Legal Background
As per provisions of section 135 of the Act and the rules made thereunder, every company having a (i) net worth of Rs. 500 crore or more, or (ii) a turnover of Rs. 1,000 crore or more, or (iii) a net profit of Rs. 5 crore or more during any of the 3 preceding financial years is required to spend on CSR activities in accordance with the provisions of the Act and the relevant rules.
As per provisions of section 135(5) of the Act, the Board of every company mentioned aforesaid “shall ensure” that the Company spends, in every financial year, at least 2% of its average net profits during the 3 (three) immediately preceding financial years, in pursuance of its CSR Policy.
If the Company fails to spend such amount, the Board is required to specify the reasons for not spending the amount.
In case a company does not disclose the reasons in the Boards’ report, the company shall be punishable with fine which shall not be less than Rs. 50,000 but which may extend to Rs. 25,00,000 and every officer of the company, who is in default shall be punishable with imprisonment for a term which may extend to 3 (three) years or with fine which shall not be less than Rs. 50,000 but which may extend to Rs. 5,00,000, or with both.
Neither section 135 nor any other provisions of the Act prescribe for any penal provisions specifically in the event a company fails to spend the prescribed amount of CSR expenditure. Even the Companies (Corporate Social Responsibility) Rules, 2014 do not contain any penal provisions.
However, section 450 of the Act provides that if a company or any officer of a Company or any other person contravenes any of the provisions of this Act or the rules made there under and for which no penalty or punishment is provided elsewhere in the Companies Act, 2013, the company and every officer of the company who is in default or such other person shall be punishable with fine which may extend to Rs. 10,000 and where the contravention is continuing one, with a further fine which may extend to Rs. 1,000 for every day after the first during which the contravention continues.
Issue
As per section 135 of the Act, if a company fails to make the CSR expenditure, the Board of directors of that company has to specify the reasons for not spending the amount in the Board’s report.
As mentioned, neither section 135 nor any other any other provisions of the Act prescribe for any penal provisions specifically when a company fails to make the prescribed amount of CSR expenditure.
In view of the aforesaid provisions, the following issue arises for consideration:
Whether a company and / or any of its officers, directors etc can be penalized for not spending on CSR activities (even though the company has specified the reasons for not spending in the Board’s report) and if yes, then under what provisions of the Act and to what extent?
Views
In support of the interpretation that CSR is not mandatory (i.e. Section 135 mandates a “comply or explain” principle)
Though section 135 of the Act requires the Board of the Company to ensure that the Company spends the amount on CSR, as per the said section, if the Company fails to make the CSR spending, the Board of directors of the Company is required to specify the reasons for non-spending in the directors’ report. While the Act provides for penalty provisions for non disclosures under the director’s report, it does not contain penal provisions specifically for non spending on CSR. If it was the intention of the Legislature to penalize the company and / or its officers for not spending on CSR even when the company has justified the reasons for non spending in the directors’ report, then section 135 or any other provisions of the Act would have specifically contained penal provisions for such non spending. However, as mentioned, neither section 135 not nor any other any other provisions of the Act prescribe for any penal provisions specifically if a company fails to spend the prescribed amount of CSR expenditure. Therefore, one may infer that neither the Company nor any of its officers, directors etc can be penalized if the company does not spend on CSR provided the Board of directors of the company specifies the reasons for non spending in the directors’ report.
The requirement of specifying the reasons for non spending in the directors’ report under section 135 has been stipulated by way of a “proviso”. It is a well settled rule of interpretation that a “proviso” carves out an exception to main operative parts of the section and its object is to cut down or qualify something which has gone before. It has a limitation upon effect of the main provisions. While section 135(5) requires the Board of directors of the company to ensure that the company spends on CSR activities, as per the proviso to the said section, if a company fails to make the CSR expenditure, the Board has to specify the reasons for non spending in the Board’s report. Hence, it may be argued that even while ordinarily, a company is mandatorily required to spend on CSR, but the effect of the said mandatory compliance is qualified and limited when the Board specifies the reason for non spending in the Board’s report. Therefore, if the company fails to spend on CSR and if Board of the company specifies the reasons for non spending in the directors report, then neither the Company nor any of its officers shall be liable to any penalty under any provisions of the Act because then effectively there is no contravention of provisions of section 135 of the Act.
Section 135 of the Act requires the Board to specify the reasons for non spending on CSR, if the Company fails to do so. Dictionary meaning of failure is “the neglect or omission of expected or require action”. Therefore, in a way, section 135 of the Act already provides for a penalty or a consequence if the company fails to make the CSR spending; and that penalty / consequence is specifying the reasons for non disclosure. Therefore, if the reasons are specified in the Board’s report, then there is no other penalty / consequence which would entail upon the Company.
