CSR issues continue to remain unresolved

We have discussed a lot on 'why CSR'. It's time to discuss 'how', rather than 'why'. Draft rules are before us. The provision (section 135) of the Companies Act 2013 shall be applicable from the financial year 2014-15 and companies hardly have five months to formulate the CSR policy. Certain issues are bothering those who are responsible for formulating the CSR policy and implementing the same.

The Draft Rules state, "CSR projects/programmes of a company may also focus on integrating business models with social and environmental priorities and processes in order to create shared value." Michel Porter, the Harvard Professor, who introduced the term 'shared value' in a HBR (January-February 2011) article defines shared value as, "policies and operating practices that enhance the competitiveness of a company while simultaneously advancing the economic and social conditions in the communities in which it operates."

An example of shared value initiative is the 'Project Shakti' of Hindustan Unilever Limited (HUL).It enhances the direct rural reach of the company while empowering women. Can we classify 'Project Shakti' as a CSR project? Whether training expenses on Shakti entrepreneurs should be classified as CSR expenditure?
The concept of 'shared value' blurs the boundary between pure business activities and CSR activities. 'Shared value' strategies definitely serve the CSR objectives, but they are closely intertwined with the business strategy. Clarification on this issue is essential, as companies and regulators should have a common understanding on which items should be included in calculating CSR spend. The Act (schedule VII) stipulates that 'social business projects' may be included in the CSR policy. By definition, surplus from those projects are ploughed back to improve the product or service or to provide subsidy. For example, the 'agarbatti' (incense sticks) business ofITC started to provide livelihood support to retired employees and then it was extended to other members of the community located around ITC's manufacturing facilities.

If ITC designates it as a 'social business project', it shall not include surplus from this business in the net profit of the company.

A clarification is required on whether a part of general overheads and the cost of service provided by employees, who are employed primarily to work for the core business of the company, but spend some time on those projects, should be considered as CSR spend.

The Draft Rules state, "Only activities, which are not exclusively for the benefit of employees of the company or their family members shall be considered as CSR activity." Companies build and operate facilities (e.g. educational institutions and health care facilities) primarily for employees and their families. Members of the local community also use those facilities. A clarification is required on whether only proportionate expenditure that can be assigned to the use of those facilities by local community members should be considered as CSR spend. Allocation of expenditure will be an issue that should be addressed by cost accountants.

Activities related to 'environmental sustainability' are also classified as CSR activities. Companies undertake research projects to improve existing products or processes to make them environment friendly.

A clarification is required on whether such research expenses will be considered as CSR spend.The Draft Rules state, "CSR Policy would specify that the corpus would include the following: 2% of the average net profits; any income arising therefrom; and surplus arising out of CSR activities."

This implies that every year, companies should transfer two percent of average net profit before tax (calculated as per section 198) of the previous three years to the CSR corpus and then spend money for CSR activities from that corpus. A clarification is required on whether companies should transfer the amount to the corpus at the beginning of the financial year and invest the corpus fund outside the business to earn an income that will form a part of the corpus.

The Act mandates that every company having a net worth of Rs 500 crore or more, or turnover of Rs 1,000 crore or more or a net profit of Rs 500 crore or more during any financial year shall constitute a CSR Committee of the Board consisting of three or more directors, out of which at least one director will be an independent director.

A clarification is required on whether a company that is not otherwise required to appoint independent directors is required to appoint an independent director only to comply with the requirement under section 135 of the Act.

The government should come out with detailed clarifications as early as possible to enable companies to formulate the CSR policy. In the absence of clarity, unscrupulous companies will take advantage of loopholes and honest companies will get harassed.