THE LEGAL BRIDGE

Topic 70 — Corporate Social Responsibility

Companies Act, 2013 — Section 135, Schedule VII, and the 2% Spending Mandate

I. Conceptual Foundation: Why Statutory CSR?

Corporate Social Responsibility, in its philosophical sense, is the recognition that a company is not merely an economic agent but a social institution — its profits flow from a society that supplies it with workforce, infrastructure, customers, and legal protection. Voluntary CSR has existed in India for centuries — the Tata, Birla, Bajaj, and Godrej houses pioneered education, healthcare, and rural development funded from their profits long before any law required it. But voluntary CSR was patchy and concentrated in a few houses. The Companies Act, 2013, in Section 135, made India the world's first country to legally mandate CSR spending — a legislative bridge between corporate profit and social investment.

The provision is rooted in the constitutional Directive Principles (Articles 38, 39, 41, 43, 47) which envisage a welfare state. Section 135 acts as a private-sector channel for advancing those goals. Listed and unlisted companies above prescribed financial thresholds are required to spend at least 2% of their average net profits on activities specified in Schedule VII. This Topic addresses Section 135 and Schedule VII as originally enacted; Topic 72 will address the post-2021 amendments — CSR Impact Assessment, ongoing project mechanics, and Significant Beneficial Ownership (SBO).

II. Applicability — Section 135(1)

Threshold Test — Disjunctive, Any-One Trigger

The three thresholds are disjunctive — any one is enough to attract Section 135. A company satisfying ANY of (i) net worth ≥ ₹500 crore, (ii) turnover ≥ ₹1,000 crore, or (iii) net profit ≥ ₹5 crore in the immediately preceding financial year is brought within the CSR regime. The reference is to standalone (not consolidated) financials. Once triggered, the company is bound until it ceases to meet any of the criteria for three consecutive financial years (Section 135(1) third proviso, inserted by 2017 amendment).

'Net Profit' — Section 198 Adjustments

'Net profit' for Section 135 purposes is calculated under Section 198 — the same provision that governs managerial remuneration. Specific adjustments under Rule 2(1)(h) of the CSR Rules: exclude capital profits, profits from overseas branches, dividends from CSR-applicable companies. The aim is to focus on India-source operating profits — the surplus actually generated from Indian operations.

III. The CSR Committee — Section 135(2) and (3)

Composition Relaxations

• 3 or more directors with at least one independent director — default rule.
• If the company is not required to have an independent director under Section 149(4), the CSR Committee may consist of just 2 directors.
• Foreign company under Section 379: at least 2 persons — one nominated under Section 380(1)(d) and the other a person resident in India.
• Where CSR spend ≤ ₹50 lakh in a year, no CSR Committee is required (post-2020 amendment); the Board itself discharges the functions.

IV. The 2% Mandate — Section 135(5)

Calculation of CSR Obligation

Steps to compute the annual CSR spend:

• Identify net profit for each of the three immediately preceding financial years (calculated as per Section 198 with CSR Rule 2(1)(h) adjustments).
• Average the three years' net profits.
• Multiply by 0.02 — that is the minimum CSR spend for the current financial year.
• If the company has been incorporated less than 3 years, average is taken from such years as it has been in existence.

Local-Area Preference

The proviso to Section 135(5) directs preference to local areas. This recognises that the company's operations bear directly on the surrounding community, and benefit-sharing is most meaningful when localised. The preference is a directional principle, not a hard rule — a company may spend across India, but the Board's report must explain why local areas were not preferred.

V. Schedule VII — Permitted CSR Activities

Schedule VII to the Companies Act enumerates the categories of activities that qualify as CSR. The list has been progressively expanded — initially 10 items in 2013, now 11 broad categories with multiple sub-items. The Schedule reads as exhaustive but is interpreted purposively by the Ministry of Corporate Affairs through circulars.

