Constitutional Validity of CSR By Ms. Amudha Murthy

 Introduction: Corporate Social Responsibility is also called as Corporate Citizenship or Corporate Responsibility. Generally, CSR is understood to be the way firms integrate social, environmental and economic concerns into their values, culture, decision making, strategy and operations in a transparent and accountable manner and thereby establish better practices within the firm, create wealth and improve society. The basic premise is that when the corporations get bigger in size, apart from the economic responsibility of earning profits, there are many other responsibilities attached to them which are more of non-financial/social in nature. These are the expectations of the society from these corporate to give something in return to the society with whose explicit or implicit help these entities stand where they are. Companies are aware that they can contribute to sustainable development by managing their operations in such a way as to enhance economic growth and increase competitiveness whilst ensuring environmental protection and promoting social responsibility, including consumer interest.[1]

Section 135 of Companies Act, 2013 violates Article 14 of the Constitution: Article 14 of the Constitution guarantees to every person, equality before law and equal protection of law within the territory of India. Moreover Article 14 allows reasonable classification of the legislation. In Re: Special Courts Bill[2] the Supreme Court has consistently ruled that classification is valid only if

(i) It is founded on an intelligible differentia and

(ii) The differentia has a rational relation to the object sought to be achieved by the statute in question.

CSR spending is made mandatory to only company form of organisation .CSR is not applicable to partnership firm or LLP or any other form of organisation, even though it’s net worth or profit or turnover is more than the prescribed limit.

As per Section 135(1), once a company has met any one of the thresholds relating to net worth, turnover or net profits, it comes within the purview of section 135. Thus a company which does not meet the thresholds at a future point in time would nevertheless continue to be obliged to spend on CSR activities.[3]

The explanation to Section 135 states that ‘average net profits’ shall be computed in accordance with the provisions of Section 198. Section 198 (4) (l) permits only accumulated losses incurred after the date of effectiveness of the said Section (but not for periods prior to such effectiveness) to be set-off against net profits for arriving at ‘average net profits’ for the purposes of Section 135. Thus, a company which has earned profits during the preceding three financial years but is yet to recoup its carried forward losses relating to the period prior to effectiveness of Section 198 will be required to spend on CSR. [4]

A loss-making company’s obligation to contribute to CSR is the same as that of a profit-making company so long as the ‘average net profits’ test is met.

Lastly, Section 135 also applies to companies registered under Section 8 of the Act, which are statutorily obliged to apply their profits only for promoting their objects and Net Profit calculation for foreign company having subsidiary in India is not clear and  it is ambiguous.[5]

Since, test for classification is not met, as Section 135 treats unequal’s as equals is violates Article 14.

Section 135 violates Article 19 (1) (g) of the Constitution of India: Article 19 (1) (g) of the constitution of India, vest freedom of trade, commerce and profession. By section 135 of companies Act 2013, CSR activity is made mandatory to certain companies which meet the required criteria.

CSR is a restriction: Section 135 constitutes such a restriction since it requires the company to divert the money which could have otherwise been reinvested into the company’s business for incremental returns or paid as dividend to shareholder, for being spent on CSR activities.

CSR does not fall under reasonable restriction: Article 19(1) (g) is subject to the provisions of Article 19(2) to 19(6) which permit the state to make laws which impose reasonable restrictions on the exercise of the right granted by Article 19(1)(g), inter alia, ‘in the interests of the general public’[6]. The Supreme Court has, by and large, given an expanded meaning to the language of Article 19(6). The fundamental principle that the Supreme Court has enunciated in the matter of interpreting Article 19(6) is that the reasonableness of restriction is to be determined in an objective manner and from the standpoint of the interests of the general public and not from the standpoint of the persons upon whom the restrictions are imposed.[7]

Section 135 is nothing but the outsourcing by the Government of its duty to provide its citizens with health care, education, housing and other basic life-sustaining amenities.  Section 135 is not intended to limit the adverse impact of business on the public.

