Case Study on CSR under Companies Act 2013

Case Study of CSR Provision of Companies Act 2013

Section 135 of the Companies Act, 2013 and Rules in this regard have been notified and shall be applicable w.e.f  01.04.2014.

Section 135 (1) provides that every company having net worth of Rs. 500 crore or more or turnover of Rs. 1000 crore or more or net profit of Rs. 5 crore or more during any financial year shall constitute a CSR Committee. Section 135 (5) further provides that the Company shall ensure to spend 2% of the average net profits of the Company made during the three immediately preceding financial year. The Explanation to this subsection provides that the average net profit shall be calculated in accordance with the provisions of section 198 of the Companies Act, 2013.

The CSR Rules defines Net Profit as under:

 “Net Profit” means the net profit of a Company as per its financial statement prepared in accordance with the applicable provisions of the Companies Act, 2013, but shall not include the following, namely:

1. Any profit arising from any overseas branch or branches of the Company, whether operated as a separate company or otherwise, and
2. Any dividend received from other companies in India, which are covered under and complying with the provisions of section 135 of the Companies Act, 2013;

 Provided that net profit in respect of a financial year for which the relevant financial statements were prepared in accordance with the provisions of the Companies Act, 1956, (1 of 1956) shall not be required to be re-calculated in accordance with the provisions of the Companies Act, 2013.

 However section 198(4)(l)provides as follows:

“the excess of expenditure over income, which had arisen in computing the net profits in accordance with this section in any year which begins at or after the commencement of this Act, in so far as such excess has not been deducted in any subsequent year preceding the year in respect of which the net profits have to be ascertained;”

Interpretation of the above strictly provides to deduct the loss which occurred at or after the commencement of the Companies Act, 2013 viz. financial year starting on or after 1st April, 2014. However, pursuant to provisions of Section 135 of the Act, the Company have to spent at least two percent of the average net profits of the Company made during the three immediately preceding financial years, which we assumes for CSR spending in the financial year 2014-15 the Company has to work out average net profits for the financial years 2011-12, 2012-13 and 2013-14.

 It seems that there prevails some ambiguity in the section itself as it provides  for set off of only those losses that occur only after the commencement of the Companies Act, 2013 and not earlier ones, whereas at the same time the profits to be considered is of immediately preceding three financial years. In all fairness, profits and losses, both, for the preceding three years and accumulated losses of earlier years should be considered for arriving at the average Net Profit as we feel that profits and losses are part and parcel of any business and one cannot discriminate between the same.

 The said clause is debatable in the absence of any clarification or circular from Ministry in the matter….and considering the Rule of Equality the law shall be interpreted on “Just and Equal Principle”…

 In view of above, we require your detail opinion on the following supported with the relevant provisions/extracts of Companies Act, 1956 or Companies Act, 2013 or Rules made thereunder and explanations:

 Query 1: The financial statements of ABC Ltd, for preceding 3 financial years i.e. 2011-12, 2012-13 and 2013-14 were prepared under Companies Act, 1956.  has profit in 2011-12 and 2012-13 and loss in 2013-14. How the average net profit will be calculated?

 Query 2: Do accumulated losses of past years be allowed to be deducted for recalculation of profit under the provisions of section 198 (4)(l) of Companies Act, 2013? If yes, How? Any period upto which  can carry forward its accumulated losses for recalculation of profit to ascertain CSR expenditure?

1. ANALYSIS

A.1       The expression ‘net profit’ is important in two ways in the context and applicability of Section 135 of the Act.

 Firstly, it is one of the criteria to determine whether companyis covered by section 135(1) so as to attract CSR provisions.

 Section 135 (1) is reiterated as follows:

“Every company having net worth of rupees five hundred crore or more, or turnover of rupees one thousand crore or more or a net profit of rupees five crore or more during any financial year shall constitute a Corporate Social Responsibility Committee of the Board consisting of three or more directors, out of which at least one director shall be an independent director.”

 Secondly, for determining the quantum of CSR spends is stipulated as a percentage of “average net profits” as provided in Section 135 (5) of the Act.

 Section 135 (5) reiterated as follows:

“The Board of every company referred to in sub-section (1), shall ensure that the company spends, in every financial year, at least two per cent. of the average net profits of the company made during the three immediately preceding financial years, in pursuance of its Corporate Social Responsibility Policy:

 Explanation.—For the purposes of this section “average net profit” shall be calculated in accordance with the provisions of section 198.”

 The above can be conceptualized in two ways:

1) The Calculation of “Net profits” for deciding the criteria

2) The Calculation of “Average Net profit” for deciding the quantum

• CALCULATION OF NET PROFITS

 The term ‘net profit’ is not defined by section 135 or by any other provision of the Act. But the same has been provided in the Companies Social Responsibility Policy Rules, 2014.

