CSR is Now a 'Cess' Pool

Bar & Bench August 9 2019
lawyers

Somasekhar Sundaresan

The sovereignty of Kashmir was not the only estate that was taken charge of in the current session of Parliament. Just days earlier, the government got Parliament to approve firmer entry of the State into yet another facet of corporate affairs.  Not only was Section 135 of the Companies Act, 2013, (a “nudge”[1] of voluntary deployment of corporate funds corporate social responsibility (“CSR”) work) converted into a mandatory provision, it is now criminal law, with the sanction being a jail term of up to three years.

Spending by companies on social work under the head of CSR was “nudged” by the Companies Act, 2013.  The move was inherently controversial – a moralistic requirement to “do good” being embedded in a law that essentially regulates the organisation and conduct of enterprise aimed at earning profits.  The provision was structured as an obligation for a company having had three years of existence, to either spend an amount equal to 2% of the average of the past three years’ profits, or to make disclosures about why the company could not or would not spend the amount towards CSR.

Society could then read the disclosures (about the spending or the failure to spend) and factor that into its perception of the company and those in charge of it.  It would be open for members to society to feel warm and fuzzy about the company being socially responsible, or feel warm and fuzzy about the company being profit-focused and not distracted by extraneous factors.  It was felt that societal pressure and peer pressure would make corporates more socially aware and responsible.

That framework changed on July 31, 2019.  First, even companies that do not have a three-year track record must spend 2% of the average profits of the immediately preceding financial years.  Second, just a disclosure of explanations for not having spent the amounts will no longer suffice.  Companies now have to move the monies into one of the funds specified in company law.  These are funds such as the Prime Minister’s National Relief Fund or the Clean Ganga Fund.  Third, in the interim, any shortfall in the expenditure would need to be moved into a segregated “Unspent Corporate Social Responsibility Account”. Finally, a violation would be a criminal offence, inviting fine of at least Rs. 50,000 and at worst Rs. 25 lakhs on the company, while the officers in default can go to jail for up to three years and also pay fine in a range similar to the company.  The government has only stopped short of getting Parliament to amend the Insolvency and Bankruptcy Code, 2016 to make the “Unspent Corporate Social Responsibility Account” a bankruptcy-remote account.

These amendments are problematic for a number of reasons.  To begin with, they appear to have been brought in without any empirical study of what the impact of the nudge has actually been – more about that later.  Next, although the Supreme Court has been increasingly frowning at the unreasonableness and arbitrariness of minimum punishments in law, a voluntary position has been converted into a criminal law provision, with a minimum fine.  By providing for a jail sentence for not being a do-gooder, the law could well have incentivized misconduct – corporates and their management would well create bare-minimum-compliant CSR recipients to check the box of expenditure, eroding the really desirable impact that was sought to be achieved from the CSR spending.

Company law seems to have taken the cue from regulations governing “priority sector lending” by banks – the RBI has mandated that 40% of net credit from banks must be lent to specific sectors such as agriculture, MSME, housing, renewable energy etc. This is known to be a recipe for scams – the alleged cobbler co-operative scam in the 1990s was a result of such forced priority sector money finding its way businesses that organized allegedly fake co-operatives to be able to tap into such funds.  Banks that did not meet the priority sector lending targets could invest the shortfall amount in bonds of specified institutions – say, NABARD (lending to agriculture) or SIDBI (lending to MSME).

With CSR, it appears that had an empirical study of the impact of Section 135 been conducted, the amendment would have been rendered unnecessary.  The Indian Express reports, based on a study by Prime Database of CSR data available in annual reports of companies listed on the National Stock Exchange, showing that CSR spending has actually seen a steady rise – from 70.19% in 2014-15 to 91.47% in 2018-19. Since the number of companies yet to publish their annual reports for 2018-19 is low (224 companies), even data available for 2017-18 (1,077 companies) would show that 83.20% was spent on CSR.

Law-making in India has largely been based on the belief that societal virtue can be attained by edict of legislation.  We believe that by stepping up the criminal sanction for an undesirable outcome, good behavior would follow.  The brutal Nirbhaya atrocity in Delhi in 2012 led to criminal sanction for sexual assault being stepped up to capital punishment in April 2013.  Our society believed this would instill the fear of the law, leading to good behavior.  Tragically, we were confronted with the Shakti Mills assault in Mumbai in August 2013.  Sadly, this was a heavy price to pay to learn the lesson that administering a greater dosage of an expired medicine would not cure an ailment not diagnosed properly.

An investor (whether Indian or foreign) who is to be lured into investing in India will have to factor in the requirement of expending this additional cost of doing business organized in corporate form.  The forcible and mandatory requirement to make companies spend the stipulated percentage on CSR or to contribute to state-controlled funds, with the threat of going to jail, is a back-door imposition of a cess to create a pool from corporate profits.

The author is an advocate with a regulatory practice focus.

[1] A concept in behavioral economics and political theory, made popular by a book titled Nudge co-authored by economist Richard Thaler (Nobel laureate in economics in 2017 for such work) and lawyer Cass Sunstein.  The book led to various governments, starting with the United Kingdom, setting up “nudge units” (behavioral insights teams) to achieve desirable social outcomes with an approach of “liberal paternalism” as opposed to prescriptions mandated by law.