Tuesday, March 10, 2015

Is provisioning a necessary precursor to CSR spending?

[The following post is contributed by Prachi Narayan and Swati Rampuria at Vinod Kothari & Co. They can be contacted at prachi@vinodkothari.com and swati@vinodkothari.com respectively]


Corporate social responsibility (‘CSR’) was made mandatory by Companies Act, 2013 (‘Act’). Al though it has been a year since this concept has entered the Indian corporate regime, still there are lurking questions with respect to CSR spending and its nature.

This post is an attempt to throw further light upon the nature of CSR spending whether the same is mandatory or not in light of the provisions of the Act.

CSR expenditure under the Act

Section 135 (5) of the Act states that:

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:

Provided that the company shall give preference to the local area and areas around it where it operates, for spending the amount earmarked for Corporate Social Responsibility activities:

Provided further that if the company fails to spend such amount, the Board shall, in its report made under clause (o) of sub-section (3) of section 134, specify the reasons for not spending the amount.

Apparently, the text of the section suggests that companies falling under section 135 (1) of the Act have to ensure that the companies spend at least 2% of their average net profit to society and in CSR activities. The reading of the section prima facie makes it apparent that applicable companies are to ensure that the stipulated expenditure in CSR activities is incurred.

The question that arises herein is whether such an act of ensuring CSR expenditures, as envisaged under the regime of Companies Act, 2013, is in nature of a liability and thus is the company under an obligation to create a provision or the intent is otherwise?

What is liability?

Black’s law dictionary defines ‘liability’ as:

“the state of being bound or obliged in law or justice to do, pay, or make good something; legal responsibility.”

Further, ‘liability’ as defined under Accounting Standard 29 means as follows:

“A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”

From conjoint reading of the above, it is clear that a liability is:

- A present obligation in law;
- To do, pay or make good something;
- That results or is expected to result in expenditure.

Applying a similar principle to the section in question, on a prima facie reading it would appear that companies are to ensure to spend the stipulated amount in CSR activities. However, to ascertain whether such expenditure is mandatory or not one has to closely see the provisos to the section also. The second proviso to the section provides that if the company fails to spend the required amount in CSR activities in any financial year, the board shall specify reasons for such non-spending in its report.

The insertion of the proviso thus helps to ascertain that the expenditure in CSR activities is not mandatory, if the board has reasons enough to provide reasons for the same.

The approach of the Act since its inception has been on lines of the “comply or explain”- either the company complies with the provisions or has reasoned explanations available for non-compliance. This holds true in the current scenario too. In light of the second proviso, it can be fairly established that the liability to spend in CSR activities does not in essence remain a liability per se.

Having said so, it would also be pertinent to evaluate whether a commitment to spend would tantamount to liability. A commitment in general parlance means a “promise” or “agreement” to do something. A promise made or an agreement to do something would actually mean that the person making the promise binds itself or creates an obligation on itself to do something, in essence creating a liability for itself.

The company can undertake CSR activities either by itself or through third parties. Any agreement or promise by the company to invest in certain identified CSR activities or any agreement or promise made to a third party to undertake such activities through that entity would qualify as a commitment made by the company with respect to such activities and hence a liability for the company.

Creation of provision for CSR spending

Once having identified the nature of the liability, a question that would arise is whether it is necessary to create a provision for such liability?

‘Provision’ as defined under Accounting Standard 29 means:

“A provision is a liability which can be measured only by using a substantial degree of estimation”.

Thus, when a liability is measured or estimated a provision is created, the essential ingredients being:

- Presence of a liability; and
- Measured by using substantial degree of estimation.

Thus, creation of provisions would come into picture where there is an identified liability which is mandatory in nature and that the only way to measure such a liability is by way of estimation. 

Applying similar analogy to expenditure of CSR activities, the need for creation of provision would arise (a) when the CSR expenditure is liability; (b) where such a liability has been estimated.

In light of the above discussions, it has been established that CSR expenditure in essence is not in nature of liability per se as the company always has the option of not actually spending in CSR activities by way of disclosure in board’s report. Since the same is not in nature of ‘liability’, provisions created in pursuance may also not be required. Assuming, the company has created a provision, then the company shall use the same in spending towards CSR activities, unless the company has reasonable justification for not utilizing the same. 


The carve-out as provided under the second proviso to section 135 could become potential tool of misuse to evade CSR expenditure. Each time the company does not spend, the only compliance required would be a disclosure in board’s report. The non-spending and reporting thereof has to be used in a bona fide manner and the company should not make it a practice of evading from spending towards CSR activity. The company should use the tool of reporting in the board’s report in a reasonable and sensible manner that is to say only when the Company genuinely is not being able to spend. Thus, at some point of time the company shall actually spend the amount towards CSR.

- Prachi Narayan & Swati Rampuria

1 comment:

vswami said...

On CSR spending, there are any number of questions, on which no clear-cut answers are available or could be expected so soon or feasible.
The concept of ‘provision’, as conventionally understood, by an accountant is at variance as understood by any other; e.g. IT authority. Albeit, by and large, connotes setting aside an amount in the final accounts, for a "known liability the amount of which cannot be ascertained with substantial accuracy". What 'substantial' in this context, just as in several other contexts, means itself is bound to prove 'subjective', not 'objective' in its profound sense. Again, for accounting, there are other criteria coming into play- namely, 'materiality', 'matching' concept. Expending mandated 2 % as envisaged, is of profits of the relevant year in that year itself. If do remember, wrt an earlier write-up, certain areas of grave doubts requiring deliberation have been brought to focus.
Incidentally, to one's recollection, as per info. in a write-up in CA journal, the fundamental exercise of monitoring the 'initiative' and follow-up action is still a matter proposed and to be gone into by a special committee and reported on.
As such, it appears, even as of date, the mandated CSR requirement cannot be taken to have reached the stage of a successful 'throttle', before take-off.
Invited to share any other possible views/different angles.