Social spending for social companies: The paradox of CSR spend for not-for-profit companies

Ankit Singh Mehar, Assistant Manager | corplaw@vinodkothari.com

Statutory provisions for mandatory CSR spending envisage that companies go out of their business models, and “give back to the society” at least to the extent of 2% of their net profits. The underlying principle is that before the profits are distributed to the stakeholders, companies should contribute a minimal amount on social engagement. However, how do we relate this requirement to a company which does not exist for profit-making? How do we relate it to a company which cannot distribute even one penny, in whatever form, to its shareholders? Or all the more importantly, how do we relate this to a company whose business model itself is for some social good? It is formed for, and exists for social good, and that is what it does. So how does the company spend that 2% on social good, if that is what the company does with all that it earns?

We are talking about section 8 companies, which are commonly referred to non-profit organizations (NPOs), or not-for-profit (NFP) companies. A lot of NPOs exist in non-corporate form – e.g. trusts, where the question of applying sec 8 of the Companies Act, 2013 (‘‘Act’’) will not arise. However, there is an increasing number of NPOs registering as sec 8 companies. As on October, 2024^[1][2], there are 52000+ companies registered as sec 8 companies in India, of which nearly 40,000+ companies are registered on Darpan Portal.^[3] These companies may not exist for profits, but of course, they may make profits. If they make profits, the question of applicability of sec. 135 of the Act comes – whether a 2% of the average profits needs to go “outside the business model” into activities that are listed in Schedule VII.

Before we delve any further, it is important to note that not every company licensed u/s 8 is engaged in activities listed in Schedule VII. To cite examples: a sec 8 co may be running a hospital or educational institution which serves the higher segments of the population pyramid. A sec 8 co may be running a microfinance business or be running as an industry association such as Association of Mutual Funds in India (AMFI) or Association of Registered Investment Advisers (ARIA). The key feature of a sec 8 is the bar on distribution of profits, whereas Schedule VII has a list of activities which are treated as CSR-eligible.

So, the questions that we are trying to answer in this write up are:

• Will a company, whose business model is to carry the activities listed in Schedule VII, for the masses and social good, have to spend 2% of the profits on CSR over and above their routine spending?
• Will a company, whose business model is to carry the activities listed in Schedule VII, but not for masses or BoP (base of pyramid) segment, have to spend 2% of the profits on CSR?
• Will a company, whose business model is to not engage in activities listed in Schedule VII, have to spend 2% of the profits on CSR?
• In either case, even if there is no spending requirement, will the company have to do procedural compliance, viz., a CSR Committee, to examine the obligations of the company from a large social perspective, and give a report to the Board whether the company at all needs to go beyond its domain and spend on a larger social good?

Fitting into the ‘frame of CSR’ – the paradox!

A company required to spend on CSR is inter-alia required to ensure two things while selecting for an activity / project to be undertaken:

1. The activity / project proposed to be undertaken should be covered under the Schedule VII of the Act; and
2. The activity / project proposed to be undertaken should satisfy the condition set out under rule 2(1)(d) of CSR Rules^[4].

Rule 2(1)(d) of CSR Rules inter-alia states that an activity undertaken in pursuance of normal course of business of the company cannot be undertaken as a CSR activity / project. Now, for a section 8 company which undertakes activities covered under Schedule VII of the Act in its normal course of business, complying with section 135 would become an impossibility. On one hand, such a company is obligated to spend 2% of its net profits on Schedule VII activities. On the other hand, if the company does so, one may also contend that such activity is in its normal course of business which is prohibited under the regulatory framework for CSR.

Further, Section 8 companies can also act as an ‘implementing agency’ for the companies covered u/s 135(1) of the Act. An implementing agency essentially undertakes CSR activities / Schedule VII activities on behalf of a company. Therefore, even for a section 8 company acting as an implementing agency, it is engaged in Schedule VII activities in its normal course and being as such it is likely to receive restricted funds specifically provided for implementing CSR projects. Accordingly, if a sec. 8 company undertakes any Schedule VII activity to fulfil its own CSR obligation, it may, in effect, be pursuing an activity that forms part of its normal course of business, thereby conflicting with the prohibition under the CSR regulatory framework.

