Understanding CSR Expenditure and Deductions under Income Tax

understanding-csr-expenditure-and-deductions-under-income-tax

The allowability of deduction of Corporate Social Responsibility or CSR as mandated under section 135 of the Companies Act, 2013 under the Income Tax Act, 1961 requires in-depth understanding due to express disallowance under the Income Tax Act, 1961 and the Circular No. 01/2015 dated 21.01.2015 issued by CBDT in this matter.

The scope of Explanation 2 in Section 37(1) of the Income Tax Act, 1961 and its applicability is discussed. Further, whether CSR expenditure is allowed under section 80G or not is also discussed.


    Introduction

    The expenditure incurred on account of Corporate Social Responsibility or CSR under the mandatory requirement of the Companies Act, 2013 and its allowability as a deduction under the Income Tax Act, 1961 is not a complex topic to understand.



    The precondition is to understand ceratin provisions of the income tax law and a circular issued by the CBDT in this behalf.


    Background

    Section 135 of the Companies Act, 2013, inter alia, provides for companies having-

    > net worth of Rs. 500 crore or more, or
    > turnover of Rs. 1,000 crore or more, or 
    > a net profit of Rs. 5 crore or more in a financial year
    to spend at least 2% of the average net profits of last 3 years for the company’s Corporate Social Responsibility (CSR) policy.

    In case the said amount is not spent, the reasons for not doing so are to be disclosed in the Board’s Report. Activities that may be included in the CSR policy by the companies are specified in schedule VII of the Companies Act, 2013.

    The mandatory provisions of CSR as envisaged in section 135 along with Schedule VII and corresponding Corporate Social Responsibility Policy Rules have been notified on 27.02.2014 and have come into effect from 1st April 2014.

    Under the company rules, the CSR activities may be undertaken by the company itself or may undertake the charitable activities through a registered trust or a registered society or a company established by it or its holding or subsidiary or associate company under section 8 of the Act.

    However, any contribution of any amount directly or indirectly to any political party under section 182 of the Act, shall not be considered as CSR activity.

    Section 135 of the 2013 Act, mandating CSR activities to corporates, is a new section and introduced for the time in India in the law itself. There was no corresponding provision in the Companies Act, 1956.

    Income Tax Provisions on CSR

    Section 135 of the Companies Act, 2013 requiring certain companies to mandatorily spend on CSR activities was made effective from 01.04.2014 which corresponds to FY 2014-15. The relevant assessment year is 2015-16.

    Hence, necessary amendments in the Income Tax Act, 1961 was made through the Finance (No.2) Act, 2014[1]. Due to 16th General Lok Sabha Election that happened in 2014, the full-fledged Union Budget 2014 was presented on July 10, 2014, by the then Finance Minister Shri Arun Jaitley.

    It is the settled principles of law that in case a person is under a legal or contractual obligation to incur any expenditure then such expenditure is taken as expenditure incurred wholly and exclusively for the purpose of the business of the assessee. Hence, such expenditure is always allowed as business expenditure.

    If such expenditure does not fall under any of the specific provision then the same is allowed as expenditure under the residual section 37 of the Income Tax Act, 1961.

    Prior to the amendment by the 2015 Act, it was the common apprehension that the CSR expenditure as envisaged in the Companies Act, 2013 will be allowed as allowable expenditure or deduction under the income tax law. This was because there was no specific provision in the Income Tax Act to disallow such a mandatory incurring of expenditure.

    However, to a surprise to all, the Finance (No. 2) Act, 2014 has amended section 37 of the Income Tax Act, 1961 to contain a provision to expressly disallow the deduction for CSR expenditure.

    For this purpose, an explanation was added in section 37(1) to clarify that any corporate social responsibility (CSR) expenditure incurred by an assessee on the CSR activities as per section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.

    The intention of the government behind disallowing the expenditure as business expenditure was narrated in the 'Notes on clauses'[2] appended in the Finance (No. 2) Bill, 2014.

