Summary on FAQs released by ICAI on Corporate Social Responsibility, Section 135 (Companies Act 2013) provisions and rules made thereon: The Institute of Chartered Accountants of India (ICAI) has come out with its guidance note in the form of “Frequently Asked Questions (FAQ) on April 1, 2015[1] for treatment of Corporate Social Responsibility (CSR) provisions as mandated under section 135 of the Companies Act 2013 ( hereinafter referred to as the “Act”) . We know, the 2013 Act requires the Board of every company (with a net worth of Rs 500 crore or more, or turnover of Rs 1000 crore or more, or a net profit of Rs 5 crore or more during any financial year); to ensure that it spends, in every financial year, at least 2% of the average net profits made during the three immediately preceding financial years, on CSR activities. In addition, the Companies (Corporate Social Responsibility Policy) Rules, 2014 and Schedule VII of the 2013 Act lays down the framework for companies to formulate their CSR policies. In wake of these stringent provisions, it had become absolutely essential for companies to formulate their financial decisions on the CSR policies, ensuring that books of accounts clearly showcase the treatment met out to activities undertaken in this regard correctly. So far we had, two circulars[2] issued by Ministry of Corporate Affairs (MCA) to provide clarifications and additional guidance on this subject. With the launch of FAQ by ICSI, the picture of treatment of CSR provisions in company’s books of accounts looks more clearer. Let us discuss some of the significant guidelines given by ICAI with respect to noting of CSR provisions:
CSR expenditure – Capital expenditure or Revenue expenditure
The FAQs clearly mentions that any CSR expenditure that could satisfy the definition of an asset[3] should be properly acknowledged in the balance sheet of the company under specific headings as applicable with “CSR” prefix to it. For example – if a building has been constructed for CSR purpose, it may be labelled as “CSR property”. However, care has to be exercised on such assets at the time of calculating depreciation on such assets. Once the cost of the asset has been considered as CSR expenditure, any subsequent depreciation on it will not be considered, in order to avoid instances of double accounting. For assets that are under-construction as on the date of balance sheet , companies must disclose it by way of footnote in the statement of Profit & Loss Accounts (P & L) together with other CSR expenditure as expressed under Item 5(a) of the General Instructions for Preparation of Statement of Profit and Loss, Schedule III[4]. On the other side, where an expenditure does not give rise to an ‘asset’ as explained above, the same may be treated as expenditure of revenue nature and continues to be charged to P & L accounts as part of its normal business activity. However, it is important for the companies at the first place to recognize whether the amounts incurred are part of its normal business activity or not. Please note, a CSR activity excludes activities undertaken in pursuance of its ‘normal course of businesses. For example, a coffee plantation company planting trees and shrubs in close proximity to such coffee plantations cannot be classified as CSR spending since they are in the ordinary course of business of such businesses. Similarly, projects or activities that are carried out as a pre-condition for setting up a business or as part of a contractual obligation undertaken by the company or in accordance with any other law, should not be considered as CSR. For Example – environmental permits undertaken by company as per the law cannot include within CSR ambit any activity that is essentially an environmental regulation. The FAQs provides certain good examples of activities and expenditures that in the ordinary course of businesses cannot be considered as CSR expenditure.
Summarily, the FAQs provides the following expenditure out of the ambit of “CSR expenditure”:
- Activities carried out as a pre-condition for setting up a business, or
- Activities carried out as part of a contractual obligation undertaken by the company, or
- Activities carried out in accordance with or in order to comply with any other law,
- Activities that benefit only the employees and their families shall not be considered CSR expenditure, unless the benefit is also available to the general public.
Thus, CSR expenditure, incurred as part of the normal business activity (for e.g. a FMCG company distributes its ready-to-eat products free of cost to people affected by flood), the same shall continue to be charged to the statement of profit and loss. On the contrary, if the CSR expenditure is not incurred as part of normal business activity (e.g. an IT company distributes ready-to-eat products free of cost to people affected by flood), the same shall be presented as an appropriation of profit. Morover, the FAQ signifies expressly that expenditures in regards to CSR activities may be labelled under a separate item head, called “CSR Expenditure” in the profits & loss account to ease the recognition of CSR expenditure and activities. However, this is only a suggestive guideline, and companies are free to classify CSR expenditures according to their natural classification.
