Resolving Ambiguities in CSR Provisions

[Bunny Sehgal is an Associate at Vinod Kothari & Co. and can be reached at [email protected]]

With the enactment of the Companies Act, 2013 (‘Act’), India has become one of the leading countries to mandate spending on corporate social responsibility (‘CSR’) activities through a statutory provision. Since then CSR has become a topic of interest for corporates. Further, with the passage of time, the Ministry of Corporate Affairs (‘MCA’) issued several FAQs to facilitate better implementation of the CSR provisions. However, there were certain ambiguities which were still pending for resolution, owing to which the MCA by way of its notification dated 19 September 2018 has notified the provisions of section 37 of the Companies (Amendment) Act, 2017 (‘Act, 2017’). This amends the provisions of section 135 of the Act, which deals with CSR. On the same day the MCA, by a separate notification, amended the Companies (Corporate Social Responsibility Policy) Rules, 2014 (‘Rules’). This post seeks to explain the amendment brought in through the Act, 2017 and the amended Rules along with its impact on corporates.

Amendment to Section 135 of the Act

Clarification in the meaning of the phrase ‘during any financial year’

According to section 135(1), the meaning of the phrase ‘during any financial year’ is not clear. Owing to the ambiguity in the provisions, different views were adopted by corporates as to whether the determining criteria should be for the immediately preceding financial year or the current financial year. To address this issue, the MCA through its FAQs dated 12 January 2016 provided that the said phrase implies ‘any of the three preceding financial years’.

However, contrary to the interpretation provided in the FAQs, the MCA has amended the text of the provision by way of the Act, 2017, which replaces the words ‘during any financial year’ with ‘during the immediately preceding financial year’. Therefore, now the amended text of the provision removes the ambiguity, and the applicability of the provisions will be clearly decided based on the net worth, turnover or profitability criteria, as the case may be, for the immediately preceding financial year.

Provisions mandating appointment of independent directors

Section 135(1) of the Act requires a CSR committee to be constituted with three or more directors, out of which at least one director should be an independent director.  However, rule 5(1)(i) of the Rules provided an exemption regarding the appointment of an independent director, such that companies are not required to appoint any. Therefore, the requirement to have an independent director in the composition of CSR Committee was specified in the Act, but the exemption provided in the Rules seemed to be overriding the Act.

Considering the same, the Act, 2017, in order to clear the ambiguity, has inserted a proviso  to section 135(1) of the Act, which states that where a company is not required to appoint an independent director, it should constitute the CSR committee with two or more directors only.

Broader scope of schedule VII

Section 135(3)(a) requires that the CSR policy should indicate ‘the activities to be undertaken by the company as specified in schedule VII’. Schedule VII indicates broad areas, which have been further explained to be interpreted liberally in General Circular no. 21/2014 issued by the MCA. Therefore, in order to remove the ambiguity regarding the limit of scope mentioned in schedule VII, the Act, 2017 has modified the said clause to refer to the ‘subjects in schedule VII’ within which CSR activities could be taken up by an eligible company.

Clarity regarding net profits

The explanation to Section 135(5) of the Act provides that for the purpose of this provision the ‘average net profit’ shall be calculated in accordance with section 198; however, the CSR Rules defines the term ‘net profit’. Considering the same, there was contradiction in the provisions of the Act and the Rules. In this regard, Act, 2017 has replaced the phrase ‘average net profit’ with the ‘net profit’ in order to bring harmony between the Act and the Rules.

Amendment to the CSR Rules

The amendment to the CSR Rules have been carried out mainly to align the requirements of the Rules with the amended CSR provision brought in through the Act, 2017, i.e., in order to align the scope of Schedule VII, align the requirement of composition of committees, and the other matters discussed above.

Conclusion

The loose language appeared in the existing provisions of section 135 has now been removed in order to provide clarity on the applicability of the provisions to be based on the preceding year’s performance. Further, the clarifications earlier introduced by the MCA by virtue of amendment to Rules have been brought into the section itself to provide for the composition of the CSR committee for companies not required to have independent directors. Also, based on the recommendation of the Companies Law Committee, the ambiguity regarding the net profit has also been done away with. To sum up, the amendment brought in by the Act, 2017 has removed the ambiguities of section 135, which facilitate better implementation of the provisions by the corporates, which in turn will be beneficial keeping in mind the objective of the CSR provisions.

–Bunny Sehgal