Who is a socially responsible corporate?

India is possibly the only country in the world which mandates that a profit-making company spend two percent of its after-tax profits on “corporate social responsibility’ (CSR). This requirement came as part of the new company law of 2013, which replaced the fifty-seven-year-old company law of 1956. The reason to have a brand-new law to govern the functioning of companies, was because in half a century the world had seen several changes in the corporate landscape. For instance, the norms and practices of corporate governance, the accountability to small shareholders had become more stringent.

Firstly, after paying taxes, the profit entirely belongs to the owners, i.e. the shareholders of the company. So, the management of the company cannot spend any amount from post-tax profit, without the explicit consent of the shareholders. This would be a breach of contract law. Secondly, the two percent imposition was a de facto tax. Why not simply increase the corporate income tax rate, and keep it simple? On one hand governments are committed to bringing down the income tax rate to 25 percent, but on the other there is this backdoor way of increasing the de facto tax burden.

This was anyway being enforced by the stock market regulator (Securities and Exchange Board of India, SEBI) for those companies that were listed, and whose diktat often overlapped, or in some rare cases contradicted the provision of company law. The new law passed by Parliament in 2013 was well debated and discussed in parliamentary committees, and there was also consultations with industry. While there was an effort to strengthen governance, there also was progress in the ease of doing business. But the unexpected googly was the introduction of the CSR spending obligation.

All companies which were above a defined threshold of net worth, or revenue or profits, were required to spend two percent of after-tax profit on CSR. There were several problems with this provision.

Firstly, after paying taxes, the profit entirely belongs to the owners, i.e. the shareholders of the company. So, the management of the company cannot spend any amount from post-tax profit, without the explicit consent of the shareholders. This would be a breach of contract law. Secondly, the two percent imposition was a de facto tax. Why not simply increase the corporate income tax rate, and keep it simple? On one hand governments are committed to bringing down the income tax rate to 25 percent, but on the other there is this backdoor way of increasing the de facto tax burden. Thirdly, the regulation under this law had to specify what was allowed or disallowed as legitimate CSR spending. Would employee welfare spending or increase in cafeteria allowance be allowed? No. Would spending on tribal welfare be ok, even if accompanied by branding by the company? Yes, but conditionally. Would scholarships for children of employees be ok? No. So you can imagine the can of worms, as some bureaucrat had to decide what was ok under CSR, and then the litigation in case of disputes or disagreements.

Five years later the situation on the CSR law is as follows. This month the Parliament amended the 2013 Company Law, which among other things, changed the CSR mandate from “comply or explain” to “comply or imprisonment”! Senior officials of companies can go to jail for non-compliance! This was a hastily passed amendment in Parliament, due to the brute majority, even though the government’s own specially appointed committee was examining the issue.

The fourth reason for the CSR requirement to be problematic, was that this was an implicit admission by the government that it had failed to discharge its own obligation to bring development in backward areas, and hence had to use coercive tax-like methods to involve corporations in this activity. Lastly, one could also argue that the business of business is business. By providing goods and services that consumers need, by creating employment, by paying taxes on inputs, outputs and profits, and by complying with various laws of the land, including those on environment and pollution, the corporations anyway contribute to the wellbeing of society and to nation building. Why then impose an extra obligation of shouldering the burden of development spending? 

Presumably the rationale to impose the two percent CSR law was because the public sector companies were anyway doing it, whereas their private sector brethren were going scot free. This is a piece of inverted logic. Perhaps the PSU’s should be given more autonomy and be told to focus on running their businesses efficiently, and their profits could be spent by the government directly. Anyway, all these arguments were moot, and the law was enacted. The regime of the CSR mandate, was to comply or explain. That is, it was not compulsory, and if a company did not spend the obligated amount, it had to explain it in its annual report.

Five years later the situation on the CSR law is as follows. This month the Parliament amended the 2013 Company Law, which among other things, changed the CSR mandate from “comply or explain” to “comply or imprisonment”! Senior officials of companies can go to jail for non-compliance! This was a hastily passed amendment in Parliament, due to the brute majority, even though the government’s own specially appointed committee was examining the issue. That committee submitted its report, after the amendment was passed, and it has recommended that the criminal aspect be removed from penal provision. If CSR compliance fails, then a company has to pay a penalty, not have officials imprisoned. The Minister also clarified that the amendment will not be enforced. Which means that the amendment will hopefully be amended soon.

The modern corporation has to not only earn the license to operate in society since it uses infrastructure built with public funds, uses natural resources, degrades the environment and benefits from stability of law and order. But it also must earn the goodwill of society at large. So increasingly profitable companies will have to do much more to create lasting value in terms of wealth for shareholders and goodwill amongst all.

Why then this haste, in the first place? The other notable fact emerging from the committee’s reports, is that almost half the companies are not complying with the CSR law, as of March 2018. Of the roughly 21,000 companies required to comply as per the conditions under the law, only about 11,000 have bothered to comply. The total spend on CSR by these 11,000 odd companies is barely 13,000 crore, which is 0.4% of the Central government’s budget this year. Or it is barely two or three percent of the Centre’s annual development spending. And such a lot of regulation, cross-checking, bureaucracy to ensure compliance, that too by just 21,000 companies who make up perhaps 2 percent of all registered companies. Is it really worth this effort and complication? 

It is undoubtedly true that the modern corporation has to not only earn the license to operate in society since it uses infrastructure built with public funds, uses natural resources, degrades the environment and benefits from stability of law and order. But it also must earn the goodwill of society at large. Besides we have moved away from shareholder capitalism to stakeholder capitalism, which includes customers, employees, vendors and suppliers, government, regulators and all of society. So increasingly profitable companies will have to do much more to create lasting value in terms of wealth for shareholders and goodwill amongst all. But let CSR remain in the purely private, voluntary and individual domain.

(The writer is an economist and Senior Fellow, Takshashila Institution)