India’s new CSR law – Will mandating corporate charity work?

With the implementation of the Companies Act 2013 earlier this year, the Indian government has made history by requiring eligible Indian businesses to “turn CSR from voluntary activities to mandated responsibilities”. Will this succeed in boosting the non-profit sector without hobbling economic competitiveness? And will it set an example for the world to follow?

CSR in India

The term Corporate Social Responsibility (CSR) came into common usage in the early 1970s. The 20th century witnessed a shift in focus of global CSR from traditional philanthropy – giving out donations – towards more direct and sustained engagement by business in both broad-based and cause-specific interventions.

In India, CSR has traditionally been an activity that was performed in a perfunctory manner, but not deliberated. Although India’s CSR still remains within the philanthropic space, its focus has shifted to institutional building (educational, research and cultural) with the aim of lifting community welfare in measurable ways.

In India, as is the case world-wide, CSR has become a necessary part of operations for all large companies. While proponents of CSR argue that companies would be able to increase long-term profits by embracing CSR, critics argue that CSR distracts companies from the economic role of businesses by corporatizing that which is best left to individuals. Nevertheless, the importance of CSR in today’s world cannot be denied.

India’s new Companies Act, 2013

According to the Indian Institute of Corporate Affairs, at least 6,000 Indian companies will be required to undertake CSR projects in order to comply with the provisions of the Companies Act, 2013. Furthermore, some estimates indicate that mandatory CSR commitments from companies under the new law may amount to as much as INR 15,000 crore or USD 2.5 billion.

Mandatory CSR commitments from companies under the new law may amount to as much as INR15,000 crore or USD2.5 billion.

The government recently implemented the new Act – which came into effect on 1 April 2014 – to impose compulsory CSR obligations upon both private and public limited companies in India.

• A company with a net worth of INR 5 billion, a turnover of INR10 billion, or net profit of INR 50 million, is required to spend at least 2% of its average net profit over the three preceding financial years on CSR activities. If they do not comply, then the reasons for not spending the amount would have to be specified in their Board of Director’s annual report.
• Companies specified under the Act must maintain a CSR committee consisting of at least three directors. This committee is required to draw up a formal CSR policy and execute monitoring of CSR activities. Moreover, the committee is required to issue a detailed report to the government describing the company’s CSR policy, CSR committee work, CSR amount expenditures and specific CSR projects.

How will this make a difference?
How will the new Act, which came into force in April 2014, impact Indian businesses?

• Social sector career opportunities

If companies start to expand CSR Activities seriously, career opportunities for those in the social sector are bound to pick up. The extent of this would depend on how companies treat CSR – as a core function with dedicated staff or a minor function with additional roles grafted on.

With this in mind, the Institute of Corporate Sustainability Management in New Delhi signed a Memorandum of Understanding with University of Mysore in April 2014 to launch a specialized MBA in CSR .

• Setting the bar high for CSR legislation

This Act sets the stage for India on an international level as the first country to implement CSR legislation. The European Union is also considering a similar law for companies to disclose and report their CSR spending .

India is now the first country to implement mandatory CSR for some firms. The European Union is considering a similar law.

Challenges in the new Act

While the new CSR guidelines require large companies to spend 2% of their net profit on social development, there are problems of implementation which warrant a closer look.

• Forced philanthropy

The 2% ruling could lead to forced philanthropy – ‘tick-box’ behaviour – or even corruption, with “round-tripping” of funds to circumvent the law. Most companies feel that spending 2% on CSR is a substantial amount; SME companies are likely to feel the pinch in terms of profitability. There are also bound to be implications for national economic competitiveness – for example in terms of attracting the domestic and foreign investment needed to build up India’s infrastructure.

• No tax break

A tax break was expected by the companies but the 2014 budget announcement featured no tax break leaving companies disappointed. Tax breaks were expected for several independent activities.

• Multi-layered investments

Indian companies often set up investment companies or subsidiaries to assist in the acquisition of shares and securities. The new Act restricts companies from making investments through more than two tiers of such subsidiaries. This may eventually deter private equity players from investing in sectors such as infrastructure, where such structures are common.