    It was stated that under the Companies Act, 2013 certain companies are required to spend a certain percentage of their profit on activities relating to Corporate Social Responsibility (CSR). The Income Tax Act, under the existing provisions, expenditure incurred wholly and exclusively for the purposes of the business is only allowed as a deduction for computing taxable business income.

    The contention behind such a disallowance for deduction of CSR expenditure was that CSR expenditure is an application of income and thus is not incurred wholly and exclusively for the purposes of carrying on the business.

    It was further stated that as the application of income is not allowed as a deduction for the purposes of computing taxable income of a company, any amount spent on CSR cannot be allowed as a deduction for computing the taxable income of the company.

    The objective behind such a disallowance of CSR expenditure was that the objective of introducing the mandatory CSR activities by the corporates was to share the burden of the Government in providing social services by wealthy companies having net worth or turnover or net profit above a threshold which the government did not want to subsidize by giving tax benefits on such CSR expenditure.

    If such expenses are allowed as a tax deduction, this would result in subsidizing of around one-third of such expenses by the Government by way of tax expenditure.

    The existing provisions of section 37(1) of the Act provide that deduction for any expenditure, which is not mentioned specifically in section 30 to section 36 of the Act, shall be allowed if the same is incurred wholly and exclusively for the purposes of carrying on business or profession.

    As the CSR expenditure (being an application of income) is not incurred for the purposes of carrying on business, such expenditures cannot be allowed under the existing provisions of section 37 of the Income-tax Act.

    Therefore, in order to provide certainty on this issue, it is proposed to clarify that for the purposes of section 37(1) any expenditure incurred by an assessee on the activities relating to corporate social responsibility  (CSR) referred to in section 135 of the Companies Act, 2013 shall not be deemed to have been incurred for the purpose of business and hence shall not be allowed as a deduction under section 37.

    However, the CSR expenditure which is of the nature described in section 30 to section 36 of the Act shall be allowed a deduction under those sections subject to fulfilment of conditions, if any, specified therein. The reason was that such an allowance or tax benefits are already there in the statute even before the introduction of section 135 of the Companies Act, 2013.

    Thereafter, on January 21, 2015, the CBDT has issued a Circular No 01/2015 dated 21-01-2015[3] to clarify the amendments introduced by the Finance (No. 2) Act, 2014. The para 13 of the Circular reiterated the intentions of the government and the applicability of the amendment to the provisions of the Act for disallowance of the CSR expenditure under section 37(1).

    Whether any CSR expenditure is wholly and fully disallowed as a deduction under the Income Tax Act, 1961

    The answer is 'No'. There is a misconception among the assessee as well as tax officers that any CSR expenditure incurred by a company pursuant to compliance of section 135 of the Companies Act, 2013 is a disallowed expenditure and can't be allowed as an expenditure under the Income Tax Act, 1961.

    This is not true. It may be noted that CSR expenditure can be disallowed if the same falls under the provisions of section 37(1). If any CSR expenditure falls within the provisions of sections 30 to 36 then such CSR expenditures cannot be disallowed under section 37(1). In other words, such CSR expenditure cannot be disallowed in general.

    The allowability of deduction for such CSR expenditure will be governed by the provisions of sections 30 to 36. If the company meets the conditions for claiming the expenditure as business expenses, under those sections then such CSR expenditure will be allowed as a deduction under the respective provisions. In case the company does not meet any condition(s) to claim such CSR expenditure as a business expense then such expenditure will be disallowed under those sections 30 to 36 but not under section 37.

    If any CSR expenditure fails to satisfy any of the conditions for availing business deduction under sections 30 to 36, then such expenditure cannot be allowed under section 37 due to specific restrictions on the allowability of CSR expenditures.

