Corporate Social Responsibility (CSR) – 2% of average profit stand mandatorily and statutorily diverted at source and is not profit or income of the company – a point of view

[CA DEV KUMAR KOTHARI]

Sections 134 , 135 of the Companies Act, 2013. (CA 2013)

Schedule VII to the Companies Act, 2013.

The Companies (Corporate Social Responsibility Policy) Rules, 2014.

Earlier article on this website “CORPORATE SOCIAL CONTRIBUTION [CSR} – must be allowed in interest of business and society. Proposed amendment in section 37 deserves to be deleted.” By the same author published on 16.07.2014 after proposed amendment  to disallow CSR expenses u/s 37 of IT Act.

CSR obligation:

In this write-up, CSR obligation is to be understood as the minimum amount which a company is required to spend for CSR obligation as per provisions of S.135.

Obligation imposed under law is mandatory.

In case of any company to which provisions of CSR is applicable, there is mandatory provision for spending CSR obligation amount as per law and it is not at discretion of Board of Directors or even shareholders of company to vary the same so as to reduce CSR obligation. Any provision contrary to the provisions for CSR in the MOA or AOA of company or in any Resolution of the company shall be void, as inconsistent with the provisions of the CA 2013.  The language used is mandatory. Provisions of Sub-section (5) of S.135 reads as follows (with highlights added):

Quote:

           (5) The Board of every company referred to in sub-section (1), shall ensure that the company spends, in every financial year, at least two per cent of the average net profits of the company made during the three immediately preceding financial years, in pursuance of its Corporate Social Responsibility Policy:

     Provided that the company shall give preference to the local area and areas around it where it operates, for spending the amount earmarked for Corporate Social Responsibility activities:

     Provided further that if the company fails to spend such amount, the Board shall, in its report made under clause (o) of sub-section (3) of section 134, specify the reasons for not spending the amount.

Unquote:

In view of mandatory language used in provisions it is clear that that there is statutory obligation for CSR spending.  Therefore, to the extent, a company is required to make CSR spending, the net profit which belongs to the company are reduced and there is statutory diversion before accrual as income of company. The company is not free to use amount to the extent of CSR obligation at its free will.

The income earned is to that extent does not belong to the company. Though the amount will be determined after ascertaining profit of the year and average of three years, the CSR obligation is attached beforehand and this is a case of diversion of income and not a case of application of income.

Therefore, a possible view is that amount required to be mandatorily required to be spent as per S.135 of the CA 2013, stand statutorily diverted at source and does not belong as income of company and need to be reduced from profit while determining profits of company under the Companies Act, 2013 and also for determining taxable income of company under tax laws.

The amount remaining unspent out of minimum CSR obligation is not property of company, but it is held for spending  as per CSR obligation.

Accounting for CSR obligation:

Minimum amount which the company is required to spend on CSR must therefore be accounted for in a separate account and preferably can be kept in separate bank account also. The following accounting entries can be made:

P & L account Dr.

To CSR liability account.

(Minimum amount statutorily required to be spent by company under CSR, accounted for and credited in CSR liability account).

Spending against CSR:

Amount spent from time to time under CSR obligation can be debited in CSR liability account directly or through a general account to be adjusted at year end in the CSR account, and excess amount spent in the P & L account.  Therefore, the amount spent out of CSR liability shall not  be debited in P & L account of company. Therefore, no claim for deduction shall be made in P & L account for amount spend out of CSR obligation.  

For example suppose CSR obligation is  for ₹ 50 lakh.

Company had spent ₹ 45 lakh.

In this case ₹ 50 lakh will be credited in CSR liability account and ₹ 45 lakh spent will be debited. Balance ₹ 5 lakh , remaining un-spent shall be carried forward for spending in future.

Suppose company spent ₹ 55 lakh, than ₹ 50 lakh will be debited in the CSR account and ₹ 5 lakh in P & L account.

 In this regard suitable report will have to be made in the Directors Report of the company regarding CSR obligations, spending, and balance un-spent if any with reasons for short fall in spending, and plan for spending the same in future.

Claim of CSR under the Income-tax Act:

If a claim is made and allowed on the basis of diversion, then there will be no claim as expenditure. The claim should be made in the P & L account, above the line because such amount is not profit of company.

 However, if no claim is made as per CSR obligation, then expenses debited in P & L account for CSR spending need to be considered while computing income of company.

As per Explanation to S.37, CSR spending is not allowed as residuary revenue business expenditure allowable u/s 37. As per provisions if an expenditure is deductible under other provisions (S. 30 -36 of IT Act) it will be allowable under such provision.

If an expenditure is eligible for deduction u/c VIA, e.g. S.80G it will be deductible to the extent allowable as per applicable provision and subject to other conditions.

