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

Corporate Social Responsibility (CSR) is no longer a voluntary initiative but a statutory mandate for many Indian companies under Section 135 of the Companies Act, 2013. For founders, investors, and legal professionals alike, a thorough understanding of these obligations is crucial for ensuring compliance and fostering sustainable business practices.

Understanding the Mandate: Who is Covered by Section 135?

Section 135 of the Companies Act, 2013, mandates CSR spending for companies that meet specific financial thresholds. These thresholds are:

Net worth of ₹500 crore or more; or
Turnover of ₹1,000 crore or more; or
Net profit of ₹5 crore or more

during the immediately preceding financial year. The Act defines 'company' broadly, encompassing both public and private companies, as well as a 'foreign company' as defined under Section 2(42) of the Act, having its place of business in India.

The CSR Expenditure Mandate: What and How Much?

Companies meeting the criteria under Section 135 are required to spend, in every financial year, at least 2% of the average net profits of the company made during the three immediately preceding financial years, computed in accordance with Section 198 of the Act.

The CSR policy must specify the projects and programmes that a company will undertake and the manner of their execution. The activities must fall within the scope of Schedule VII of the Companies Act, 2013, which includes areas such as:

Eradicating hunger, poverty, malnutrition and promoting health care including preventive health care.
Promoting education, including special education and vocational education that enables livelihood.
Promoting gender equality and empowering women.
Ensuring environmental sustainability, ecological balance, conservation of natural resources, preservation 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; promoting performing arts.
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 socially and educationally backward classes of citizens, 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 making contributions to public academic institutions, partly funded by government, involved in research and development in science and technology.
Rural development projects.
Slum area development.

Crucially, the Act specifies that CSR expenditure shall not include the normal course of business of the company. Furthermore, expenditure incurred by the company for the benefit of its employees, other than mandated under the provisions of the Act, will not be considered CSR expenditure.

CSR Committee and Policy: The Governance Framework

Companies subject to Section 135 are required to constitute a Corporate Social Responsibility Committee (CSR Committee) of the Board. This committee typically comprises at least three directors, with at least one being an independent director. For unlisted public companies or private companies with only two directors, the committee can consist of those two directors.

The CSR Committee is responsible for:

Formulating and recommending to the Board, a CSR Policy which shall indicate the activities to be undertaken by the company as specified in Schedule VII.
Recommending the amount of expenditure to be incurred on the activities referred to above.
Monitoring the CSR policy of the company from time to time.

The Board of Directors must consider the recommendations of the CSR Committee and approve the CSR policy. The policy must be disclosed on the company’s website, and the annual report of the Board must include an annexure regarding the CSR policy.

Reporting and Disclosure Requirements

Section 135 mandates comprehensive reporting and disclosure of CSR activities. The Board's report must include an annexure containing details of the CSR policy, the composition of the CSR Committee, the CSR expenditure during the financial year, and the reasons for spending less than the mandated 2% (if applicable).

Failure to comply with the CSR provisions can lead to penalties. If a company fails to spend the mandated amount, the Board must report the reasons for not spending the same in its report. While there is no direct penalty for non-spending of the 2% amount itself, the failure to report the reasons can attract penalties under Section 134 of the Companies Act, 2013. Additionally, directors responsible for the contravention may be liable for imprisonment or fines.

Practical Implications

Founders must proactively assess if their company will meet the CSR thresholds and plan accordingly from the early stages.
Investors should conduct due diligence on a target company's CSR compliance and potential liabilities.
Companies need to develop a robust CSR policy aligned with Schedule VII and their business objectives.
Establishing a dedicated CSR committee and ensuring its proper functioning is critical for governance.
Accurate record-keeping and transparent disclosure of CSR activities are paramount to avoid penalties.
Consider integrating ESG (Environmental, Social, and Governance) principles beyond the statutory CSR mandate for long-term value creation.

Common Pitfalls

Treating CSR as a mere compliance exercise rather than a strategic opportunity.
Incorrectly calculating the average net profits for the 2% mandate.
Undertaking CSR activities that do not fall within the purview of Schedule VII.
Failing to establish a CSR committee or ensure its proper constitution and functioning.
Inadequate disclosure of CSR policy and expenditure in the annual report.

Key Takeaways

Section 135 of the Companies Act, 2013, makes CSR spending a statutory obligation for qualifying companies.
The mandate requires spending at least 2% of average net profits on specified CSR activities.
A CSR Committee and a well-defined CSR policy are essential governance components.
Transparency in reporting and disclosure is crucial for compliance.
Non-compliance can attract penalties for the company and its directors.
Proactive planning and strategic integration of CSR can enhance brand reputation and stakeholder value.

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.