Tax twists in CSR spends
The Financial Express
Tax partner, EY
Ritika Loganey Gupta
Associate Director - Tax & Regulatory Services
With the enactment of the Companies Act, 2013, India has become the forerunner to mandate spend on Corporate Social Responsibility (CSR) activities through a statutory provision.
While many corporate houses have been traditionally engaged in doing CSR activities voluntarily, the new CSR provisions put formal and greater responsibility on companies in India to set out clear framework and processes to ensure strict compliance. However, what the Companies Act does is bring more companies into the fold and increase the total CSR spend.
As per Section 135 of the Act, companies with an annual turnover of at least R1, 000 crore, or a net worth of minimum R500 crore, or a net profit of R5 crore and above shall constitute a CSR panel of the Board. Reporting will be done on an annual basis, commencing from FY15. Such companies (including foreign companies in India) are required to mandatorily spend 2% of their average net profit towards specified CSR activities during the year.
Schedule VII of the Companies Act prescribes activities towards which CSR expenditure should be incurred, including eradicating extreme hunger and poverty, promoting education, ensuring environmental sustainability, social business projects, reducing child mortality and improving maternal health, etc.
Being a tax professional, the first thing that comes to fore is what is the impact of CSR contributions from a tax deductibility point of view.
The general rule has been to allow tax deduction for donations, contributions, etc., made for charitable purposes under Section 80G of the Income Tax Act, 1961 (I-T Act). With the enactment of the Companies Act, the focus is now on expenditure of funds by companies for CSR purposes.
As per the notified rules, it has been clarified CSR spends excludes “activities undertaken in pursuance of the normal course of business of the company”. If expenditure on CSR is not one contemplated under Section 37 of the I-T Act—which provides for allowance of any expenditure not being in the nature of capital expenditure or personal expenses of the assessee laid out exclusively for the purposes of the business or profession—we have tax issues emerging. The dilemma is if any expenditure on CSR is considered by the taxman as not expended wholly or exclusively for the purposes of the business, on the backdrop that the CSR rules excludes “activities undertaken in pursuance of the normal course of business of the company”, will this contribution be considered as permissible CSR spending. From a technical perspective, there is good ground to suggest that the required-to-spend amount is perceived by the legislature to be mandatory in nature. The expression “shall ensure” used in section 135(5) of the Act does suggest that there is a mandate to spend 2% of average net profits of the preceding three years on CSR activity. In fact, even when Companies Act, 1956, did not prescribe any statutory requirement for CSR, there have been court decisions that examined the nature of CSR expenses and ruled them as deductible, but on a case-to-case basis.
Where CSR expenditure results in creation of capital assets like a school or a hospital building, or ambulance, or planting of trees, etc—would the same be considered as a revenue or capital expense? Section 37(1) of the I-T Act grants deduction for expenditure which is not of capital nature. If the nature of CSR expenditure is such that no capital asset of taxpayer’s ownership is created (such as expenditure incurred on distribution of clothes or medicines, expenditure on free health camps, etc.) this condition will not be a hurdle. As per judicial interpretations, if the assets do not to belong to the taxpayer, the expenditure cannot be regarded as capital expenditure for the taxpayer.
The CSR Rules contain guidance on how the companies can undertake CSR activities. For example, CSR can be implemented through trusts or a Section 8 company set up for this purpose. The company may itself set up such entities or may use entities set up by others for its CSR programs. This leads to the third issue—whether for income tax purposes, contribution to the trust would be allowed wholly or restricted to 50% under Section 80G of the I-T Act. Under Section 80G of I-T Act contributions to only certain trusts are given 100% deduction. Suitable amendments would need to be made to provisions relating to trusts and 80G of the I-T Act to provide for full allowance of contribution to such trusts.
There are certain provisions in the Companies Act which grant normal or weighted deduction for contributions made to specified institutions for specified purposes and/or expenditure incurred for specified purposes. There does not appear to be any bar on a company desirous of incurring CSR expense to associate with some other charity or association to discharge its obligation or duty cast under the Companies Act.
For example, a company decides to associate with an association which is covered by Section 35AC of I-T Act and makes contribution to the said association for undertaking construction of school or pollution control which is one of the projects listed in Schedule VII to the Act. This way the company will get a 100% deduction of the contribution made and may have greater comfort in claiming deduction regardless of whether the deductibility under sections 37 of I-T Act is challenged by the Tax Authority in relation to expenditure incurred by the company.
Considering this, it may be possible to explore whether the corporate or a corporate group may consider operating through certain entities such as charitable trust or institutions which are implementing agencies but are covered in their own right under the relevant exemption or concession provision of I-T Act.
With Corporate India getting ready to face the next phase of political turmoil and current economic crisis, any impact to profitability by 2% on CSR spend may make or break the investor perceptions. It now needs to be seen how the investor perceives the contributions for CSR. Suitable amendments to the I-T Act are necessary to ensure allowance for deduction of CSR expenditure to avoid needless litigation. Let us hope mandatory CSR doesn't herald taxing times for Corporate India.
Views are personal.