Another interesting situation to be noted is a case where a sec 8 company being an implementing agency or a beneficiary receives restricted funds which could not be entirely spent in a particular financial year due to a number of reasons, say, disbursement by a company just before conclusion of the financial year. In such a case, it will be absolutely illogical to consider the increase in the net profit of the company to the extent attributable to unutilized restricted funds. The reasoning is simple – when the company does not have the discretion to use these funds freely and they are earmarked for a specific purpose, considering such amounts as income and hence, part of profits for the company in the context of CSR applicability or spending should be incorrect.

Now, coming back to the issue, even if one takes the view that such section 8 company may undertake, as a CSR activity / project, any Schedule VII activity other than those it already undertakes in its normal course of business, this contention would be counterintuitive, as it would essentially create no distinction between the activities such section 8 company is already undertaking and the ones it would otherwise be required to pursue.

Regulator’s take on the issue

The position discussed in the Report of the Companies Law Committee^[5] is as follows:

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The High level CSR Committee had recommended for Section 8 companies to be exempted from the provisions on CSR. It had been noted by the said Committee that “Section 8 companies are ‘not for profit’ companies registered under Section 8 of the Companies Act, 2013 (Section 25 of Companies Act, 1956) with the basic object of working in social and developmental sector. Their involvement in charitable and philanthropic activities is already 100 percent. These companies prepare income and expenditure statements which reflect the surplus/deficit of an organization and not the profit of the company. The surplus accrued to such company is not distributed amongst members, but is ploughed back to the expenditure of the company, that in turn is spent on social welfare activities already included in Schedule VII. Therefore, it may be not necessary for these companies to undertake CSR activities outside the ambit of their normal course of business.” The Committee, however, felt that it would not be appropriate to give differential treatment to section 8 companies in the matter of providing exemptions from compliance of CSR provisions, as there are certain areas where examples could be found of section 8 and other companies co-existing, for example, companies in microfinance business. Further, there should not be a difficulty in section 8 companies using the prescribed percentage of its surplus for CSR activities. Thus, it was decided not to recommend for exemption of Section 8 companies from the CSR provisions of the Act.

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The recommendations of the High Level CSR Committee (’HLC’) were not accepted and no exemption was conferred upon section 8 companies from the CSR provisions. However, the views of the HLC are still relevant for a section 8 company which is otherwise engaged in Schedule VII activities in its normal course of business. Their contribution towards CSR activities is 100 percent (far beyond the regulatory threshold of 2% of networth). Therefore, requiring them to comply with the CSR provisions seems to be quite quixotic.

Worthwhile to note that even the FAQ of ICSI on section 8 company states that a section 8 Company would not be considered as compliant with CSR provision if it contributes the CSR amounts towards its own activities which may be charitable in nature and in line with the CSR approved.

7.2 Is Section 8 Company compliant if it contributes the CSR amounts towards its own activities which may be charitable in nature and in line with the CSR approved areas of spent?

No, spending by the company in its own activities will not qualify as CSR spend. The amount needs to be spend on activities other than normal activities of the company and not for the benefit of the company or its employees.

Seemingly, the FAQ confirms, to some extent, the paradox discussed above. However, we humbly hold a different view for the reasons discussed below.

What looks like a sensible interpretation?

1.     For sec 8 companies carrying on CSR like activities and reaching masses

To take a view on the subject matter, one may look into the basic intent of the CSR provisions. The idea behind CSR is to ensure that besides the business motive, companies should be doing ‘social spending’ so that it gives back to the society from where it is earning its bread and butter. In other words, the idea is that besides distributing the profits to the shareholders, a company is also expected to undertake certain activities for the welfare of the society by taking out certain portions of its profits. A section 8 company engaged in Schedule VII activities in its normal course of business is already fully engaged in social development and contributes significantly towards social causes. More so, their entire profits are applied towards social activities only. In this way, one can logically conclude that such a section 8 company is already compliant with the true spirit of CSR.

