The Ministry of Corporate Affairs (MCA) with a view to roll out the requirements of Corporate Social Responsibility (CSR) from the beginning of the new financial year 2014-15 as proposed by the Hon™ble Minister of Corporate Affairs have come out with three notifications on February 27,2014 which are as under:
1) Vide the first notification which has been issued by virtue of the powers conferred u/s 1(3) of the Companies Act,2013(The Act),the appointed date for the operation of section 135 in the Act and Schedule VII there under have been fixed as April 1,2014.It is pertinent to note that under the above provision, which was incidentally notified on September 12,2013 ,the Central Govt. is empowered to appoint different dates for the coming into force of the different provisions of the Act.
2) In exercise of the powers conferred under Section 467(1) of the Act, amendments have been made to Schedule VII of the Act and the activities encompassing CSR have been enlarged. Under Section 467(1), the Central Govt. has the authority to alter by notification any of the regulations contained in any of the Schedules to the Act. It is however , necessary as ordainedby Section 467(3) that the alterations so made are laid before both Houses of Parliament while it is in session for a period of thirty days either entirely in one session or in two or more successive sessions .Both Houses shall be authorized to make such changes to the regulations to the Schedule as deemed appropriate. The modification or annulment so made shall not, in any way, vitiate the validity of any action taken on the basis of the regulations in the Schedule that existed prior to the modification or annulment.
3) By virtue of the third notification which has been issued conjointly under the aegis of Section 135 and section 469(2) of the Act, the Central Govt. have issued the Rules called Companies (Corporate Social Responsibility Policy ) Rules 2014.These Rules will substitute the draft Rules which were circulated in the public domain previously for debate and the final version of the Rules do take into consideration suggestions received from various stakeholders. It may be noted that the above Rules have been framed in line with the authority bestowed upon the Govt. to make rules in respect of all or any matters which under the Act are to be administered by the issuance of appropriate Rules.
It is significant to note that Section 469(3) provides that any rule that is prescribed by the Govt. under sub-section (1) ibid may contain the stipulation that any contravention thereof may entail a penalty by way of fine which may extend to Rupees five thousand and if the contravention is of a continuing nature there may be a further fine of Rupees Five Hundred for every day after the first during which the contravention continues. From a plain reading of the CSR Rules above it is seen that the Rules do not contain the penalty clause as contemplated in Section 469(3).
It is also important to note that Section 469(4) ordains that the Rules notified be placed before parliament exactly on the lines stated in Section 467(3) as enumerated above.
Analysis of the CSR Rules
Against the above backdrop, it would be meaningful to analyze as under the contents of the CSR Rules.
Rule 2( c) provides a definition to the term CSR. Readers may recall that under the draft CSR Rules circulated earlier, Rule 3(b) provided that CSR means CSR as defined in Section 135 of the Act. Ironically Section 135 does not contain any definition of CSR. Thus the drafting aberration that existed in the draft Rule 3(b) now stands obliterated by the appropriate definition of CSR as provided by Rule 2(c ).
Net Profit defined- Is the definition legally tenable
Rule 2(f) provides that Net profit shall mean the net profit of a company as per its financial statements prepared in accordance with the applicable provisions of the Act but shall not include the following:
i) Any profit arising from any overseas branch or branches of the company, whether operated as a separate company or otherwise and
ii) any dividend received from other companies in India which are covered under and complying with the provisions of section 135 of the Act.
It would be appropriate at this juncture to look at the Explanation contained in Section 135 which states that for the purposes of this section average net profit shall be calculated in accordance with the provisions of Section 198.
Section 198 contains a list of items against which credit hall not be given/items which are not deductible while computing the net profits of for the purposes of Section 197.Although the Section does not specify that the formula provided therein can be extended for the purposes of any other provision of the Act, in as much as section 135 contains the Explanation quoted above, it willy-nilly follows that the formula prescribed by section 198 has to be necessarily applied for the purposes of Section 135.
It is pertinent to note that Section 198 does not consider the exclusions carved out by Rule 3(f) as reproduced partially above. Having said this, the important question that arises is whether the contours of any provision in the mother Act can be extended through sub-ordinate legislation. The two items of exclusion provided in Rule 3(f) do not figure in Section 198.It can therefore be stated that Rule 2(f) contains provisions which are inconsistent with the provisions of the Act. It is a settled judicial principle that sub-ordinate legislation cannot override the provisions of the statute and if so does, it is to be deemed unconscionable. There exist a catena of judicial pronouncements to support the view that sub-ordinate legislation by way of Rules cannot override the provisions of the Statute under which they are made. The following citations can be quoted in support of the above postulate.
i)Assistant CIT Vs. Tusnial Trading (61 ITTJ)(Gau.700)
ii)Rallis India Ltd.Vs.State of Andhra Pradesh (1980 AIR 749)
iii)Shish Chand and others Vs .Bhagwan Pershad (ILR1973 Delhi 698)
In the light of the above, it is submitted humbly that Rule 2(f) to the CSR Rules may not stand the test of judicial scrutiny if subjected to challenge before an appropriate forum.
We would also submit that the exclusions provided in Rule 2(f) ought to have been inserted through a statutory amendment to section 198 of the Act which of course could be done only through parliamentary procedure and sanction .
Assuming but not admitting that Rule 2 (f) is tenable, we would state that the proviso to the above Rule stipulates that the net profits for the relevant financial years determined in accordance with the provisions of the Companies Act,1956 need not be re-computed in accordance with the provisions of the Act.
The second proviso to Rule 2(f) clarifies that in the case of a foreign company which comes within the CSR requirements its net profits will have to be computed in accordance with Section 381 (1)(a) read conjointly with Section 198 of the Act. It is interesting to note that neither Section 198 nor section 381 have been notified yet for operation.
