[The following post is contributed by Vinod Kothari of Vinod Kothari &
Co. The author may be contacted at vinod@vinodkothari.com]
Co. The author may be contacted at vinod@vinodkothari.com]
A
circular of the Ministry of Corporate Affairs (MCA), with a set of FAQs along
with response dated 12 January 2016 through general circular no.
01/2016 has clarified that the expenditure on corporate social
responsibility (CSR) is not deductible as a business expenditure for tax
purposes. The MCA circular has also clarified that the expenditure is based on
the profits before tax (PBT) of the entity.
circular of the Ministry of Corporate Affairs (MCA), with a set of FAQs along
with response dated 12 January 2016 through general circular no.
01/2016 has clarified that the expenditure on corporate social
responsibility (CSR) is not deductible as a business expenditure for tax
purposes. The MCA circular has also clarified that the expenditure is based on
the profits before tax (PBT) of the entity.
There
is a question as to whether the CSR spending is an appropriation of profits, or
a charge against profits? If it is an appropriation of profits, the spending is
not debited as an expense to the profit and loss account; it will be treated a
distribution of profits or application thereof, and accordingly, will not be
recognised for the purpose of reporting of earnings of the entity, including
earnings per share (EPS). On the contrary, if it is an expense, it is a charge
to the profit and loss account. While the computation may be based on PBT, it
will yet be an expense item, and the actual PBT will be determined after debiting
the CSR spending.
is a question as to whether the CSR spending is an appropriation of profits, or
a charge against profits? If it is an appropriation of profits, the spending is
not debited as an expense to the profit and loss account; it will be treated a
distribution of profits or application thereof, and accordingly, will not be
recognised for the purpose of reporting of earnings of the entity, including
earnings per share (EPS). On the contrary, if it is an expense, it is a charge
to the profit and loss account. While the computation may be based on PBT, it
will yet be an expense item, and the actual PBT will be determined after debiting
the CSR spending.
This
post examines the question. There are arguments on both sides of the motion. We
discuss those.
post examines the question. There are arguments on both sides of the motion. We
discuss those.
Arguments for treating CSR
spending as an appropriation:
spending as an appropriation:
The
idea of CSR is that companies apply their profits not merely for shareholder
wealth maximisation, but also for social good. Hence, while 98% of the profits
of the company are distributable to shareholders, a small amount, 2%[1] of
the profits, is applied for specified social causes. Thereby, the society
becomes a stakeholder in the company.
idea of CSR is that companies apply their profits not merely for shareholder
wealth maximisation, but also for social good. Hence, while 98% of the profits
of the company are distributable to shareholders, a small amount, 2%[1] of
the profits, is applied for specified social causes. Thereby, the society
becomes a stakeholder in the company.
“Expenditure”
is what is laid out or incurred for business purposes, in ordinary course of
business. CSR spending is certainly not incurred for business purposes. On the
contrary, there is a clear contradiction between CSR spending and a business
expense, since MCA’s circular provides that CSR spending cannot include an
activity in the ordinary course of business[2].
is what is laid out or incurred for business purposes, in ordinary course of
business. CSR spending is certainly not incurred for business purposes. On the
contrary, there is a clear contradiction between CSR spending and a business
expense, since MCA’s circular provides that CSR spending cannot include an
activity in the ordinary course of business[2].
Para
70 (a) of the Framework for Preparation and Presentation of Financial
Statements defines “expense” as follows:
70 (a) of the Framework for Preparation and Presentation of Financial
Statements defines “expense” as follows:
Expenses are decreases in economic
benefits during the accounting period in the form of outflows or depletions of
assets or incurrences of liabilities that result in decreases in equity, other
than those relating to distributions to equity participants.
benefits during the accounting period in the form of outflows or depletions of
assets or incurrences of liabilities that result in decreases in equity, other
than those relating to distributions to equity participants.
Para
78 further states:
78 further states:
The definition of expenses encompasses
losses as well as those expenses that arise in the course of the ordinary
activities of the entity. Expenses that arise in the course of the ordinary activities of the entity include, for
example, cost of sales, wages and depreciation. They usually take the form of
an outflow or depletion of assets such as cash and cash equivalents, inventory,
property, plant and equipment.
losses as well as those expenses that arise in the course of the ordinary
activities of the entity. Expenses that arise in the course of the ordinary activities of the entity include, for
example, cost of sales, wages and depreciation. They usually take the form of
an outflow or depletion of assets such as cash and cash equivalents, inventory,
property, plant and equipment.
The
stress in para 78 seems to be on ordinary course of activities of the entity.
In that sense, CSR is something which is completely outside the scope of
ordinary activities.
stress in para 78 seems to be on ordinary course of activities of the entity.
In that sense, CSR is something which is completely outside the scope of
ordinary activities.
Arguments for treating CSR
as a charge against profits:
as a charge against profits:
Properly
speaking, CSR is a part of the business model of the entity. There seems to be
a global convergence on business sustainability principles currently, that not
only does a business have to run for profits, a business has to care for the
society, community, environment, and so on, to make the business sustainable.