    Let us understand the concept with an example. Assume that a company has contributed Rs. 50 Lakh to an institution that is approved for scientific research u/s 35(1)(ii) of the Income Tax Act, 1961 in FY 2019-20. Further, a sum of Rs. 5 Lakh was donated to an institution. The contribution and the donation to the institutions were made as a matter of compliance to section 135 of the Companies Act, 2013.

    The expenditure of Rs. 50 Lakh to the approved scientific institution qualifies as CSR expenditure of the company. This CSR expenditure of Rs. 50 Lakh will be allowed to the company as a business expense u/s 35(1)(ii) as the company has satisfied the prescribed conditions.

    Section 35(1)(ii) allows a weighted deduction of 150 percent of contribution amount and hence deduction of Rs. 60 Lakh will be allowed to the company in AY 2020-21.

    Any question of disallowance under Explanation 2 to section 37(1) does not arise at all.

    If it is assumed that the company fails to satisfy any of the prescribed condition then the company even if takes the alternative claim of claiming the said CSR expenditure as a deduction under 37, then such claim will not be allowed and the CSR expenditure of Rs. 50 Lakh will be disallowed u/s 37.

    In respect of donation of Rs. 5 Lakh, the deduction was claimed under section 37 of the Act. Since Explanation 2 to section 37 prohibits the allowability of CSR expenditure, the same cannot be allowed as a deduction under the Income Tax Act, 1961.

    Hence, it can be concluded that if a CSR expenditure is allowable as a deduction under sections 30 to 36 then the same cannot be disallowed under section 37. Only those CSR expenditure which cannot be claimed as deduction under sections 30 to 36, then the same is not allowed as a business expense under section 37.

    Let us take another example. A company is required to make CSR expenditure under section 135 of the Companies Act, 2013  of Rs. 30 Lakh in FY 2019-20. The company has contributed/donated Rs. 40 Lakh in FY 2019-20. During the year, the company has secured a large government contract under which the company is under a contractual obligation to donate Rs. 10 Lakh to a specified charitable organization.

    The details of contributions/donation are given below-
    Contribution/Donation Paid -
    Amount (Rs.)
    To an institute approved  u/s 35(1)(ii)
    Rs. 20 Lakh
    To an institute approved  u/s 35(1)(iii)
    Rs. 7 Lakh
    To a Charitable Institution  eligible for 80G only
    Rs. 3 Lakh
    To a Charitable Institution
    Rs. 10 Lakh

    In the above example, the company should claim the contributions to approved scientific institutions under sections 35(1)(ii) and 35(1)(iii) as CSR expenditure since these will be always allowed as business expenditure. (Obviously, if the conditions mentioned therein are satisfied.)

    Further, CSR expenditure of Rs. 3 Lakh voluntary donation to the charitable organization will be disallowed as business deduction as claimed u/s 37.

    Remember, it is the actual expenditure that is counted towards CSR expenditure and not the deduction that is allowed or allowable under the Income Tax Act, 1961. In the given case Rs. 20 Lakh will be counted towards CSR expenditure and not Rs. 30 Lakh that is allowable u/s 35(1)(ii) under the Income Tax Act, 1961.

    Hence only Rs. 37 Lakh will be allowed under the Income Tax against the incurred CSR expenditure of Rs. 30 Lakh.

    The company has donated Rs. 10 Lakh under a contractual obligation for securing a contract for the business of the company. Such a contribution was not gratuitous or voluntary and hence is allowable as a deduction from computing the total income of the company under section 37.

    It must be remembered that Explanation-2 to section 37(1) contains the provision to disallow only the CSR expenditure which is required to be incurred u/s 135 of the Companies Act, 2013 and does not extend to other expenditures incurred under other business compulsions. Hence, the donation of Rs. 10 Lakh will be allowed as a deduction u/s 37.

    However, if the donation is voluntary and gratuitous then such a donation claimed as expenditure u/s 37 will always be disallowed since such an expenditure is not incurred for the purpose of the business of the company and which is a pre-condition of claiming an expenditure as business expenses u/s 37.