CSR Compliances are company specific
Rule 3(1) which has inadvertently been numberd as Rule 8 makes it abundantly clear that the CSR requirements are to be complied with by every company which satisfies the criteria laid down in section 135(1) on a standalone basis. The Rules will apply to the Holding company as also to its subsidiary. There will therefore be no aggregative approach for CSR spends in the context of a group of companies. A foreign company which has either a branch office or project office in India will have to comply with CSR requirements subject to the company meeting the prescribed criteria.
Rule 3(2) lays down the exemption clause, so to say, where it comes to compliance. Any company which drops short of the criteria provided in section 135(1) for a consecutive period of three financial years will be exonerated from the requirement of constituting a CSR committee as also from ensuring other compliances contemplated u/s 135 for the period it does not meet with the criteria in section 135(1).
Rule 5 CSR Committees-Does Rule 5(1) override the statutory provisions in section 135(1) of the Act
Rule 5(1)provides that an unlisted public company or a private company which is covered u/s 135(1) which is not required to appoint an Independent director pursuant to sub-section(4)of section 149 of the Act can have a CSR Committee without an Independent director.
Readers are aware that CSR requirements are to be complied by every company including a private company which meets the prescribed criteria. Section 135(1) provides that every such company should set up a CSR Committee of the Board which should consist of at least one Independent Director. The requirement of appointing an independent director is therefore thrust upon a private company which falls under the ambit of Section 135(1).
Rule 5 (1) as above negates the need for appointing an independent director in a private company. Thus private companies get a huge reprieve from the onerous responsibility of having an independent director on board due to the insert of the above Rule.
In as much as the requirement appointing an independent director as part of the CSR Committee is enshrined in the Statute itself u/s 135(1),the question that emanates is whether Rule 5(1) above would have the legal force to displace a statutory provision.
The Supreme Court has held in Hukamchand Vs Union of India (AIR 1972, SC2427) that the power to make subordinate legislation is derived from the enabling Act and it is fundamental that the delegate on whom such a power is conferred has to act within the limits of authority conferred by the Act.
The Apex Court has also observed in St.Johns Teachers Training Institute Vs Regional Director(2003)3SCC 321 at page 331) that Rules cannot be made to supplant the provisions of the enabling Act but to supplement it.
The above observations of the Apex Court are relevant in the context of this discussion and certainly cast a shadow of doubt as to the validity of Rule 5(1) as it has the effect ,in a sense, of diluting or overriding the statutory provision contained in section 135(1) of the Act.
We would also point out that the CSR Rules have been notified in exercise of the powers conferred under sections 135 and 469 of the Act . It is pertinent to note that Section 135 does not empower the Central Govt. to notify any sub-ordinate legislation. We have discussed above the provisions contained in Section 469 which empower the Central Govt. to make rules for carrying out the provisions in the Act.
We may now turn our attention to Section 462 of the Act which empowers the central Govt. to ,inter alia, direct ,in the public interest, by notification that any of the provisions of the Act shall not be applicable to such class or classes of companies as considered appropriate. We have explained above that Rule 5(1) has the effect of supplanting the provisions of Section 135 (1) in terms of which the requirement of appointing at least one independent director in the CSR Committee applies to every company which satisfies the criteria laid down in the said section. If companies belonging to a particular genre are to be exonerated from the rigours of a particular provision, the right course would have been to invoke the powers provided by Section 462. It is pertinent to note that as specified in Section462(2) the copy of every notification proposed to be issued under this Section has to be placed in draft form in both houses of parliament when it is in session and the notification can be issued only after the same is approved by both houses.. Having regard to the fact that parliament is not in session , for facility of disposal, the CSR Rules have been notified u/s 469. Rule 5(1) ought to have been issued in our view , only through authority conferred u/s 462 for it to be legally sustainable.
Tax admissibility of CSR Spends
The amendments made to Schedule VII of the Act have widened the canvas of CSR activities. One conspicuous omission from the original list of activities is that contributions made to funds set up by the state Governments for socio-economic development and relief and funds for the development of scheduled castes etc will not be considered as CSR spends.
The draft CSR Rules issued earlier provided that tax treatment of CSR spends shall be in accordance with the Income Tax Act as may be notified by the CBDT. The final rules now notified do not throw any light on the tax treatment to be accorded to CSR spends. Given the fact that the CSR requirements will kick in come April 1, 2014 ,corresponding to Assessment year 2014-15, the Income tax law should be suitably tweaked to accommodate CSR spends. As per the existing provisions in the Income Tax Act,1961, CSR expenditure can be conceivably admitted only under the residual provisions of section 37. There are three conditions as given below which have to be satisfied in Section 37 for any expenditure to be allowed as a business deduction .
1) The Expenditure should be incurred wholly and exclusively for the purposes of business.
2) It should not be in the nature of capital expenditure.
3) It should not represent personal expenses of the Assessee.
CSR spends can be capital in nature such as the construction of a school building, old Age home etc which cannot pass muster u/s 37.Further in the case of several spends for CSR, the nexus between the expenditure and the business cannot be strongly established. Hence unless the provisions of the Income Tax Act are appropriately enabled to admit CSR spends incurred both on revenue and capital account, India Inc will certainly not be over-enthused in embracing the CSR obligations.
The CSR Rules notified do clear to some extent the cobwebs of doubt that existed before. However, a lot is yet to be said and done in particular the tax status of CSR spends. Time is running out in so far as putting in place the amendments in the Taxation law is concerned. Also, as pointed out in our discussion, the legal sustainability of the amendments are not beyond a shadow of doubt.
It should not therefore end up as a story of the cart being put before the horse.