Corporate Social Responsibility

Note that the thresholds are alternatives. The word is "or", so a company crossing any one of them is covered. A company with a net worth of six hundred crore is caught although it made no profit at all.

And note the period. All three are measured during the immediately preceding financial year, words substituted for the original "any financial year", which had made the obligation permanent once triggered.

The proviso, inserted in 2018, fixes an impossibility. Where a company is not required to appoint an independent director under section 149(4), it shall have two or more directors in its Committee. Without it, an unlisted company with no independent director could not lawfully constitute a Committee at all.

Section 135(2). The Board's report under section 134(3) shall disclose the composition of the Committee.

What the Committee does: section 135(3)

The Committee shall:

• (a) formulate and recommend to the Board a Corporate Social Responsibility Policy indicating the activities to be undertaken by the company in areas or subject specified in Schedule VII;
• (b) recommend the amount of expenditure to be incurred on those activities; and
• (c) monitor the Policy from time to time.

The words "in areas or subject, specified in Schedule VII" were substituted in 2017. Before them the clause read "as specified in Schedule VII", and the change makes clear that the Schedule describes fields of activity rather than a closed list of projects.

What the Board does: section 135(4)

The Board shall:

• (a) after taking into account the Committee's recommendations, approve the Policy, disclose its contents in its report, and place it on the company's website in the prescribed manner; and
• (b) ensure that the activities included in the Policy are undertaken by the company.

Clause (b) is the operative duty. The Committee recommends and monitors; the Board must see that the work is actually done.

The two per cent: section 135(5)

The Board of every company referred to in sub-section (1) shall ensure that the company spends, in every financial year, at least two per cent of the average net profits of the company made during the three immediately preceding financial years, or, where the company has not completed three financial years since its incorporation, during such immediately preceding financial years, in pursuance of its Corporate Social Responsibility Policy.

Two figures must not be confused. The threshold in sub-section (1) looks at the immediately preceding financial year; the amount to be spent is two per cent of the average of the three immediately preceding financial years.

The words for a young company were inserted in 2017, so a company two years old averages over the years it has had.

First proviso: where the money should go. The company shall give preference to the local area and areas around it where it operates.

Second proviso: unspent money leaves the company. If the company fails to spend the amount, the Board shall, in its report under section 134(3)(o), specify the reasons; and, unless the unspent amount relates to an ongoing project under sub-section (6), transfer the unspent amount to a Fund specified in Schedule VII within six months of the expiry of the financial year.

Third proviso, inserted in 2020: set-off of excess. If the company spends more than required, it may set off the excess against the requirement of succeeding financial years, in such number of years and in such manner as may be prescribed.

The Explanation. For the purposes of the section, "net profit" shall not include such sums as may be prescribed, and shall be calculated in accordance with section 198.

So the same section 198 that fixes the base for managerial remuneration fixes it here, which is a point worth making because it means capital profits and revaluations do not swell the CSR obligation any more than they swell a director's commission.

Ongoing projects: section 135(6)

Any amount remaining unspent under sub-section (5) pursuant to an ongoing project fulfilling the prescribed conditions shall be transferred by the company within thirty days from the end of the financial year to a special account opened in any scheduled bank, to be called the Unspent Corporate Social Responsibility Account for that financial year; and that amount shall be spent in pursuance of the Policy within three financial years from the date of the transfer, failing which the company shall transfer it to a Fund specified in Schedule VII within thirty days from the completion of the third financial year.

Three periods in one sub-section: thirty days to move the money in, three financial years to spend it, thirty days to move what is left to a Fund.

And note the contrast with the second proviso to sub-section (5). Money not tied to an ongoing project goes straight to a Fund in six months; money tied to one goes to the special account in thirty days and stays available to the project for three years.

The penalty: section 135(7)

If a company is in default in complying with sub-section (5) or sub-section (6):

• the company is liable to a penalty of twice the amount required to be transferred to the Schedule VII Fund or to the Unspent Corporate Social Responsibility Account, or one crore rupees, whichever is less; and
• every officer in default is liable to a penalty of one-tenth of that amount, or two lakh rupees, whichever is less.

Note that the penalty attaches to the failure to transfer, not to the failure to spend as such. A company that spends nothing but transfers everything on time is not within sub-section (7), though its Board must still explain the failure to spend in its report.

And note that both penalties are capped, at one crore and two lakh rupees respectively.

Directions and the small company: section 135(8) and (9)

Section 135(8). The Central Government may give general or special directions to a company or class of companies as it considers necessary to ensure compliance, and they shall comply.

Section 135(9), inserted in 2020. Where the amount to be spent does not exceed fifty lakh rupees, the requirement to constitute a Committee does not apply, and the functions of the Committee shall be discharged by the Board.

That is a sensible relief. A company whose obligation is a few lakh rupees does not need a standing committee of three directors to spend it.

Schedule VII

Schedule VII lists the activities that may be included in a Policy. They should be given in an answer as a list, not paraphrased into a sentence.

