Sunday, January 29, 2012

Law Street in The Economic Times (January 2012)

Dear Readers,

As the press had a rare holiday on India's Republic Day, viz January 26, we did not get a printed copy of the newspaper the next day. However, my column was duly uploaded on the website.

It is likely that the Companies Bill, when reintroduced, will continue with its proposition to make CSR disclosures mandatory. That said, shouldn't the tax laws be in synch so as to propel the corporate sector towards CSR activities? Perhaps a weighted deduction for CSR activities would be a blessing. It would also reduce the litigation on whether a CSR expense is a business expenditure or a CSR expenditure. Click here to read the online edition of The Economic Times, or scroll below.

Tax Karma

CSR activities may be mandatory
Appropriate tax deductions should be introduced
The Finance Bill and Cos Bill must be in synch

Zenobia Aunty firmly believes in Karma, little wonder then, that Spot is forced to share his biscuit treats with the alley cat. In an ideal world, if a Company contributed towards the society, it would be amply rewarded by its various stakeholders in myriad ways. However, without expecting anything in return, many companies do contribute by building townships, providing funds or assets for schools, hospitals and the like. Yet, there are others who firmly believe that this is not their role and the taxes paid by them should cover take care of their social obligations.

Perhaps, it is only a matter of time before contribution towards Corporate Social Responsibility (CSR) will be mandatory. The Companies Bill, 2011, at the insistence of the opposition was withdrawn from the Parliament in the winter session, but it is likely to be reintroduced in the budget session in March. This Bill called upon corporate entities meeting certain parameters to engage CSR activities. In the budget session, the Finance Bill, 2012 will also be tabled and perhaps also the Direct Tax Code. Thus, here is an opportunity for our draftsmen to ensure that the tax laws cover the treatment of CSR expenditure.

The Companies Bill had prescribed that every Company having a net worth of Rs 500 crore or more; or a turnover of Rs one thousand crore or more; or a net profit of Rs 5 crore or more; during any financial year shall set up a CSR Committee, which would guide and monitor the company’s CSR agenda and expenditure. Companies meeting this criterion were required to spend at least 2 % of their average net profits made during the three previous financial years towards CSR activities. Proper disclosure of the CSR policy including reasons for not meeting the required expenditure was called for.

Schedule VII prescribed the various activities that would fit into the CSR policy agenda. Besides contribution to the PM’s National Relief Fund and certain other funds of the Central and State governments, the CSR activities covered those relating to eradicating hunger, promoting education or health, ensuring environmental sustainability and everything that could fall in the definition of social business projects.

Let us assume that the Companies Bill, containing mandatory CSR spend in some form or the other gets passed in the budget session. To ensure that the corporate sector gets its due recognition for such activities the Finance Bill should also contain suitable provisions providing for tax deductions for CSR activities.

At present tax exemption for cash donations can be broken up into various categories: donations which entitle the donor to a 100 % or 50 % tax exemption without any qualifying limit such as the PM’s National Relief Fund and PM’s Drought Relief Fund respectively; and donations which are subject to 100 % or 50 % deduction subject to a cap of 10 % of the adjusted gross total income. In such cases, even if you make a donation larger than 10 % of the adjusted gross total income the total donation amount eligible for a tax deduction would be capped at this 10 %limit.

The Companies Bill, by defining CSR activities has widened the field. Currently, it may be possible for a Company to treat a particular CSR related activity as a bondfide business deduction, say installation of solar panels in its office premise (which helps environment sustainability) against which it claims a tax depreciation. But, claiming expenses for a medical camp in a nearby rural district as a business deduction may result in litigation.

To avoid any further litigation on the issue, any expenditure that qualifies as a CSR expenditure, whether it be capital or revenue in nature, should be entitled to a separate tax treatment. A deduction, for tax purposes of 120-150 per cent of the CSR expenditure should be permitted with a prescribed cap. As, the Companies Bill calls for a minimum spend of 2% of the average net profits during the previous three years, perhaps a cap of 5% of this amount should be set for the purpose of claiming a tax deduction. Any excess expenditure beyond 5% should not be permitted, as this would ensure that scrupulous companies do not overspend under the CSR banner just for the sake of a tax claim.

Several companies have set up their own trusts or foundations for CSR activities. Perhaps companies may need to move these activities within the corporate fold so as to take the tax benefit. However, it would be best for the tax laws to provide that a contribution to the trust or foundation is also regarded as a CSR expenditure, provided the trust or foundation has spent that money fully during a financial year.

While internal CSR committees would bear the responsibility of ensuring that the prescribed funds are used for genuine CSR activities, appropriate tax policies would ensure clarity and also prompt India Inc to fully support this initiative.

Source of the photograph