According to Rule 2(1)(f)of the CSR Rules, “Net Profit” means the net profit of a Company as per its financial statement prepared in accordance with the applicable provisions of the Companies Act, 2013, but shall not include the following, namely:

1. Any profit arising from any overseas branch or branches of the Company, whether operated as a separate company or otherwise, and
2. Any dividend received from other companies in India, which are covered under and complying with the provisions of section 135 of the Companies Act, 2013;

Provided that net profit in respect of a financial year for which the relevant financial statements were prepared in accordance with the provisions of the Companies Act, 1956, (1 of 1956) shall not be required to be re-calculated in accordance with the provisions of the Companies Act, 2013.

It is inferred from the above that for calculation of Net profits for a particular Year out of any of the three preceding financial years, for deciding the criteria of applicability of CSR Provisions in the first case, the net Profits shall be taken as it is calculated in the relevant financial year whether under the Act or the previous Act.

 For Instance if we are taking Net Profits of Financial Year 2012-2013,  for which Financial Statements were prepared as per Previous Act, than it is not required to re calculate the Net Profits in financial Statements of Financial Year 2012-2013 by making changes as per Schedule II and other provisions of new Act.

• CALCULATION OF AVERAGE NET PROFITS

 ‘Average net profit’ shall be calculated as per section 198 of the Act.

 Thus, it appears that, average net profits will have to be calculated as under:

• Take net profit as per its financial statements prepared in accordance with the applicable provisions of the Act/of the previous Act. [As per Rule 2(1)(f) of CSR Rules]

• Exclude the following from net profits:

• any profit arising from any overseas branch or branches of the company, whether operated as a separate company or otherwise;
  and
• any dividend received from other companies in India, which are covered under and complying with provisions of section 135 of the Act.

[As per Rule 2(1)(f) of CSR Rules]

• Make adjustments required by section 198 [As per explanation to Section 135 (5)]

• Calculate net profit for each of the preceding three financial years as per (a) to (c) above, aggregate them and divide by 3.

 In other words we can say Average Net Profit is the “Average of Adjusted Net Profits” of preceding 3 Financial Years, whereby adjustment means debits and credits as provided by the Act.

 The proviso of Rule 2(1)(f) of the CSR Rules specifically eliminate the requirement of recalculation of Net profits as per new Act.

Does it mean that recalculation of “adjusted net profits” is not required as per new Act or it says recalculation of “net profits” is not required as per new Act?

 As per our view, the proviso eliminates the requirement of recalculation of net profits for the purpose of A.1.1 and A.1.2.a. In other words the net profit before any adjustments shall be taken as it is as calculated in the financial statements of relevant period as per then prevailing Act.

A.2       Now the Question arises whether net profits of past years for which accounts were prepared in accordance with the previous Act should be adjusted in accordance with section 198 of the Act or should they be adjusted in accordance with corresponding section 349 of the Previous Act?

 If we look at the literal interpretation of section 135(5) of the Act, it seems that the Adjusted Net profit of each preceding Financial Year shall be calculated as per section 198 of the Act.

 Our view is as follows on the basis of following contentions:

1. Section 198 of the Act is exact corresponding section of Section 349 of the previous Act.

 If we look into the content of the referred sections, we will find that section 198 of the Act is corresponding provision of section 349 of the previous Act without any major variations in the content.

 For Instance,

While calculating adjusted Net profit for Financial Year 2012-2013, then we have to make debits and credits exactly in accordance with section 198 of the Act. Accordingly while making debits of Section 198(4) (k) also, Depreciation would be required to re calculate as per the provisions of section 123 and schedule II of the Act, which is not compatible neither intended by legislators.

 Section 198(4) (k) of the Act reiterated as follows for reference:

“(k) Depreciation to the extent specified in section 123;”

 There is drastic change in the calculation pattern of Depreciation in the Act as compares to previous Act. We believe that this is not the purpose and intention of legislator to re calculate the depreciation of financial years prior to commencement of this Act to give effect to the explanation of section 135 (5) of the Act.

 Similarly section 198 (4) (j) of the Act permitting deduction of outgoings inclusive of contributions made under section 181 of the Act, whereas the said section is applicable only after 01st April 2014.  Now, if we are calculating the profits for financial year 2012-2013, as in above instance, than would we take the deduction of all outgoings in accordance with section 181? Absolutely not but the corresponding section 293(1)(e) of the previous Act have to be followed as provided in section 349(4) (j) of the previous Act.

