Mandatory CSR: A win-win?

Mandatory CSR: A win-win?

Amid all the bad press the mandatory CSR has received, Akshaya Kamalnath and Ashrita Kotha attempt to demystify and look at the policy implications of the provision which is the first of its kind in the world.

Akshaya Kamalnath is a doctoral student at the University of Newcastle.  Ashrita Prasad Kotha is pursuing her BCL at the University of Oxford.

Although there is panic about the government dangling the sword of ‘mandatory’ corporate social responsibility (CSR) spending over corporates, it is important to take a step back to understand what the Companies Act, 2013 (the Act) actually says about CSR. It may turn out to be a win-win for all concerned.

Section 135 of the Act requires that companies of a certain size (those with a net worth of at least ₹500 crore or turnover of at least ₹1,000 crore or a net profit of at least ₹5 crore during any financial year) must spend a minimum of 2 per cent of its average profits of the past three years on CSR activities. While this requirement definitely sounds mandatory, the only consequence for companies failing to spend this amount is that they are required to give reasons for the failure in their annual report. Thus, although it is technically a mandatory obligation, the penalty for non-fulfilment is merely drawing shareholders’ attention to the fact of non-compliance. This has the potential of making companies focus more on reputational value.

Critics argue that companies can use CSR as a competitive strategy only if it remains voluntary. However, in the way the Act conceives CSR, while spending 2 per cent of the preceding three years’ profit is required, companies are free to spend more than this minimum and devise innovative ways of spending to have a greater impact on society.

Enhancing reputations
It is precisely for such innovation that Section 135 requires companies to which it is applicable to appoint a CSR committee comprising three or more directors, including an independent director to decide policy. Again, in the spirit of drawing shareholders’ attention to this, the Act also requires that the CSR policy is displayed on the company’s web site. The only restriction is that it has to be framed within the categories specified. But there is still ample scope for innovation as the categories are broadly listed.

Therefore, contrary to all the doom-and-gloom predictions about mandatory CSR, the Section provides an opportunity for companies to take advantage of shareholder attention and to use it not only to make meaningful social contributions but also gain reputational capital from it. From society’s perspective, the Section pushes companies to spend a miniscule portion of their profits for society, while, from shareholders’ point of view, it ensures transparency by requiring that the annual report show what activities the CSR fund was spent on or, if there was no spending, the reasons for this.

Not a tax
The 2 per cent rule does not operate as a tax. A company that does not incur the CSR expense is only required to justify the omission to its shareholders. A tax is a compulsory exaction, levied, collected and spent by the government. The CSR spend is neither imposed nor collected and spent by the government. The CSR expense structure is meant to help identify the specific social initiatives taken by a company and thus highlight its contribution to society. If it is subsumed within the framework of a tax, the prerogative of how much to spend and for which initiatives would be that of the sovereign. CSR spending that aims to form a part of the company’s competitive strategy cannot, thus, be designed as a tax.

Policy angle
One valid policy question one may ask at this juncture is whether the CSR spend is justified in light of the existing gamut of taxes a company pays. These taxes are already supposedly used by the government to finance social programmes and services. Then, what is the rationale for CSR spending, over and above these taxes?

The answer may be found by observing some other policies of the government. A company wishing to undertake foreign investment in the multi-brand retail sector has inter alia to commit to spending 50 per cent of the FDI in back-end infrastructure over a three-year period and satisfy a 30 per cent local procurement condition. Even the Defence Procurement Policy has an offset policy that seems to resonate the same idea.

While the case of foreign investment may be distinguished from domestic corporate activities, the trend of the government’s policy seems to indicate the general opinion that companies are required to increasingly legitimise their existence in society. The backdrop of scams and corruption seems to have shaken the people’s faith in corporate institutions. A CSR policy may thus be better understood as not just a mechanism to highlight a company’s social initiatives but also as part of a larger strategy to restore the position of companies in society.

This article originally appeared in The Hindu Business Line.