Tax Deductibility in the Light of the New CSR Regime

[Shivani Pattnaik and Sourav Jena are undergraduate students at the National Law University, Odisha]

Recently, the Ministry of Corporate Affairs (“MCA”) along with the Government of India has amended section 135 of the Companies Act, 2013 (“the Act”), thereby bringing upon significant changes to corporate social responsibility (“CSR”) regulations in India.

After years of mandated CSR in the legislation, the Companies (Amendment) Act, 2019 (“2019 Amendment”), and the Companies (Amendment) Act, 2020 (“2020 Amendment”) have been brought out against the backdrop of bolstering the CSR position keeping in view the effects of the pandemic on the country. The amendments contain provisions relating to defining and modifying existing terminology, the transferring of unspent CSR amount, focusing on impact assessment of CSR contributions, and CSR reporting—thereby ushering a shift from “comply, or explain” (the company either complies with the statutory CSR expenditure in section 135(5) or explains the reasons for the unspent amount by disclosing it in the Board’s report) to mandatory adherence to New CSR Rules (the company either complies with the new regulations or pays fines for non-compliance.) As a result, the companies would now face immense responsibility to comply with provisions precisely, thereby treading the fine line between corporate philanthropy and inescapable CSR obligation. 

This post seeks to make a case for the inclusion of CSR expenditure as tax-deductible to ease the responsibility on companies in the light of recent CSR amendments.  

Key Changes

On January 22, 2021, the Companies (Corporate Social Responsibility Policy) Amendment Rules (“New CSR Rules”) incorporated the changes from the amendments to make considerable alterations.

The 2021 Amendment has shed light upon the treatment of any unspent CSR amount remaining from any ‘ongoing project.’ According to section 135(6) of the Act, the company must open an account for the unspent amount, namely, ‘Unspent CSR Account’, and transfer the funds there. Additionally, having introduced the meaning and scope behind the term ‘ongoing project,’ which had an indirect reference in CSR Policy Rules, 2014, has now been elucidated upon to comprise of multi-year CSR projects commenced by a company. However, there is looming ambiguity upon implementing projects that go beyond four years as they fail to qualify as ‘ongoing projects’ under section 135.

As a result, this impacts the CSR expenditure undertaken by a company. Under rule 7 of the New CSR Rules, the ‘administrative overheads’ must not surpass five per cent of the total spending on CSR as ascertained by the Board. However, under rule 8(3)(c), companies have been permitted to avail the “five per cent of total CSR expenditure or fifty lakh rupees, whichever is less”—provided they carry out impact assessments of their project.

Furthermore, the provisions also clarify that any remaining surplus from the implementation of CSR activities must either be “utilized in the same project or transferred to the unspent CSR account or transferred to a Fund specified under Schedule VII within six months from expiry of the financial year.”

Taxation Stance on CSR

Despite the companies being beleaguered by additional and stricter compliances in the new CSR regime, there has been no amendment to section 37(1) of the Income Tax Act, 1961. The section delineates that CSR expenses have an inherent philanthropic connotation attached to them which removes them from the ambit of business expenses. Therefore, though companies would shoulder the responsibility of sustainable development with the Government, they would not avail the benefit of deduction on the CSR expenditure.    

Similarly, the Central Board of Direct Taxes (“CBDT”), in one of its circulars, was of the opinion that “CSR expenditure is not incurred for the purposes of carrying on business” and therefore, CSR expenditure cannot be brought under the ambit of tax deduction. However, it was also mentioned that if the CSR expenditure falls under the realm of expenditures declared under section 30 to 36 of the Income Tax Act; it can be claimed as a tax deduction, provided that the conditions specified under section 30 to 36 are met.

Furthermore, corporate expenditures on PM National Relief Fund relating to skill development activities and agricultural projects turned to avail tax deductions as recourse under section 80G of the Income Tax Act. However, the tax authorities contended that in order to avail a tax deduction under the section, the ‘amount paid’ is required to be in the form of a ‘donation.’ Moreover, a ‘voluntary act’ on the part of the donor is a necessary element for the amount to be considered as a ‘donation.’ As CSR expenses are considered to be paid mandatorily by a company according to the Companies Act, therefore, it does not qualify for tax deduction under 80G.