• Independent directors

The tenure of independent directors is now linked to two consecutive terms – with restrictions on issuance of stock options and sitting fees. This will increase the difficulty of locating qualified professionals to fill board seats.

• Auditor rotation

Auditors can now handle a company’s account for a maximum of 5 consecutive years in the case of an individual auditor, and 10 years if the auditor is a company. This requirement is expected to create some disruption, as there are only a limited number of companies who are in position to serve larger clients – and the possible unintended consequence may be to encourage big audit firms to expand.

What the future holds

CSR in India today has gone beyond charity and donations, into a new era where sustained and structured programs with a clear focus are becoming the norm. The basic objective of CSR these days is to maximize a company’s overall impact on society and stakeholders.

Some key trends which we expect to unfold in response to the catalyst of the CSR Act:

• Role of Social media in CSR set to rise

India accounts for the second largest number of Facebook users globally. This has enabled greater involvement of employees and consumers in CSR activities through Facebook as a platform. The CSR Act will accelerate this trend. Organizations are not afraid to use this medium to tap into the power of collective thinking and collaboration.

• Number of Non-governmental organizations (NGOs) to increase

A provision under the CSR guidelines states that a company can implement CSR activities on its own through a non-profit foundation or with an independent (registered) NGO that has a track record of at least 3 years in similar activities. This has inadvertently led to a sudden spurt in the number of NGOs that can implement CSR Activities. There are now approximately 2 million operational NGOs in India, as of February 2014. This number looks set to rise dramatically.

• The rise of the internal social activist

According to the NASSCOM Foundation’s report in 2013, there seems to be a greater awareness among employees about the social impact of actions that companies take. Companies are developing programs to tap into this. For instance, Vodafone in India has a program known as ‘World of Difference’ where all employees spend 5 weeks with NGOs (that the company supports) in locations around the country.

A change for good or bad?

India has become the first country in the world to mandate a minimum 2% spending on CSR initiatives for larger firms. The reverberations from this fateful move will be felt in India’s CSR landscape for years to come.

The new Act is bound to stimulate the CSR sector – leading to more inbound revenues, more jobs being created and more social impact. It may also set a standard that other countries in the world emulate to some degree. Global anxiety about rising income and wealth inequality is leading to clamours for giant companies to act more responsibility.

However, the downsides are more subtle. The new Act lowers company profits by 2%, though in reality the hit is smaller than that since most affected companies would already be incurring some CSR spending even prior to the Act coming into force. Nevertheless, even a small impact is vital. This could hurt economic competitiveness, inducing investment dollars, from both foreign and domestic investors, to move abroad. However, the risk of this does not seem too great, given the huge size and attractiveness of India’s market, particularly in the context of a slowdown in China and China-related geo-political tensions.

Another danger is that companies will respond to the CSR Act by disguising or “round-tripping” normal business expenditure or compensation to share-holders or employees as CSR spending. However, since the ruling only applies to the very largest firms, who are mostly audited by large and reputable auditors, this risk will probably be contained.

Yet another danger is that the Act risks destroying the genuine impulse to do CSR at one fell swoop. If CSR becomes a matter of legal compliance rather than a matter of choice, could this not undermine the formation of values and a culture that are conducive to CSR? Might this not give the CSR sector a bad name?

If CSR becomes a matter of legal compliance rather than a matter of choice, could this not undermine the formation of values and culture that are conducive to CSR?

The last limitation is that of marginality. Even with an increased spending of over USD 3 billion, the impact of this Act in a huge country like India facing multiple socio-economic challenges will be limited. In India, only 600 million (36% of the population) have access to a clean toilet , for example. But then again, this is not an argument against undertaking small acts of goodness, which is what the CSR Act is trying to do.

In the final analysis, India’s legislators should be saluted for avoiding the path of passivity in favour of bold experimentation. Whatever its long-term effects, India’s CSR Act will raise the significance of CSR in global discussions of corporate strategy. It will reverberate in the classrooms of business schools world-wide. And it will be grist for the mill for policy-makers and development economists for years to come.

https://www.spireresearch.com/spire-journal/yr2014/q3/indias-new-csr-law-will-mandating-corporate-charity-work/