Navigating CSR Obligations Under Section 135 of the Companies Act, 2013: A Comprehensive Guide for Indian Businesses

Corporate Social Responsibility (CSR) is no longer a voluntary add-on but a statutory mandate for many Indian companies. Section 135 of the Companies Act, 2013, lays down the framework for CSR, impacting founders, investors, and the overall governance structure of businesses operating in India.

Understanding the Mandate: Who is Covered Under Section 135?

Section 135 of the Companies Act, 2013, mandates CSR spending for companies that meet certain financial thresholds. Specifically, it applies to every company having:

A net worth of Indian Rupees 500 crore or more; OR
A turnover of Indian Rupees 1000 crore or more; OR
A net profit of Indian Rupees 5 crore or more

during the immediately preceding financial year. This includes holding companies, subsidiary companies, and joint ventures. Companies failing to meet these criteria are not obligated to comply with the CSR provisions, but they must disclose the reasons for non-compliance in their Board's Report.

The CSR Committee: Formation and Responsibilities

Companies falling under the purview of Section 135 are required to constitute a Corporate Social Responsibility Committee (CSR Committee). This committee typically comprises at least three directors, with at least one independent director. For One Person Companies (OPCs), a single director can form the CSR Committee.

The primary responsibilities of the CSR Committee include:

Formulating the CSR Policy, which shall be placed on the company's website.
Recommending the CSR activities to be undertaken by the company.
Recommending the amount of expenditure to be incurred on CSR activities.
Monitoring the company's CSR policy and ensuring its effective implementation.
Conducting due diligence on implementing agencies to ensure their credibility and track record.

CSR Expenditure: What Qualifies and What Doesn't?

Section 135 mandates that companies spend at least 2% of their average net profits made during the three immediately preceding financial years on CSR activities. The Act specifies a list of eligible CSR activities, which are broad and encompass various social development areas:

Eradicating hunger, poverty, and malnutrition, promoting preventive health care, and sanitation, and making safe drinking water available.
Promoting education, including special education and vocational skills for children, the elderly, and the differently-abled, and livelihood enhancement projects.
Promoting gender equality, empowering women, setting up homes and hostels for women and orphans; setting up old age homes, day care centres, and such other facilities for senior citizens; and measures for reducing inequalities faced by socially and economically backward groups.
Ensuring environmental sustainability, ecological balance, conservation of natural resources, protection of flora and fauna, animal welfare, agroforestry, conservation of natural resources and maintaining the quality of soil, air and water.
Protection of national heritage, art and culture, including restoration of buildings and sites of historical importance and works of art; setting up and promoting public libraries; promotion and development of traditional arts and handicrafts.
Measures for the benefit of armed forces veterans, war widows and their dependents.
Training to promote rural sports, nationally recognized sports, Paralympic sports, and Olympic sports.
Contribution to the Prime Minister's National Relief 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.
Contributions to incubators funded by the Central Government or State Government or any public sector undertaking or any agency of the Central Government or State Government and institutions recognized by the Central Government or State Government as on date of the commencement of the Companies (Corporate Social Responsibility Policy) Amendment Rules, 2020.
Rural development projects.

Exclusions: CSR expenditure does not include activities undertaken in the normal course of business of the company. Furthermore, any amount spent by a company for the benefit of its employees, their families, or any expenditure incurred outside India (unless specifically permitted) will not qualify as CSR expenditure.

Reporting and Disclosure Requirements

Companies subject to Section 135 must include a detailed CSR report in their Board's Report. This report must contain information about the company's CSR policy, the composition of the CSR Committee, the CSR activities undertaken, the total amount spent on CSR during the financial year, and the reasons for any shortfall in spending. The CSR policy must also be displayed on the company's website.

Failure to comply with these reporting requirements can attract penalties under the Companies Act, 2013. For listed companies, SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 also mandate disclosures related to CSR, ensuring transparency and accountability to stakeholders.

Practical Implications

Founders must proactively identify if their company meets the CSR thresholds and plan for compliance from an early stage.
Investors should assess a company's CSR compliance as part of their due diligence, as it reflects governance standards and long-term sustainability.
Companies need to develop a robust CSR policy that aligns with their business objectives and societal impact goals.
Establishing a dedicated CSR committee and ensuring its effective functioning is crucial for compliant and impactful CSR initiatives.
Accurate record-keeping and transparent reporting of CSR activities are essential to avoid penalties and build stakeholder trust.
Consider the impact of CSR on cash flow and budget allocation, especially for startups nearing the compliance threshold.

Common Pitfalls

Treating CSR as a mere compliance exercise rather than a strategic opportunity for brand building and social impact.
Lack of clear objectives and measurable outcomes for CSR projects, leading to ineffective spending.
Failure to conduct adequate due diligence on implementing agencies, resulting in misappropriation of funds or poor project execution.
Inadvertently including activities that do not qualify as CSR expenditure, leading to non-compliance.

Key Takeaways

Section 135 of the Companies Act, 2013, is a mandatory CSR provision for companies meeting specific financial criteria.
A CSR Committee is essential for formulating, recommending, and monitoring CSR policies and activities.
CSR expenditure must be directed towards eligible activities, with a minimum of 2% of average net profits to be spent.
Transparent reporting and disclosure of CSR activities in the Board's Report and on the company website are mandatory.
Compliance with CSR provisions demonstrates good corporate governance and contributes to a company's social license to operate.
Startups should be aware of these provisions as they scale, as compliance becomes a necessity upon meeting the thresholds.

Disclaimer: This advisory is for informational purposes only and does not constitute legal advice. Themis Lexsol Consulting does not accept liability for reliance on the content of this article.