privileges and immunities) Act, 1947 (46 of 1947), to which the provisions of the Schedule to the said Act apply.
8 Under Rule 2(i) of the Draft Rules, a “Public Authority” means ‘Public Authority’ as defined in sub-clause (h) of section (2) of Right to Information Act, 2005.
9 Rule 4 of the Draft Rules. Rule 4 also provides that each entity undertaking CSR must register itself with the government by filing Form CSR-1.
10 Para. 3.22 of the Report of the High Level Committee on Corporate Social Responsibility, August 7, 2019.
11 Rule 5 of the DraftRules.
12 Rule 4 of the DraftRules.
13 This amendment is yet to be notified.
14 This amendment is yet to be notified.
15 Rule 2(c) of the Draft Rules.
16 Insolvency and Bankruptcy Code, 2016