    Thus, it is clear that the expenditure on CSR activities is not deductible for tax purposes unless the CSR expenditure falls within provisions of Sections 30 to 36 of the Income Tax Act, 1961.

    Can CSR expenditure be claimed as deduction under section 80G

    The deduction under section 80G for making donations to charitable organizations is contained in Chapter VI-A of the Income Tax Act,1961 whereas the income under the head 'Income from business' is computed under sections 28 to 44 which falls under Chapter IV.

    In the entire income tax law, only the Explanation 2 to section 37 prohibits the allowance of CSR expenditure as business expenditure. None other provisions contain such restriction.

    Except section 37, no other provisions in the Income Tax Act, 1961 contain any provision to disallow or restrict or prohibit the claim of any deduction for CSR expenditure if the CSR expenditure is otherwise eligible for deduction.

    Further, section 37 is related to the computation of business income and its scope is limited to Chapter-IV only. The scope of the restriction imposed in section 37 does not extend to Chapter VI-A of the Act which is independent of section 37.

    Hence, it can be safely concluded that CSR expenditure is eligible for deduction under section 80G of the Income Tax Act, 1961 even if the expenditure was disallowed under section 37(1) by virtue of Explanation 2.

    Deduction u/s 80G is available from the Gross Total Income of the assessee which is the aggregate of all heads of income in contrast to section 37 which is applicable for computing the income under the head 'business income' only. Hence, the scope of section 37(1) is very limited so far as section 80G is concerned.

    CBDT's Circular No. 1/2015 dated 21-01-2015 also fortifies this view.

    How much deduction is available u/s 80G for CSR expenditure

    The limit on quantum on the maximum amount of deduction under section 80G shall be required to be computed with reference to the provisions of section 80G. There is no special provision contained therein for CSR expenditure.

    The amount of deduction for CSR expenditure under section 80G may range from 50 percent to 100 percent of the amount donated with or without any restriction as to 10 percent of the adjusted gross total income.

    For example, if the company has donated to the Prime Minister National Relief Fund then 100 percent of amount contributed by the company will be allowed as a deduction under section 80G.

    In case the donation is given to a charitable organization that is exempt u/s 80G(5)(vi) then 50 percent of the amount of donation will be allowed as a deduction u/s 80G subject to overall limit of 10 percent of the adjusted gross total income.

    It may be noted that if a company executes CSR activities directly on its own then such CSR expenditure though complied with the requirements of the company law but there could be disallowance of such CSR expenditure under the income tax provisions. There will be no tax benefits to the company for incurring expenditure on CSR activities for executing CSR activities on its own. On the other hand, if the CSR activities are executed through other charitable organizations like NGOs, trusts, societies, section 8 companies or erstwhile section 25 companies, etc. the company may be able to claim tax benefits on the CSR expenditure. Such CSR expenditure will not only comply with the requirements of the company law but also tax-neutral too.

    TDS on CSR expenditure

    If a company executes the CSR activities on its own then the CSR expenditure incurred for those nature of activities which calls for TDS then the provisions of TDS shall equally apply to those CSR expenditures. The obligation from TDS is not absolved only due to the fact that the expenditure is incurred for CSR activities.

    Generally, for fulfilling CSR obligation of the company if the payment made towards CSR expenditure falls within the scope of-
    Payment of salary u/s 192;
    Payments under a Contract including advertisement u/s 194C;
    Fees for Technical Services or Royalty u/s 194J;
    Consultancy or Professional Services etc. u/s 194J
    then the company is liable to deduct TDS.

    The obligation to deduct income-tax or TDS for expenditure on CSR activities depends on the nature of the activity for which payment is being made.

    On the contrary, if the CSR activities are carried out through NGOs etc then the amount of contribution or donation does not attract TDS even though the donation is made for meeting the expenditure by the NGOs which attracts TDS. The obligation to deduct TDS is shifted to the NGOs. The onus is not on the company to deduct the TDS from the amount donated.

