It is a matter of great consternation that the Department of Company Affairs is working overtime to book companies for alleged violations of the provisions of Section 135 of the Companies Act, 2013 (hereinafter the “Act”).Show cause Notices are being issued to companies on various grounds of non-compliances. Considering the fact that Section 135 by itself does not contain any penal provisions, proceedings are being initiated under Section 441 of the Act and companies are being asked to show cause as to why they should not be directed to file applications for compounding of offences allegedly committed by them under Section 135. The alleged offences cover the entire gamut of conceivable non-compliances ranging from failure to incur expenditure for CSR activities against statutory obligations, failure to constitute a CSR Committee, failure to include in the Report of the directors as called for under Section 134(1)(o)of the Act, details about the CSR policy developed and implemented by the company during the year even in cases where no expenditure had been mandated either due to the absence or the net profits being below the prescribed thresholds.
It is against this background that it would be appropriate to analyse the legal provisions contained in Section 135, to also examine the vires of the MCA General Circular No.21/2014 dated 18.6.2014 on the strength of which such notices are being issued In our view the said circular travels beyond the scope of the Act.The Department appears to be oblivious to the amendment proposed to the Section under the Companies (Amendment)Bill, 2016 which has unfortunately gone into cold storage and the recommendations of the Company Law Committee .A deep dive into the above provisions will soon reveal that the overdrive launched by the MCA to bring ostensibly to book the recalcitrant companies is in many cases somewhat misplaced, is legally untenable and not entirely based on a proper appreciation of the statutory provisions of the Act .
Section 135(1) -Year of applicability of the prescribed thresholds
We are aware that Section 135 has been made enforceable in the Statute vide Notification no..SO 582(E) dated 27.2.2014 with effect from 1.4.2014.
Section 135(1) provides that every company:
- having a net worth of rupees five hundred crores or more or
- a turnover of rupees one thousand crores or more or a net profit of rupees five crores or more
- a net profit of rupees five crores or more,
during any financial year(Emphasis supplied) shall constitute a CSR Committee of the Board consisting of three or more directors out of which at least one director shall be an independent director.
It is pertinent to note that the above thresholds are mutually exclusive and if a company comes within the ambit of one of the above, it will be necessary for it to constitute in the first place a CSR Committee of the Board with the required composition of directors. The Sub-section makes use of the expression “during any financial year”. It does not provide any insight as to the particular financial year in respect of which the prescribed thresholds are to be applied. As the Section has become applicable to the financial year 2014-15, it would be a logical conjecture to assume that the reference should to the preceding financial year ended March,31, 2014. Any other presumption would necessarily bring in an element of retrospectively to the provision, a consequence which is totally undesirable in what is an essentially a procedural law.
It is also pertinent to note that Section 135(1) only calls for the constitution of the CSR committee in cases where the prescribed thresholds are breached.
Section 135(5) - Provides for determination of quantum of CSR spends based on average profits for three preceding financial years
In contrast to Section 135(1), Section 135(5) sets out the obligations to make CSR spends in applicable circumstances. It provides that the CSR spends should be at least equivalent to two percent of the average net profits of the company made during the three immediately preceding financial years.The Section having been introduced with effect from April, 1, 2014, in its first year of applicability, the CSR spends have to be determined with reference to the average net profits during the three immediately financial years.
It is pertinent to note that the terminology of “three immediately preceding financial years” is used only in Section 135(5) in contra-distinction with Section 135(1) which speaks only about “any financial year”. From this, it is abundantly clear that the thresholds for net worth and turnover should be applied in the first year of operation of the Section with reference to the status obtaining as of March,31, 2014 as per the audited financial statements of the company. Only Section 135(5) provides the mechanism for determining the quantum of CSR spends thus making it necessary to consider the net profits for the preceding three financial years.
Will the three year benchmark under Section 135(5) apply to every company
Neither Section 135(5) nor the Rules introduced by the MCA through the Companies(Corporate Social Responsibility Policy) Rules, 2014 address the question as to how the bench mark under Section 135(5) has to be applied in the case of a company which has not been in existence for three years or more as of April 1, 2014.In our view, if a company has been in existence only for say two years as of April,1, 2014, the quantum of CSR spend should logically be based on average net profits for the last two years, given the legislative intent under Section 135(5).