The view towards sustainability is nothing but an approach that balances short
term and long term objectives of a business. Thus, if a business spends on
social good while running its business, it is not an act of philanthropy or
distribution of the results of its enterprise – it is an effort towards
ensuring those results are sustainable in nature.
speaking, CSR is a part of the business model of the entity. There seems to be
a global convergence on business sustainability principles currently, that not
only does a business have to run for profits, a business has to care for the
society, community, environment, and so on, to make the business sustainable.
The view towards sustainability is nothing but an approach that balances short
term and long term objectives of a business. Thus, if a business spends on
social good while running its business, it is not an act of philanthropy or
distribution of the results of its enterprise – it is an effort towards
ensuring those results are sustainable in nature.
CSR
spending is based on profits, but it is not an appropriation of profits. The
linkage with profit is merely the desired level of spending. In any case, CSR
spending is based on average profits of 3 preceding years and is not even
linked with the profits of the current year. Even if it was connected with the
profits for the year, that by itself does not mean that the expenditure ceases
to be an expense. For instance, managerial remuneration is based on profit –
however, it is admittedly a charge against profits and not an appropriation.
spending is based on profits, but it is not an appropriation of profits. The
linkage with profit is merely the desired level of spending. In any case, CSR
spending is based on average profits of 3 preceding years and is not even
linked with the profits of the current year. Even if it was connected with the
profits for the year, that by itself does not mean that the expenditure ceases
to be an expense. For instance, managerial remuneration is based on profit –
however, it is admittedly a charge against profits and not an appropriation.
ICAI
issued a Guidance
Note on Accounting for Expenditure on Corporate Social Responsibility
Activities –
issued a Guidance
Note on Accounting for Expenditure on Corporate Social Responsibility
Activities –
16.
Presentation and Disclosure in Financial Statements
Presentation and Disclosure in Financial Statements
XX
From
the perspective of better financial reporting and still be in line with the requirements
of Schedule III in this regard, it is recommended that all expenditure on CSR
activities, that qualify to be recognised as expense in accordance with
paragraphs 10-14 above should be
recognised as a separate line item as ‘CSR expenditure’ in the statement of
profit and loss. Further, the relevant note should disclose the break-up of
various heads of expenses included in the line item ‘CSR expenditure’
the perspective of better financial reporting and still be in line with the requirements
of Schedule III in this regard, it is recommended that all expenditure on CSR
activities, that qualify to be recognised as expense in accordance with
paragraphs 10-14 above should be
recognised as a separate line item as ‘CSR expenditure’ in the statement of
profit and loss. Further, the relevant note should disclose the break-up of
various heads of expenses included in the line item ‘CSR expenditure’
Importantly,
the purpose of computation of earnings per share (EPS) is for equity
participants to compute the earnings available to them, so that they may
appraise the true value of the equity. If CSR is a spending made before the
profits are available to the equity participants, certainly, the shareholders’
entitlement is to profits after CSR spending.
the purpose of computation of earnings per share (EPS) is for equity
participants to compute the earnings available to them, so that they may
appraise the true value of the equity. If CSR is a spending made before the
profits are available to the equity participants, certainly, the shareholders’
entitlement is to profits after CSR spending.
The issue of deductibility
for tax purposes:
for tax purposes:
The
Income tax Act was amended by Finance Act 2015 to provide specifically that CSR
spending will not be claimed as an expense for the purpose of sec. 37 (1) of
the Income-tax Act. However, the non-deductibility of an expense cannot become
the basis to argue that the item is not an expense at all. Fiscal
considerations are completely different. For example, there are several items
of expenditure that either may be allowed subject to restrictions (sec. 36) or
several items that may not be allowed (sec 40A, 43B), etc. However, each of
these are items of expenditure.
Income tax Act was amended by Finance Act 2015 to provide specifically that CSR
spending will not be claimed as an expense for the purpose of sec. 37 (1) of
the Income-tax Act. However, the non-deductibility of an expense cannot become
the basis to argue that the item is not an expense at all. Fiscal
considerations are completely different. For example, there are several items
of expenditure that either may be allowed subject to restrictions (sec. 36) or
several items that may not be allowed (sec 40A, 43B), etc. However, each of
these are items of expenditure.
Conclusion:
The
definition of “expense” in Para 70 (a) of the Framework is to state that
expenses include all those decreases in economic benefits that are done other
than distributions to “equity participants”. There is no basis to regard the
society as an “equity participant”. Hence, properly speaking, CSR spending
should be treated as an expense rather than an appropriation of profits. The
ICAI’s view on the matter, therefore, seems to be a correct view. Also,
generally speaking, the guidance notes of ICAI have a strong recommendatory
value and they are to be followed unless there is a strong reason to deviate
therefrom.
definition of “expense” in Para 70 (a) of the Framework is to state that
expenses include all those decreases in economic benefits that are done other
than distributions to “equity participants”. There is no basis to regard the
society as an “equity participant”. Hence, properly speaking, CSR spending
should be treated as an expense rather than an appropriation of profits. The
ICAI’s view on the matter, therefore, seems to be a correct view. Also,
generally speaking, the guidance notes of ICAI have a strong recommendatory
value and they are to be followed unless there is a strong reason to deviate
therefrom.
–
Vinod Kothari
Vinod Kothari
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