Treatment of profits/losses included in Net Profit from overseas branches of the Company for calculating CSR expenditure
The ICAI guidelines provides that Net Profit for the purpose of calculating CSR spend, shall not include any profit arising from any overseas branch or branches of the company, whether operated as a separate company or otherwise. Additionally, any dividend received from other companies in India, which are covered under and complying with the provisions of section 135 of the Act as well as, any dividend received from a company incorporated outside India shall also be excluded from the Net Profit. The idea behind this ruling is that CSR aims to benefit citizens of India, and CSR spent outside India does not qualify as CSR spent under Section 135 of the Companies Act, 2013. Also, as a corollary, income earned outside India shall also not be considered for determining CSR spend in India.
Disclosure guidelines on shortage and excess of CSR expenditure
As per the guidelines of ICAI’s FAQs, any shortfall in the CSR expenditure from the 2% threshold shall not be recognised as a provision for CSR expense unless it meets the recognition criteria of the relevant accounting standard. On the other hand, if a company incurs CSR expenditure in excess of the 2% threshold in a financial year, the same shall not be counted towards the 2% threshold in the subsequent financial years. The FAQs remarks that it is imperative for the company, while explaining the shortfall, if any, in its annual report of such subsequent financial years, should also be entitled to disclose such excess spending in the past.
Actual CSR spend v. Amount earmarked but not yet spent
The FAQs provides that companies shall consider only such amount as CSR expenditure which has been put to actual expenditure for the purpose it was intended to. If the company has only earmarked an expense for undertaking CSR activity in future and has not put to use the designated expense, the company can in no way automatically consider it in its books of accounts. For example – if a company has earmarked funds to be contributed towards slum development on account of sales of its product made in a month, such expenditure shall qualify for CSR expenditure only when the actual expense on slum development has been undertaken by the company.
Expenditure on training
The FAQs clarifies that any expenditure incurred on training of existing employees will not qualify as CSR expenditure. However, if a company incurs expenditure on skill development for apprentice trainees, cost of such training shall be eligible to be considered as CSR expenditure. For e.g – expenditure incurred for training eligible candidates for faculty or staff positions, can be attributed as a CSR training expenditure and therefore, considered accountable. This is irrespective of the fact that such training may increase the employability of the apprentices and that the company may actually hire the apprentices as full-time employees at the end of their apprenticeship.
CSR activities undertaken through charity organisations, NGO’s etc.
The FAQs provides that companies deciding to make contributions through charities, NGOs, Section 25 companies etc. Can expressly consider such contribution as a CSR expenditure provided they meet the track record and other criteria as per Rule 4(2) of the Companies (Corporate Social Responsibility Policy) Rules, 2014 (CSR Rules)[5].
Guideline on Net Profit
As per the FAQs released by ICAI, Net Profit as per Section 135 is required to be calculated as per Section 198[6] of the Companies Act, 2013. Presently, Net profits as defined in the Companies (CSR Policy) Rules, 2014 defines Net Profit as - Net Profit as per financial statements prepared in accordance with the Act. Since the Rules specify that the net profits are as per provisions of the Act and the relevant Section 135 of the Act requires such net profits calculations to be done as per Section 198 of the Companies Act 2013. In light of such circumstances, it is important that the net profit be calculated as per section 198 of the Companies Act. This is based to construe a harmonious interpretation of the specific section in the Act and the relevant Rules framed under that Section. Overall, the FAQs released by ICAI is an extremely important note for helping companies prepare their financial statements for the year ending 2014-15. The express solutions to specific queries posted for provisions u/s 135 of the act will go a long way in preparation of correct financial books of accounts by the company.
[1] “ FAQ on the provisions of CSR under Section 135 of the Companies Act 2013 and rules made thereon”, I Corporate Laws & Corporate Governance Committee, ICAI, 1st April 2015. Available at [x], last accessed 8th April 2015 [2] Available at [x] dated 27th Feb 2014 and [x] dated 18th June 2014; last accessed 8th April 2015 [3] An asset is defined as a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise [4] Available at [x], last accessed on 8th April 2015 [5] Ministry of Corporate Affairs, dated 27th Feb 2014, Pg 7; Available at [x], last accessed 8th April 2015 [6] Section 198 of the Companies Act 2013 lays down provisions to calculate profits of the company. Available at [x], last accessed 8th April 2015