    CSR expenditure and impact on Book Profit for MAT u/s 115JB

    When a company incurs expenditure on CSR activities then the company charges the expenditure in its Profit and Loss account. The 'Net Profit' in the P&L account is reduced to the extent of CSR expenditure.

    Such debited CSR expenditure may be allowed as a deduction under sections 30 to 36 of the Income Tax Act or may be subject to disallowance under section 37. Such expenditure may or may not be claimed as a deduction under section 80G.

    The computation of Book Profit for the purpose of payment of Minimum Alternative Tax or MAT is governed by section 115JB. The computation of Book Profits begins with the 'Net Profit' as per the statement of profit and loss prepared in accordance with the company law. Certain additions and deductions are made in the determined net profit to arrive at the 'Book Profit' u/s 115JB.

    The scope of additions to the 'Net Profit' is prescribed in Explanation 1 to section 115JB. The scope of such addition is very limited and cannot go beyond the prescribed items.

    It may be further noted that the prescribed items of addition are called for only when the same is debited to the statement of profit and loss which will have the effect of reducing the net profit. If such items are not debited in the statement of profit and loss then addition to net profit is not warranted.

    Apart from the list of additions in the net profit, there are certain items that are required to be deducted from the net profit to determine the Book Profit u/s 115JB.

    The prescribed list of additions and deletions in Explanation 1 to section 115JB are exhaustive in nature. Any other addition or deletion beyond the prescribed list is ulterior to the provisions of the law and thus will be invalid.

    The prescribed list of additions inter alia includes-
    1. income tax paid or payable,
    2. transfer to any reserves,
    3. provision for unascertained liabilities,
    4. provision for losses of subsidiary companies
    5. dividend paid or proposed
    6. expenditure on earning exempt income,
    7. amount of deferred tax
    8. provision for diminution of assets, etc.

    If we go through the prescribed list of additions, there is no provision in the law to add back the amount of CSR expenditure which is debited in the statement of profit and loss to the net profit reported by it. It is irrespective of the fact that such CSR expenditure may be subject to disallowance under section 37.

    In the absence of any such provision to disallow the CSR expenditure for computing the Book Profit u/s 115JB, any expenditure incurred on CSR activities cannot be added back to the net profit as disclosed in the statement of profit and loss. Hence, it can be safely concluded that the CSR expenditure is allowed for computing the 'Book Profit' u/s 115JB if debited to the statement of profit or loss.

    Reporting of CSR expenditure in Tax Audit Report (Form 3CD) and ITR-6

    The Tax Audit Report (TAR) in Form 3CD does not expressly require any disclosure or reporting of expenditure on CSR activities by the assessee company. This is as per the TAR in Form 3CD for FY 2018-19.

    In the ITR-6, applicable for a company assessee, apart from the disclosure in the Profit & Loss account schedule, there is a specific item of addition as a disallowance under section 37 in 'Part A OI-Other Information ((mandatory if liable for audit under section 44AB, for other fill, if applicable' in serial 7h.

    This is the disallowance of that part of CSR expenditure which is not allowed as per explanation 1 to section 37(1).


    References

    [1]Amendment in section 37(1) by the Finance (No. 2) Bill, 2014

    13. In section 37 of the Income-tax Act, in sub-section (1), the Explanation shall be numbered as Explanation 1 thereof and after Explanation 1 as so numbered, the following Explanation shall be inserted with effect from the 1st day of April, 2015, namely:—

    “Explanation 2.—For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.”.

    [2]Notes on Clauses to Finance (No. 2) Bill, 2014

    Clause 13 of the Bill seeks to amend section 37 of the Income-tax Act relating to general expenditure. The existing provisions contained in sub-section (1) of the aforesaid section provide that any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.

    It is proposed to insert a new Explanation in sub-section (1) of section 37 so as to clarify that for the purposes of sub-section (1) of the said section, any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.

    This amendment will take effect from 1st April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent years.