Net Profit includes “Loss”
Section 135(5) speaks only about the consideration of the net profits for the preceding three financial years for computing the quantum of CSR spends. What if a company has net losses in any of the intervening period of three years. The term ”profit” connotes the idea of pecuniary gain.(Shivamurthy Swami v Agadi Sanganna Andanappa (1971)(3)SCC 870.
The term “profit” has been held to mean for the purposes of Section80 HHC (1) and (3) of the Income Tax Act, 1961 to mean a positive profit worked out after taking into consideration the losses, if any.(A.M.Moosa v Commissioner of Income Tax(2007)(9 SCR831).
In Commissioner of Income Tax v Harprasad &Co.P.Ltd (99 ITR 118),the Supreme court has held that “for the charging provisions of the Act, it is discernible that the words ”Income “ or “profits and gains” should be understood as including losses also, so that, in one sense, ”profits and gains ”represent” plus income” whereas losses represent ”minus income”. In other words, loss is negative profit” .
From the above, it follows that while computing the average profits for the three preceding years, if a company has incurred for any year net loss, the same should be taken into consideration while determining the average net profits.
Para V of MCA General Circular No. 21/2014, dated 18.6.2014- Not legally sustainable-Words used in a Statute cannot be substituted or expanded
In response to the several references and representations from the stakeholders seeking clarifications on the provisions under Section 135 of the Act, the above circular was issued. Para V of the circular, clarifies the term “Any financial year” as appearing in Section 135(1), and states as under:
“Any Financial year” referred under sub-section (1) of Section 135 of the Act read with Rule3(2) of Companies CSR Rule,2014, implies ”any of the three preceding financial years”
In our view, the above extract is not legally tenable as it adds to Section 135(1) words which do not form a part of the sub-section. The above para has the effect of extending the amplitude and contours of the term ”any financial year” as contained in sub-section(1).
It is a settled principle of Statutory Interpretation that the language of the Legislature is primarily to be gathered from the language used which means that attention should be paid to what has not been said.(Gwalior Rayon Silk Mfg(Wvg.)Co.Ltd v custodian of Vested Forests(AIR 1990 SC 1747 at page 1752).As a consequence, a construction which requires for its support addition or substitution of words or which results in rejection of words as meaningless has to be avoided.(Shyam Kishori Devi v Patna Municipal corporation, AIR 1966 SC 1678).
In Pinner v Everrett(1969)3 All ER 257) the Court observed that it is wrong and dangerous to proceed by substituting some other words for words for the Statute. The above observations have been considered in several citations by the Indian courts. In State of Kerala v Mathai verghese(1986)(4 SCC 746) the court has observed that the Court cannot reframe the legislation for the very good reason that it has no power to legislate.
From the above, it is clear that words used in the Statute cannot be substituted or expanded either by the Judiciary or through sub-ordinate legislation intended to be clarificatory in nature. Besides, circulars or instructions which have no statutory backing do not amount to law and cannot dilute or override the effect of a constitutional or statutory provision.(Municipal Corporation Amritsar v Senior Superintendent of Post Offices, Amritsar division (AIR 2004 SC 586).
In the light of the foregoing, it is respectfully submitted that the relevant portion of the General circular as discussed above is legally unsustainable and suffers from infirmity.
Amendment proposed to Section 135(1) by the Companies Amendment Bill, 2016
With a view to ease the rigours of procedure in the Act, several amendments have been proposed to the Act by the companies Amendment Bill 2016 which has been referred to a select parliamentary Committee for review. Readers are aware that the bill was placed in parliament in March, 2016 and has unfortunately gone into cold storage.
The bill, inter alia, proposes to amend Section 135(1) by substituting the words ”any financial year” by the words ”the immediately preceding financial year”.