In this regard relevant portion of S.37 is reproduced below:

     37. (1) Any expenditure(not being expenditure of the nature described in sections 30 to 36 ¹[***] and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession".

¹³[Explanation 2.-For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession. ]

      13. Inserted vide THE FINANCE (No. 2) ACT, 2014, w.e.f. 1st day of April, 2015

Therefore, the amount spent shall not be allowed u/s 37, however, it can be allowable under other provisions.

Other article on the subject on other website:

CSR through the lens of Income Tax and GST Act also provides an insight in the matter and article is available on  https://www.caclubindia.com/articles/csr-through-the-lens-of-income-tax-and-gst-act-31862.asp

In that article also view has been expressed about deduction under sections 30-36 of the Income-tax Act, if relevant conditions are satisfied. 

Diversion before accrual:

It is well settled that if an obligation exist for diversion of any part of receipt , profit or income in favour of person other than the recipient, then such portion of receipt,  profit or income is not earned by recipient. The receipt is with a corresponding obligation to use the same in prescribed manner. CSR obligation is imposed under law. A company has to follow the same. Therefore, the CSR obligation amount is not receipt, revenue, or profit of company in its own right. That amount cannot be considered profit or gains of company. In this regard rules can be found in following judgments:

CIT Vs. Bijli Cotton Mills Pvt. Limited 1978 (11) TMI 1 - SUPREME COURT :

In this case the assessee has, as per trade practice and in terms of Board Resolution collected certain amount per bail towards Dharmada which was credited in a separate account and spent for charitable purposes. The Supreme Court held that the amount cannot be considered as income of assessee as it is received with an obligation and is therefore diverted at source by way of overriding title. The major aspects which governs the issue are discussed below:

About compulsory nature of the levy  the court held that  dharmada amounts cannot be said to have been paid involuntarily by the customers and in any case the compulsory nature of the payments, if there be any, cannot impress the receipts with the character of being trading receipts.

It is not possible to accept the submission that the customers being illiterate did not appreciate that they were paying the amounts with a view to create a trust, especially when it has been found that such payments were made pursuant to a custom which obtained in the commercial and trading community.

Being a customary levy the constituents or customers, whether literate or illiterate, would be knowing that the additional payments over and above the price were meant for being spent by the assessee for charitable purposes.

Assessee  having some discretion as regards the manner in which and the time when it should spend the dharmada amounts for charitable purposes would not detract from the position the assessee held qua such amounts, namely, that it was under an obligation to utilize them exclusively for charitable purposes.

Assessee did not keep these amounts in a separate bank account but admittedly a separate dharmada account was maintained in the books in which every receipt was credited and payment made there out on charity was debited and the High Court has clearly found that these amounts were never credited in the trading account nor were carried to the profit and loss statement.

Tribunal's finding that no trust could be said to have been created by the customers in respect of the impugned amounts will have to be regarded as erroneous in view of facts.

Impugned realizations made by the assessee from its customers for dharmada being validly earmarked for charity or charitable purposes could not be regarded as the assessee's income chargeable to income-tax.

Case of CSR vis a vis Dharmada:

As discussed earlier, in case of CSR there is mandatory statutory provision for CSR obligation. Therefore, there is legal obligation to the effect of diversion of income before accrual of income.

 Whereas in case of Dharmada there was obligation by way of customary practices and Resolution of the Board of assesse company  supported by actual practices followed by assesse company to collect Dharmada, keep in separately accounted for and to make spending out of the Dharmada Account.

In case of CSR obligation also suitable resolutions can be passed and account can be maintained. A separate bank account to deposit CSR obligation money can further make justification that the company has kept apart the CSR obligation money out of its business.

Some important judgments on issue of diversion of income are as follows:

Various judgments considered in Bijlee Cotton (supra.)

SIDDHESHWAR  SAHAKARI SAKHAR KARKHANA LTD. v. COMMISSIONER OF INCOME-TAX AND OTHERS , COMMMISSIONER OF INCOME-TAX v. SHRI CHATRAPATI SAHAKARI SHAKAR KARKHANA LTD. 2004 (9) TMI 6 - SUPREME COURT .

In all these cases CIT v. SITALDAS TIRATHDAS  1960 (11) TMI 17 - SUPREME COURT was  applied.

On application of the same, it can be said that the amount of CSR obligation is not profit and income of company.

Restriction provided in S.37 also appears to serve purpose of avoiding  double deduction firstly because  the amount of CSR obligation is not income or profit of  company by way of diversion therefore spending out of CSR obligation, if allowed u/s 37 will amount to second time deduction. Such purpose may not be expressed anywhere, however this is implied.