 Hence the applicability of section 198 is only for the calculation of adjusted net profits of the financial years commencing on or after the commencement of the Act and have no relevancy for calculating Adjusted net profit of the Financial Years prior to commencement of the Act. Accordingly corresponding provision of previous Act, that is section 349 should be followed for the prior period.

 (b)       Principle of Reasonable Construction

 While interpretation of law, if the literal interpretation is absurd or unclear, than we may look into Reasonable construction of law. One may understand the Intention of law and reason behind making that law.

 In our view the Intention of law makers behind giving explanation to 135(5) of the Act is to clarify that the referred net profits in section 135(5) shall be “adjusted Net profits” of the Company. After enactment of the Act, the only effective provision for adjustments (debits and credits) in the Act is S. 198 of the Act, therefore there is a reference of the same in the explanation.

But for the purpose of adjustments in the net profits of financial statements before the commencement of Act, the corresponding section was 349 of previous Act which rule out the adjustments (debits and credits) to be made.

Hence the corresponding section 349 of the previous Act should be taken for the Adjustments (debits and credits) in the Net profits of the financial Statements for the period prior to commencement of the Act.

A.3       The next question arise, What will be the implication of section 198(4)(l) for the purposes of losses ascertained in the financial year 2013-2014 or accumulated Losses at the end of  financial year 2013-2014.

 Section 198(4)(l) reiterated as follows:

(l) the excess of expenditure over income, which had arisen in computing the net profits in accordance with this section in any year which begins at or after the commencement of this Act, in so far as such excess has not been deducted in any subsequent year preceding the year in respect of which the net profits have to be ascertained;

Once again, the literal interpretation ignores the deduction of Adjusted Net loss of the financial years prior to commencement of the Act. 

“Adjusted Net loss” here means the loss aroused while computing net profits in accordance with section 198 of the Act/349 of the previous Act as the case may be.

 As per our view, as elaborated above, Adjustments in Net profits for financial Year prior to commencement of the Act should be made as per section 349 of the previous Act and for the financial Years after the commencement of the Act the adjustments should be made as per section 198 of the Act.

 Then again, how the Net Losses calculated as per section 349 of the previous Act for the financial year 2013-2014 and the accumulated adjusted Net losses as on 31st March 2014, for which deduction has not been claimed, should be treated. Whether these loss are deductible while calculating adjusted Net profit for Financial Year 2014-2015 under section 198(4)(l)?

 Lets have an example for elaboration:

 Situation A- Calculation of Average Net Profits for CSR Spends in FY 2014-2015

• The calculation would be as follows:

 (Net profit of FY 2011-2012) + (Net profit of FY 2012-2013) + (Net profit of FY 2013-2014)

“Net profits are Net profits after adjustments of section 349 of previous Act”

• Let’s assume the following figures

Financial Year	Net profits	Net Profit/Losses after adjustment of section 349	Net Profit/Losses after adjustment of section 198	Accumulated Adjusted Net loss at the end of financial year
2010-2011	100	90	--	0
2011-2012	100	(20)	--	(20)
2012-2013	100	80*	--	(20)
2013-2014	100	(5)**	--	(5)

*Losses of Rs. 20 aroused in FY 2011-12 after adjustments are eligible for deduction in next year, but was not claimed as deduction, under S. 349(4) (l), while making adjustments in Net profits of FY 2012-2013.

 **Accumulated losses of Rs. 20/- as on 31st March 2013 has been deducted under S. 349(4)(l) while making adjustments in Net profits of FY 2013-2014.

• Therefore the calculation would be :

[(-20)+(80)+(-5)] / 3

 Situation B- calculation of Average Net Profits for CSR Spends in FY 2015-2016

• The calculation would be as follows:

 (Net profit of FY 2012-2013) + (Net profit of FY 2013-2014)+(Net profit of FY 2014-2015)

                                Divided by 3

“Net profits are Net profits after adjustments of section 349 of previous Act and Section 198 of the Act as the case may be”

• Let’s assume the following figures

Financial Year	Net profits	Net Profit/Losses after adjustment of section 349	Net Profit/Losses after adjustment of section 198	Accumulated Adjusted Net loss at the end of financial year
2010-2011	100	90	--	0
2011-2012	100	(20)	--	(20)
2012-2013	100	80	--	0
2013-2014	100	(5)	--	(5)
2014-2015	100	--	(10)*	(5+10)

*While Calculating Profit for FY 2014-2015 after adjustments under section 198, the deduction will be made under section 198(4)(l) which provides as follows:

the excess of expenditure over income, which had arisen in computing the net profits in accordance with this section in any year which begins at or after the commencement of this Act in so far as such excess has not been deducted in any subsequent year preceding the year in respect of which the net profits have to be ascertained.