It applies to companies carrying on all types of businesses and not necessarily those which are harmful to the health and/or well-being of the society. Section 135 is not intended to help achieve the full fulfillment of fundamental rights of citizens which, in the absence of it, would be defeated.

There has been no study or empirical evidence to suggest that the benefits of mandating a CSR spend as stipulated in Section 135 will outweigh the benefits of not mandating such spend at all Voluntary form of  spending  made mandatory does not fall within reasonable restriction. Therefore CSR violates Article 19(1) (g) of the constitution.

 CSR violates Corporate Democracy: Shareholders are owners of the company. Management is entrusted to Board of Directors. By virtue of introduction of CSR, board of directors is given unrestricted power to decide the CSR expenditure, the CSR activity to be undertaken.

Board of directors can spend company’s money in a CSR activity for their own personal benefit. For Example: A director can approve CSR activity, relating to construction of building in a school/or college where he need to get admission for his son. In such case, shareholders cannot prevent the action of director, to use company’s fund for his personal benefit, as shareholders do not have say relating to CSR activity.

Moreover, each area has certain needs to be fulfilled if the nature of CSR activity is left to the board to be decided ,it will neither benefit the society and shareholders fund will be misused thereby shareholders right is affected. Since shareholder do not have a say in CSR and board of directors have unrestricted power and there in no check and Balance .Therefore Shareholders rights are affected.

Defining CSR: (Corporate social responsibility policy) Rules, 2014 has defined the term “corporate social responsibility (CSR)” as follows: “corporate social responsibility means and includes but is not limited to:

  1. projects or programs relating to activities specified in schedule VII to the Act; or
  2. projects or programs relating to activities undertaken by the board of directors of a company (board) in pursuance of recommendations of the CSR committee of the board as per declared CSR policy of the company subject to the condition that such policy will cover subjects enumerated in schedule VII of the Act.[8]

 Amendments in the Schedule: Section 467 of the Companies Act gives power to the central government to alter the provisions contained in any of the Schedules[9]. The section is similarly worded as Section 641 of the Companies Act, 1956 which gave power to the central government to make changes in the Schedules[10].

The notification dated February 27, 2014 is a delegated legislation issued under a statutory provision, namely Section 467 of the Companies Act which provides that the Central Government may, by notification, alter any of the regulations, rules, tables, forms and other provisions contained in any of the Schedule to the Act. Since the Schedule forms an integral part of Section 135, the power to alter the Schedule needs to be exercised with an abundant caution. Delegated legislation is a means by which the legislature delegates part of its legislative function to an executive authority. However, there are well-settled constitutional limits on the scope of delegated legislation. In the case of In Re The Delhi Laws Act, 1912[11] the legislature cannot delegate essential legislative functions such as the determination of legislative policy and cannot delegate its power to repeal or modify its essential features. The question is what constitutes essential legislative function (which cannot be delegated by Parliament). In Raj Narain v. Chairman, Patna Administration Committee[12]  the Supreme Court accepted that “exactly what constitutes an essential feature cannot be enunciated, in general terms”. The court held change in policy is not ancillary function.

The Court however, attempted to spell out it in Harishankar Bagla v. M.P. State[13]  as follows: “The essential legislative function consists in the determination of choice of the legislative policy and of formally “enacting that policy into a binding rule of conduct”. And to declare what the laws shall be in relation to any particular territory or locality, is an essential legislative act.