Therefore, for a section 8 company discussed above which is covered u/s 135(1) of the Act, the sensible interpretation would be to ignore the stipulation mentioned under rule 2(1)(d)(i) of CSR Rules which states that ‘activities undertaken in pursuance of normal course of business of the company’ are not in the nature of eligible CSR activities. To contend otherwise would be to fall squarely into the paradox discussed above. Accordingly, in our view, while all the other requirements envisaged in CSR provisions including constitution of CSR committee, formulating a CSR policy, preparing a CSR report etc., would require to be complied by a section 8 company, it may consider not to undertake a separate CSR activity/ project and spent 2% of its net profit thereon since the activities undertaken by its are eligible CSR activities itself. In this regard, the committee or similar body in a section 8 company should take note of such a situation and explicitly take note of the fact that since it is already pursuing CSR activities by the nature of activities, it need not spend funds additionally for some other project thereby putting its existing projects at stake.

Accordingly, in this case, the compliances that would be required to be observed in this case would be as follows:

1. Constitution of CSR committee
2. Formulating a CSR policy (wherein the said policy should include a reference of this interpretation in the context of mandatory CSR spending) and making the same available on the website of the company;
3. Approval of the minimum budget and Annual Action Plan (here the AAP would refer to include those spending areas for the specific year which are to be considered for this obligation);
4. Monitoring of the specific part of the spending that is considered to be made as a part of CSR spending; and
5. CSR Reporting i.e. providing CSR report in the Board’s report and filing of form CSR-2.

For example: say a company is spending INR 15 lacs across three projects (Project 1: Healthcare – 10 lacs, Project 2: Education – 4 lacs and Project 3: Sports – 1 lac). Suppose the CSR obligation of the company comes to INR 1 lac. Now, for the purpose of compliance, the company may consider the expenditure towards Project 3 as its CSR expenditures. Accordingly, the following shall also ensue:

1. The AAP shall contain details about Project 3 in manner set out in rule 5 of CSR Rules
2. The spending on Project 3 shall also be reported in the CSR report forming part of the board’s report and form CSR-2.
3. The CSR committee shall be required to monitor the progress of Project 3 on a periodic basis.

2.     For sec 8 companies either not carrying out CSR like activities or those serving the privileged segment of society

Unlike the views shared above, the same cannot be applied in cases where the sec 8 company is not serving the BoP segment of the society. For such entities, the intent is not to serve or reach out to the masses but to serve the privileged segment of the society. In doing so, the cost for the services offered is so high that a normal public cannot afford and therefore, even though the nature of service is that of a social good, it is limited to the privileged section of the society. In such cases, if the sec 8 company falls under the ambit of mandatory CSR spending, it needs to go out of its normal course of business and actually carry out CSR activities based on its CSR policy and comply with all other requirements as would have been made applicable to any other non-sec 8 company covered under section 135 of the Act. On the other hand, for sec 8 companies not pursuing CSR like activities (as in those falling under Sc VII), there also the need to comply with the CSR spending and other related provisions will be made applicable.

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Read our other resource material on CSR here

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^[1] https://sansad.in/getFile/loksabhaquestions/annex/183/AU5_HFf4SO.pdf?source=pqals&utm

^[2] https://cag.gov.in/webroot/uploads/download_audit_report/2021/Report%20No.%2016%20of%202021_E%26SM_English_PDF%20A-061c1b9cbe2d147.22751655.pdf?utm#page=34

^[3] https://ngodarpan.gov.in/#/

^[4] means Companies (Corporate Social Responsibility Policy) Rules, 2014

^[5] https://prsindia.org/files/bills_acts/bills_parliament/2016/Report_of_the_Companies_Law_Committee_3.pdf#page=47