• (i) eradicating hunger, poverty and malnutrition, promoting health care including preventive health and sanitation, including contribution to the Swachh Bharat Kosh, and making available safe drinking water;
• (ii) promoting education, including special education and employment enhancing vocational skills especially among children, women, the elderly and the differently abled, and livelihood enhancement projects;
• (iii) promoting gender equality, empowering women, setting up homes and hostels for women and orphans, old age homes, day care centres and other facilities for senior citizens, and measures for reducing inequalities faced by socially and economically backward groups;
• (iv) ensuring environmental sustainability, ecological balance, protection of flora and fauna, animal welfare, agroforestry, conservation of natural resources and maintaining the quality of soil, air and water, including contribution to the Clean Ganga Fund;
• (v) protection of national heritage, art and culture, including restoration of buildings and sites of historical importance and works of art, setting up public libraries, and promotion of traditional arts and handicrafts;
• (vi) measures for the benefit of armed forces veterans, war widows and their dependents;
• (vii) training to promote rural sports, nationally recognised sports, paralympic sports and Olympic sports;
• (viii) contribution to the Prime Minister's National Relief Fund or the Prime Minister's Citizen Assistance and Relief in Emergency Situations Fund, or any other fund set up by the Central Government for socio-economic development and relief and welfare of the Scheduled Castes, the Scheduled Tribes, other backward classes, minorities and women;
• (ix) contribution to incubators or research and development projects in science, technology, engineering and medicine funded by Government or a public sector undertaking, and to public funded universities and named national research bodies conducting research aimed at promoting the Sustainable Development Goals;
• (x) rural development projects;
• (xi) slum area development; and
• (xii) disaster management, including relief, rehabilitation and reconstruction activities.

A worked example

Ambivali Chemicals Limited has, in the immediately preceding financial year, a net worth of two hundred crore, a turnover of four hundred crore and a net profit of eight crore rupees.

Is it covered? Yes. The three thresholds are alternatives, and although it is below the net worth and turnover figures, its net profit of eight crore exceeds five crore. Section 135(1) applies.

The Committee. It must constitute a Corporate Social Responsibility Committee of three or more directors, at least one of them independent. If the company is not required to appoint an independent director under section 149(4), the proviso lets it have a Committee of two or more directors. The Board's report must disclose the composition: section 135(2).

The amount. Its net profits computed under section 198 for the three immediately preceding financial years are six crore, eight crore and ten crore. The average is eight crore, and two per cent of eight crore is sixteen lakh rupees. That is what the Board must ensure is spent this financial year: section 135(5).

A younger company. Had Ambivali Chemicals been incorporated two years ago, the average would be taken over the financial years since incorporation, by the words inserted in 2017.

The policy. The Committee formulates and recommends a Policy on activities in the areas specified in Schedule VII, recommends the expenditure, and monitors the Policy. The Board approves it after considering the recommendations, discloses its contents in its report, places it on the website, and ensures the activities are actually undertaken: section 135(3) and (4).

Where. The company's plant is at Ambivali, so under the first proviso to sub-section (5) it must give preference to the local area and the areas around it. It funds a school building under Schedule VII item (ii) and a water treatment project under item (i), both within the taluka.

A shortfall not tied to a project. It spends only ten lakh of the sixteen lakh, and the unspent six lakh is not for an ongoing project. Two things follow. The Board's report under section 134(3)(o) must specify the reasons for not spending; and the six lakh must be transferred to a Fund specified in Schedule VII within six months of the end of that financial year.

A shortfall that is tied to a project. Suppose instead the unspent six lakh relates to an ongoing project, a rural health centre being built over two years. Then it goes, within thirty days from the end of the financial year, into a special account in a scheduled bank called the Unspent Corporate Social Responsibility Account for that year, and must be spent on the Policy within three financial years of the transfer. Whatever is still unspent then goes to a Schedule VII Fund within thirty days of the end of the third financial year: section 135(6).

If it makes neither transfer. The company is liable to a penalty of twice the amount required to be transferred, or one crore rupees, whichever is less, so on six lakh unspent the penalty is twelve lakh rupees; and every officer in default is liable to one-tenth of the amount, or two lakh rupees, whichever is less, so sixty thousand rupees each: section 135(7).

Spending more than required. In the next year the company spends twenty-four lakh although only sixteen lakh was required. The excess of eight lakh may be set off against the requirement of succeeding financial years, in the number of years and manner prescribed: third proviso to section 135(5).

A small obligation. Suppose the average net profits were only twenty crore in total across the three years, so the two per cent came to well under fifty lakh. Wherever the amount to be spent does not exceed fifty lakh rupees, no Committee need be constituted, and the Board itself discharges the Committee's functions: section 135(9).

A direction. The Central Government may give the company general or special directions to ensure compliance, which it must obey: section 135(8).

A donation that is not CSR. The company also gives ten lakh rupees to a charitable trust that does no Schedule VII activity. That is a contribution under section 181, needing the prior permission of the general meeting if the aggregate exceeds five per cent of average net profits of the three immediately preceding financial years. It does not count towards the two per cent, because sub-section (5) requires the spending to be in pursuance of the company's Corporate Social Responsibility Policy.