• As per above only such losses which have aroused after the commencement of new Act (i.e after 1.04.2014) and preceding the year for which profits are being calculated (i.e before FY 2014-2015) shall be eligible for deduction.
• As 2014-2015 is the first Financial Year after the commencement of new Act therefore at the point of calculation of Adjusted Net profits for FY 2014-2015 no losses are eligible for deduction.

• The losses of FY 2013-2014 that is of Rs. 5 are not eligible for deduction as these losses has not been ascertained after the commencement of new Act.

• Therefore the calculation for CSR Spends would be :

[(80)+(-5)+(-10)] / 3

 Situation C- calculation of Average Net Profits for CSR Spends in FY 2016-2017

• The calculation would be as follows:

 (Net profit of FY 2013-2014)+ (Net profit of FY 2014-2015)+ (Net profit of FY 2015-2016)

                                              and divided by 3

“Net profits are Net profits after adjustments of section 349 of previous Act and Section 198 of the Act as the case may be

• Let’s assume the following figures

Financial Year	Net profits	Net Profit/Losses after adjustment of section 349	Net Profit/Losses after adjustment of section 198	Accumulated Adjusted Net loss at the end of financial year
2010-2011	100	90	--	0
2011-2012	100	(20)	--	(20)
2012-2013	100	80	--	0
2013-2014	100	(5)	--	(5)
2014-2015	100	--	(10)	(5+10)
2015-2016	100	--	90*	(5)

*In furtherance of Situation B, Rs.10 are the only losses which remained unsatisfied after commencement of New Act (i.e after 1.04.2014) and before the year for which profits are being ascertained (i.e before FY 2015-2016). Therefore Rs. 10 has been deducted U/S 198(4)(l) while computing adjusted Net profits of FY 2015-2016.

• Therefore the calculation for CSR Spends would be :

[ (-5)+(-10)+(90)] / 3

The contradiction is we can set off all losses since 1956 till 31st March 2013 and from 1stApril 2014 till the provision will be in effect, but we cannot set off the loss from 1st April 2013 till 31st March 2014.

Now looking at the commercial viability, we believe that Law nowhere intends to make difference between the treatments of adjusted Net losses incurred in Financial Year 2013-2014 as compared to Adjusted Net losses of other financial Years.

In our view, this is not logical. The effect of this clause in determining the net profits of any year for the purpose of calculating CSR spends shall be that, not only expenses incurred during that year but also any excess of expenditure over the income of any previous years remaining unsatisfied out of the income of those years should also be deducted, and only the balance income/loss, if any remaining after all such deduction should be the sum on which the average and then said percentage should be calculated.

CONCLUSION

No doubts, MCA needs to clarify the things to get an exact and proper literal interpretation but till such clarification comes in light, we may interpret with principal of reasonable construction and pith and substance rule.

We are at opinion, CSR is a philanthropic activity and charity shall not be on the cost of capital of the Company. Therefore the law makers intended to take out average of such Net profits, after adjustments as provided by the Act, so that actual trading profits could be calculated and CSR could be an expense on actual earned profits of the corporate.

Section 198 of the Act is exactly corresponding to section 349 of previous act with few minor changes. We believe that intention behind the Legislator is not to do changes in the items of debits and credits to ascertain the actual trading Net profits as per Companies Act. Therefore the Net profits should be calculated on the basis of then applicable provisions.

The words “on or after the commencement of the Act” in clause 135(4)(l) cannot change the basic intention of law, that is to deduct ‘excess of expenditure over income’ or we can say ‘trading losses’ of all the previous years, before the net profits are determined for calculating the quantum of CSR spends.

Query 1: The financial statements of , for preceding 3 financial years i.e. 2011-12, 2012-13 and 2013-14 were prepared under Companies Act, 1956.  has profit in 2011-12 and 2012-13 and loss in 2013-14. How the average net profit will be calculated? How much amount to be incurred by  on CSR expenditure during FY 2014-15?

A-The Average Net Profits Should be calculated as provided under para A.1.2 above

Query 2: Do accumulated losses of past years be allowed to be deducted for recalculation of profit under the provisions of section 198 (4)(l) of Companies Act, 2013?  If yes, How? Any period upto which  can carry forward its accumulated losses for recalculation of profit to ascertain CSR expenditure?

A-As per our view, Yes, accumulated losses calculated as per section 198 of the Act / 349 of the previous Act could be deducted till completely set off.

CS Ravi Bhushan Kumar

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SR & Associates|Company Secretaries

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