In support of the interpretation that CSR is mandatory and the company can be penalized for non spending even when its Board of directors has specified the reasons for non spending in the directors’ report
As per provisions of section 135(5) of the Act, the Board of every company mentioned aforesaid “shall ensure” that the Company spends, in every financial year, at least 2% of its average net profits during the 3 (three) immediately preceding financial years, in pursuance of its CSR Policy. The expression used in the section 135 is “shall ensure” which means “to make sure”. The phraseology does suggest that there is a mandate to spend 2% of average net profits of last 3 years on CSR activity. The language of section 135(5) was amended specifically on Standing Committee’s advice to remove the words “make every endeavor to” at the stage of passing of the bill in Lok Sabha and replace the same with the words “shall ensure” thereby signifying the intention of the legislature to have the CSR expenditure mandatory.
The objective of introducing Corporate Social Responsibility was clarified by a Minister in the Rajya Sabha Debate that:
a. The amount of CSR to be expended (2% of profits) is not a cess or tax. The money is not flowing to the coffers of the Government. All that is intended through Corporate Social Responsibility is the Companies should put this money as investment into those communities where they are drawing their manufacturing & earning revenue.
b. The intent behind CSR expenses is to ensure that Companies which essentially derive their revenue from the communities in which they operate, a part of the same be returned to the community for its betterment & welfare.
In view of the aforesaid statements made in the Rajya Sabha debate, the intention of the Parliament is clear that the CSR expenditure should be made mandatory. Now, if one was to take the interpretation that companies cannot be penalized for non spending on CSR by simply specifying the reasons for making the non spending in the directors’ report, then the same would not only defeat the purpose of making the CSR expenditure mandatory, it would also cause unreasonable result and grave misuse and whereby the companies may try to wriggle out the CSR obligations simply by specifying the reasons for non-spending.
The compliance of specifying the reasons for non spending on CSR under the directors’ report is an additional obligation casted upon the Board of the Company in case it fails to spend on CSR. It does not create an escape route from being penalized if the companies do not spend on CSR simply by way of providing reasons in the Board’s report. Further, there is no mechanism / parameters provided under the Act to evaluate the veracity of the reasons specified in the Report for not making the CSR expenditure. In absence of the same, it would be easy for the Boards of the companies to avert making CSR expenditure by simply specify the reasons in their reports.
Even while there are no penal provisions provided under section 135 of the Act, section 450 of the Act clearly mentions that if a company or any officer of a Company or any other person contravenes any of the provisions of this Act or the rules made there under and for which no penalty or punishment is provided elsewhere in the Companies Act, 2013, the company and every officer of the company who is in default or such other person shall be punishable with fine which may extend to Rs. 10,000 and where the contravention is continuing one, with a further fine which may extend to Rs. 1,000 for every day after the first during which the contravention continues. Therefore, if the company contravenes the provisions of section 135 of the Act with respect to non spending of the mandatory CSR amounts, then the company and its officers in default may be penalized in accordance with the provisions of section 450 of the Act.
Final comments
In consideration of the aforesaid two divergent views and as there is no authoritative legal jurisprudence on whether companies would be penalized for not pending on CSR (even if they make disclosures under the Board’s report); but given the intention, object and spirit of the CSR provisions stipulated under section 135 of the Act and also taking into consideration the penal provisions which may ensue on the company and its officers in case of contravention, it is advisable that the Board of the directors of the Company makes best efforts in making CSR expenditure in accordance with the provisions of the said section.
It is also pertinent to keep in mind that as per the definition of the term “officer who is in default” as provided under section 2 (60) of the Act, “every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance” is also regarded as an officer who is in default. Therefore, if the director is an independent director who is aware of contravention of non spending on CSR and she / he does not object to the same, he may also be regarded as officer in default and may be liable to penalty.
About Bulwark Solicitors
Bulwark Solicitors is a law firm pioneered by Solicitor Chirag Sancheti and Advocate Deep Shridharani. The firm has expertise in the areas of both Litigation and non-Litigation. Under the non-litigation Law practice, the firm practices in the areas of Corporate Law, Intellectual Property Law, Bankruptcy & Insolvency Law, Competition Law, Real Estate and Conveyancing and DTAA Advisory. Further, under Corporate Law area, we practice Company Law, Securities Law, Mergers and Amalgamations, Private Equity and Venture Capital Investment Transactions, Legal Due Diligence and Foreign Exchange Management Law.