Even so, the Income Tax Appellate Tribunal, in the case of Fnf India Private Limited v Assistant Commissioner of Income Tax, believed that under section 80G of the Income Tax Act, 1961, the benefit of deduction can be given regardless of the contrasting explanations provided under section 37. Section 37 disallows tax deduction when calculated on “income under business head and profession,” whereas tax deduction under section 80G is sanctioned from the “Total income of the assessee“, which includes both the business income as well as the income incurred other than business income. It was held that an assessee could not be exempted from tax deduction only because part of the payment includes CSR.

While calculating Profits and Gains from Business or Profession, ‘disallowance’ refers to certain expenditures which are added back to the net profit, obligating the assessee to pay taxes on them as the income tax department does not permit any benefit on them. Herein, this ‘disallowance’ is dual as the companies are levied a tax on their income as well as their CSR expenditure. As a result, a case of “double disallowance” begins to take shape deviating from the original intent of the Act’s mandate.

MCA Committee on Tax Uniformity

Regarding this difference in opinion, the MCA had instituted the High-Level Committee in 2019 (“HLC”), which in its report had recommended, “all activities under schedule VII to enjoy uniform tax benefits. CSR expenditure to be made deductible from the income earned for the purpose of taxation. The mode of implementation to be tax neutral. Implementing agencies should be treated as partners and not service providers/vendors for CSR activities, so as to address the variable incidence of indirect taxes on them.” This step towards tax uniformity shall create transparency and accountability for CSR expenditure. 

Furthermore, the Finance Bill 2014 Memorandum presented that CSR expenditure that falls under the ambit of section 30 to 36 of the Income Tax Act should be allowed for tax deduction provided it met the prescribed conditions.

Making CSR Tax-Deductible

A lack of uniform taxation policy vis-a-vis CSR expenditure is felt with the present unsatisfactory position of law. Therefore, the MCA committee had opined that the CSR funds across various sectors might get distorted in the absence of a uniform tax policy. This would lead corporate sector companies to opt for activities that are entitled to a tax deduction. In order to resolve this discord, the committee suggested that CSR expenditure should be tax-deductible.

In addition to this, the CBDT circular that mentioned CSR expenditure as non-tax-deductible was relevant to the previous policy of  “comply, or explain.” The recent amendment establishes CSR Rules as “comply or pay the penalty,” thereby making CSR mandatory for every company. Hence, it is only plausible to allow companies to avail a deduction of CSR expenditure from their taxable income. 

Cross-Jurisdictional Analysis

Taking a philanthropic view of CSR, countries across the globe have not mandated CSR expenditure even though they acknowledge the role of companies in the development and prosperity of society. Even in countries where CSR expenditure is mandatory, the expenses have been made deductible from the taxable income.

For instance, the Philippines has made CSR expenditure mandatory for all the large tax-paying corporations, whether domestic or foreign, doing business in the country, and all the expenses incurred should be deductible from the taxable income. In addition to that, Singapore provides a 250% tax deduction on salary-related expenses when the employees are sent to engage in voluntary work. In its recent budget, even Malaysia offered tax incentives on expenses incurred towards services, public amenities and charity or community projects extending to education and health.

Conclusion

While the New CSR Rules have provided companies with better clarity, structure, and uniformity, they have fallen short in allowing companies to view CSR as voluntary corporate philanthropy. Section 135(7), though it does not attract criminal liability, still dictates stringent imposition of penalty for non-compliance with CSR regulations. This means that companies take upon the arduous task of implementing CSR while incurring substantial expenditure and still are obligated to pay tax as an additional commitment. This obligation is particularly unfair and arbitrary as the companies were permitted to avail a tax deduction for such activities under the Income Tax Act, 1961, before section 135 was mandated in the Act. 

Furthermore, imposing rigid regulations on CSR would take away from its initial purpose as companies would undergo the process of complying with the regulations to avoid penalties instead of fulfilling their social responsibility of seeking the triple bottom line. Therefore, it is high time for India to reconsider its taxation policy surrounding CSR and utilize the deduction as an incentive, not an additional tax liability.  

Shivani Pattnaik & Sourav Jena

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