    Memorandum: Explaining The Provisions in the Finance (No. 2) Bill, 2014

    Corporate Social Responsibility (CSR) Under the Companies Act, 2013 certain companies (which have net worth of Rs.500 crore or more, or turnover of Rs.1000 crore or more, or a net profit of Rs.5 crore or more during any financial year) are required to spend certain percentage of their profit on activities relating to Corporate Social Responsibility (CSR). Under the existing provisions of the Act expenditure incurred wholly and exclusively for the purposes of the business is only allowed as a deduction for computing taxable business income.

    CSR expenditure, being an application of income, is not incurred wholly and exclusively for the purposes of carrying on business. As the application of income is not allowed as deduction for the purposes of computing taxable income of a company, amount spent on CSR cannot be allowed as deduction for computing the taxable income of the company. Moreover, the objective of CSR is to share burden of the Government in providing social services by companies having net worth/turnover/profit above a threshold. If such expenses are allowed as tax deduction, this would result in subsidizing of around one-third of such expenses by the Government by way of tax expenditure.

    The existing provisions of section 37(1) of the Act provide that deduction for any expenditure, which is not mentioned specifically in section 30 to section 36 of the Act, shall be allowed if the same is incurred wholly and exclusively for the purposes of carrying on business or profession. As the CSR expenditure (being an application of income) is not incurred for the purposes of carrying on business, such expenditures cannot be allowed under the existing provisions of section 37 of the Income-tax Act. Therefore, in order to provide certainty on this issue, it is proposed to clarify that for the purposes of section 37(1) any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to have been incurred for the purpose of business and hence shall not be allowed as deduction under section 37. However, the CSR expenditure which is of the nature described in section 30 to section 36 of the Act shall be allowed deduction under those sections subject to fulfillment of conditions, if any, specified therein.

    This amendment will take effect from 1st April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent years.

    [Clause 13]

    [3]Circular No 01/2015 dated 21-01-2015 issued by the CBDT (extract of relevant para 13 of the circular)

    13. Corporate Social Responsibility (CSR)

    13.1 Under the Companies Act, 2013 certain companies (which have net worth of Rs.500 crore or more, or turnover of Rs.1000 crore or more, or a net profit of Rs.5 crore or more during any financial year) are required to spend certain percentage of their profit on activities relating to Corporate Social Responsibility (CSR). Under the existing provisions of the Income-tax Act, expenditure incurred wholly and exclusively for the purposes of the business is only allowed as a deduction for computing taxable business income.

    13.2 CSR expenditure, being an application of income, is not incurred wholly and exclusively for the purposes of carrying on business. As the application of income is not allowed as deduction for the purposes of computing taxable income of a company, amount spent on CSR cannot be allowed as deduction for computing the taxable income of the company. Moreover, the objective of CSR is to share burden of the Government in providing social services by companies having net worth/turnover/profit above a threshold. If such expenses are allowed as tax deduction, this would result in subsidizing of around one-third of such expenses by the Government by way of tax expenditure.

    13.3 The provisions of section 37(1) of the Income-tax Act provide that deduction for any expenditure, which is not mentioned specifically in section 30 to section 36 of the Income-tax Act, shall be allowed if the same is incurred wholly and exclusively for the purposes of carrying on business or profession. As the CSR expenditure (being an application of income) is not incurred for the purposes of carrying on business, such expenditures cannot be allowed under the provisions of section 37 of the Income-tax Act. Therefore, in order to provide certainty on this issue, said section 37 has been amended to clarify that for the purposes of sub-section (1) of section 37 any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 shall not be deemed to have been incurred for the purpose of business and hence shall not be allowed as deduction under said section 37. However, the CSR expenditure which is of the nature described in section 30 to section 36 of the Income-tax Act shall be allowed as deduction under those sections subject to fulfillment of conditions, if any, specified therein.

    13.4 Applicability:- This amendment takes effect from 1st April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent years.



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