Activities Specifically Excluded — Rule 2(1)(d) of CSR Rules

• Activities undertaken in the normal course of business of the company — that is, products/services already commercialised.
• Activities undertaken outside India (exception: training of Indian sports personnel representing India).
• Contribution to political parties (directly or indirectly) — Section 182 covers political contributions separately.
• Activities benefiting employees of the company (defined under the Code on Wages, 2019).
• Activities supported on a sponsorship basis for marketing benefits to products/services.
• Activities for fulfilment of statutory obligations under any other law in force in India.

VI. Treatment of Unspent Amount — The Critical Section 135(5) and (6)

The Two-Track Treatment of Unspent CSR (Post-2020 Amendment)

• Track 1 — Unspent amount NOT relating to an ongoing project: must be transferred within 6 months of FY-end to a Schedule VII fund (PM CARES Fund, PMNRF, etc.). The amount permanently leaves the company.
• Track 2 — Unspent amount relating to an ongoing project: must be transferred within 30 days of FY-end to a 'Unspent CSR Account' in a scheduled bank. The amount must be spent on the same ongoing project within 3 financial years from the end of the year of original obligation. If still unspent at the end of those 3 years, it must be transferred to a Schedule VII fund within 30 days of the expiry of the third financial year.
• 'Ongoing project' means a multi-year project (initial duration up to 3 years, excluding the year of commencement) under Rule 2(1)(g)(i) of CSR Rules.

VII. Penalty for Non-Compliance — Section 135(7)

The 2020 amendment converted the Section 135 framework from comply-or-explain to comply-or-pay. The penalty structure is significant — a company that fails to transfer unspent CSR to the prescribed fund or special account faces a penalty of up to twice the unspent amount or ₹1 crore, whichever is less. Officers face a personal penalty of one-tenth of the amount or ₹2 lakh, whichever is less. Crucially, the offence has been decriminalised under the 2020 amendment — only civil penalty applies, recovered through the adjudication route under Section 454.

VIII. Implementation Modes — Direct or Through an Implementing Agency

Rule 4 of the CSR Rules (substituted in 2021) specifies the permitted implementation routes:

• By the company itself.
• Through a company established under Section 8 of the Act, or a registered public trust, or a registered society, established by the company itself or along with any other company.
• Through a Section 8 / public trust / society having an established track record of at least 3 years in undertaking similar activities.
• Through any entity established under an Act of Parliament or a State legislature.
• Mandatory CSR-1 registration with the MCA from 1 April 2021 — every implementing agency (other than the company itself) must obtain a unique CSR Registration Number in Form CSR-1.

IX. Disclosure and Reporting — Section 134 read with Section 135

The Board's report under Section 134(3)(o) must contain a detailed CSR disclosure: composition of CSR Committee, CSR Policy, average net profit, prescribed CSR amount, amount actually spent, unspent amount and reasons, treatment of unspent amount (transfer to Schedule VII Fund or Unspent Account), report on CSR projects with details. The MCA prescribes a specific Annexure to the Board's report — currently in the form prescribed by Companies (Corporate Social Responsibility Policy) Amendment Rules, 2021.

X. Landmark Decisions and Regulatory Clarifications

XI. Coaching Analogy — The Statutory Charity

Imagine a company as a successful merchant in a kingdom. The king (Parliament) noticed that prosperous merchants enjoy public roads, public security, and public goodwill — yet some hoard their wealth while their neighbours starve. The king issued a decree: every merchant whose wealth crosses one of three thresholds (treasure stored, annual sales, or surplus from last year) must each year give 2% of his last three years' average surplus to causes the king has listed in his royal scroll (Schedule VII). The merchant may give directly or appoint a registered charitable order. He must record what he gave in his annual ledger (Section 134 disclosure). If he doesn't give, he cannot simply explain why anymore — he must transfer the gold to the royal treasury (PM CARES, PMNRF) within six months, or, if it was earmarked for a multi-year project, into an escrow at his bank for three years. If even then he doesn't spend it, the gold goes to the royal treasury. If he disobeys, the king's adjudicator imposes a penalty — twice the unspent amount, capped at ₹1 crore.