Social business projects forms the core philosophy of corporate social responsibility and Schedule VII[14] of the original Companies Act, 2013 contained ‘social business projects’ among the list of various activities that a company could undertake. The Central Government vide notification dated February 27, 2014 made amendments to the Schedule while deleting ‘social business projects’ from the list of activities enlisted under the Schedule. Although Section 467 empowers the government to amend the Schedule through delegation, the power to amend under this section is meant to make simple alterations without affecting the legislative policies enshrined in the Companies Act, 2013. Deletion of ‘social business projects’ through the notification seems to override the CSR policy as envisaged under the Companies Act[15]. By deleting ‘social business projects’ through the notification, the central government seems to have exceeded its legislative mandate and the same may be subject to judicial review in future. This was observed in the case of J.K. Industries Ltd. v Union of India and Ors.[16]

Voluntary vs. Mandatory:

  1. Deciding the allocation of funds for the purpose for CSR i.e. 2% of the net profits must be done through shareholders voting and not through any legislative powers.[17]
  2. All the efforts taken by the government seems to be like forcing the companies to contribute, rather than it being voluntary. For example legislation can be in the form of stopping child labour in the factories and it cannot force any factory or a company to build schools or provide education.
  3. Moreover with the concurrence to the present case article 21-A[18] which is right to education already enforced by law and its make so clear that CSR is not the only way to bring it into practice.
  4. The above point makes it corporate compulsion responsibility and not corporate social responsibility.

Conducting all those activities which are either specified under Schedule VII to the Companies Act, 2013 or those which are recommended by the CSR Committee of the Board as per the CSR Policy and are undertaken by the Board of directors of the Company will be covered under the scope of activities of Corporate Social Responsibility. Amend schedule VII to include a board definition of CSR. The legislature cannot delegate essential legislative functions such as the determination of legislative policy and cannot delegate its power to repeal or modify its essential features. Equal treatment has to be given to all companies. There should not be any distinction between big or small companies. Moreover it is pertinent to note that Section 135 does not empower the Central Government to notify any subordinate legislation. There is no legislative competence to enact this provision under the said Act.

By :-Amudha Murthy* 5 Year Ba.Bl. (Hons.), The Tamil Nadu Dr.Ambedkar Law , School of Excellence in Law (Soel)

 

[1] Professional programme study material Governance Business Ethics and Sustainability pg.199

[2] AIR 1979 SC 478

[3] Section 135 0f Companies Act,2013

[4] https://shuklagirjesh.wordpress.com/2013/07/31/corporate-social-responsibility-a-constitutional-discourse/

(Accessed on 5.3.2015 at 6.34 pm)

 

[5]http://www.mondaq.com/india/x/307596/Corporate+Governance/Indias+New+Corporate+Social+Responsibility+Requirements+Beware+of+the+Pitfalls  (Accessed on 5.3.2015 at 6.54 pm)

 

[6] Article 19 of the Indian Constitution

 

[7] http://www.legalera.in/legal-articles/item/14404-csr-and-the-constitution-of-india.html (Data provided as on Tuesday, 02 September 2014 12:57)  (Accessed on 5.3.2015 at 6.57 pm)

[8] Rule 2(c) of (corporate social responsibility policy) rules 2014.

[9] Section 467 of Companies Act,2013

[10] Section 641 of Companies Act,1956

[11] 1951 AIR 332

[12] AIR 1954 S.C. 569

[13] AIR 1954 S.C., 468

[14] http://www.commonlii.org/in/journals/NALSARStuLawRw/2013/5.pdf  (Accessed on 5.3.2015 at 7.27 pm)

 

[15] http://www.legalera.in/legal-articles/item/14404-csr-and-the-constitution-of-india.html (Accessed on 5.3.2015 at 6.57 pm)

 

[16] 165 TAXMANN 323 (SC)

[17] See Azim Premji against law on mandatory CSR spending by corporates, The Economic Times, Mar. 24,2011 available at http://articles.economictimes.indiatimes.com/2011-03-24/news/29181451_1_csrspending-corporate-affairs-murli-deora-azim-premji; Also see IT CEOs back Premji, against mandatoryCSR, Times of India, Mar. 26, 2011 available at http://articles.timesofindia.indiatimes.com/2011-03-26/software-services/29191926_1_csr-azim-premji-corporate-social-responsibility.

[18] Inserted by the Constitution (Eighty-Sixth) Amendment Act, 2002.

 

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