Distinctions that carry marks

What this does NOT mean

It does not mean all three thresholds must be crossed. They are alternatives; any one brings the company within the section.

It does not mean the two per cent is of the preceding year's profit. It is of the average net profits of the three immediately preceding financial years, computed under section 198.

It does not mean an explanation in the Board's report is now enough. Since the 2019 and 2020 amendments the unspent amount must be transferred, and failure to transfer attracts the penalty in sub-section (7).

It does not mean every covered company needs a Committee. Where the amount to spend does not exceed fifty lakh rupees, the Board discharges the Committee's functions: section 135(9).

It does not mean any donation counts. The spending must be in pursuance of the company's Corporate Social Responsibility Policy, on activities in the areas or subjects specified in Schedule VII.

It does not mean overspending is wasted. The excess may be set off against the requirement of succeeding financial years, as prescribed.

Quick revision

• 135(1): applies to a company with net worth of five hundred crore or more, or turnover of one thousand crore or more, or net profit of five crore or more, during the immediately preceding financial year; it shall constitute a Corporate Social Responsibility Committee of three or more directors, at least one independent; where no independent director is required under section 149(4), two or more directors suffice. 135(2): the Board's report discloses the composition.
• 135(3): the Committee formulates and recommends the Policy on activities in areas or subjects specified in Schedule VII, recommends the expenditure, and monitors the Policy.
• 135(4): the Board approves the Policy after considering the recommendations, discloses its contents in its report and on the website, and ensures the activities are undertaken.
• 135(5): spend at least two per cent of the average net profits of the three immediately preceding financial years, or since incorporation if shorter; preference to the local area; failing which the Board states the reasons under section 134(3)(o) and, unless the amount relates to an ongoing project, transfers it to a Schedule VII Fund within six months of the end of the financial year; excess spending may be set off against succeeding years as prescribed; net profit excludes prescribed sums and is computed under section 198.
• 135(6): an unspent amount for an ongoing project goes within thirty days of the end of the financial year to an Unspent Corporate Social Responsibility Account in a scheduled bank, is to be spent within three financial years, and what remains goes to a Schedule VII Fund within thirty days of the third financial year's completion.
• 135(7): default under sub-section (5) or (6) costs the company twice the amount to be transferred or one crore rupees, whichever is less, and every officer in default one-tenth of it or two lakh rupees, whichever is less.
• 135(8) and (9): the Central Government may give directions; where the amount to be spent is not more than fifty lakh rupees, no Committee is needed and the Board discharges its functions.
• Schedule VII, twelve heads: hunger, poverty, malnutrition, health care, sanitation and safe drinking water; education and vocational skills; gender equality, women, orphans and senior citizens; environmental sustainability and animal welfare; national heritage, art and culture; armed forces veterans and war widows; rural, national, paralympic and Olympic sports; the Prime Minister's National Relief Fund and PM CARES Fund and other Central Government funds; incubators, research and development and public funded universities and research bodies; rural development; slum area development; and disaster management including relief, rehabilitation and reconstruction.

Test yourself

1. Which companies must comply with section 135? Every company having, during the immediately preceding financial year, a net worth of five hundred crore rupees or more, or a turnover of one thousand crore rupees or more, or a net profit of five crore rupees or more. The thresholds are alternatives.

2. How much must be spent, and on what base? At least two per cent of the average net profits of the company made during the three immediately preceding financial years, or, where three financial years have not been completed since incorporation, during such immediately preceding financial years. Net profit excludes such sums as may be prescribed and is calculated in accordance with section 198.

3. What happens to money that is not spent? The Board must state the reasons in its report under section 134(3)(o); and unless the amount relates to an ongoing project, it must be transferred to a Fund specified in Schedule VII within six months of the expiry of the financial year. Where it does relate to an ongoing project, it goes within thirty days of the end of the financial year into an Unspent Corporate Social Responsibility Account in a scheduled bank, must be spent within three financial years, and any balance then goes to a Schedule VII Fund within thirty days.

4. What is the penalty for default? The company, twice the amount required to be transferred or one crore rupees, whichever is less; and every officer in default, one-tenth of that amount or two lakh rupees, whichever is less: section 135(7).

5. Must every covered company have a CSR Committee? No. Where the amount to be spent does not exceed fifty lakh rupees, the requirement to constitute a Committee does not apply and the Board discharges the Committee's functions: section 135(9). And where the company need not appoint an independent director under section 149(4), the Committee may consist of two or more directors.

6. Name six activities in Schedule VII. Any six of: eradicating hunger, poverty and malnutrition and promoting health care, sanitation and safe drinking water; promoting education and vocational skills; gender equality and the empowerment of women, homes for orphans and facilities for senior citizens; environmental sustainability and animal welfare; protection of national heritage, art and culture; benefit of armed forces veterans and war widows; promotion of sports; contribution to the Prime Minister's National Relief Fund or the PM CARES Fund; contribution to incubators, research and development and public funded universities; rural development projects; slum area development; and disaster management including relief, rehabilitation and reconstruction.