The proposed amendment vindicates our stand that in Section 135(1) the reference only should be only to the financial year ended March,31, 2014 where it comes to the application of the benchmarks of “net worth” or “turnover” as contemplated in the provision.
Recommendations of the Company Law Committee
As a prelude to the Companies Amendment Bill, 2016, by an office order dated June,4, 2015, the Ministry of Corporate Affairs, had constituted, under the chairmanship of the Secretary, Ministry of Corporate Affairs, the Company Law Committee to , inter alia, make recommendations on the issues arising from the implementation of the Companies Act, 2013.The Committee has since submitted its Report to the Government.
It is pertinent to note that in Paragraph 9.17 of its Report, the Committee has recommended that the words “any financial year” as appearing in section 135(1) be replaced by the words ”preceding financial year”.
The Report of the Company Law Committee as also the amendment proposed in the companies Amendment Bill, 2016, conclusively demonstrate that in section 135(1) the reference should be only to the immediately preceding financial year.
Section 135(1) should be distinguished from Section 135(5)
We would reiterate our earlier submission that the tapestry weaved in Section 135(1) is different from Section 135(5). Put differently it is only where a company has a net worth of rupees five hundred Crores or more or a turnover of rupees one thousand crores or more in the financial year ended March, 31, 2014 should it be under obligation to constitute a CSR Committee as required under Section 135(1).If in addition to satisfying the above criteria in Section 135(1), the company has reportable profits based on the average of the net profits for the immediately preceding three financial years it shall be under statutory obligation to incur the mandatory expenditure towards CSR.
It, therefore, follows from the above that if a company had satisfied either the net worth or the turnover criteria in either financial year 2011-12 or 2012-13 but not in the financial year 2013-14 and in addition it has no mandate to have spent for CSR based on average profitability, it should not be called upon to constitute a CSR Committee in the financial year 2014-15.
It is viewed with concern that the offices of the Registrar of companies are issuing notices on companies for not constituting a CSR Committee or for not reporting in the Board’s Report under Section 134 on the CSR activities carried out in the year 2014-15 even in cases where the company had no obligation to make CSR spends based on its average profitability in the financial year 2014-15 nor was it called upon to constitute the CSR Committee based on its turnover or net worth for the financial year ended March,31, 2014. If the subject company had satisfied either the net worth or turnover criteria in either financial year 2011-12 or in 2012-13 but did not meet with the criteria for the year 2013-14, it is under no obligation u/s 135(1) to set up a CSR Committee of the board during the financial year 2014-15.
That the Department is trigger-happy on this score is evident from the fact that in the case of one company, the tangible net worth was in excess of the threshold in the year 2011-12 only. The net worth was below the threshold both for the years 2012-13 and 2013-14.Its turnover for all the three years under consideration was below the prescribed benchmark and the company had no obligation for making spends in the year 2014-15 since it did not have reportable profits based on the average of the preceding three financial years. Yet the Company has been served a show cause notice for not setting up the CSR Committee as also for not reporting on CSR activities in the Board’s Report for the Financial year 2014-15. While justifying the action taken, the office of the ROC has also referred to the Departmental circular dated June, 18, 2014, the legality of which has been discussed at length in the foregoing discussion.
To put the facts in the right perspective, we are of the view that precipitatory action of the genre being taken by the Registrar’s office would be justified only if the errant company had legal obligation to have spent for CSR in the year 2014-15 and it had either underspent or had not incurred any expenditure at all towards CSR and it has also not stated in the Report of its directors , the reasons for not spending the amount as called upon by the second proviso to Section 135(5).Alternatively, if the company based on either the net worth or turnover criteria for the financial year ended March,31, 2014 had to constitute a CSR Committee, it should report in its Report of the directors for the year 2014-15 about the committee having been constituted ,its composition, the fact that a CSR policy has been formulated .If the company were under no obligation to incur CSR costs in the year 2014-15 due to absence or paucity of net profits, the Board’s Report should state that it had no obligation to incur CSR costs on grounds of lack of profitability.
Requirement to set up CSR Committee should be necessary only when CSR spends are mandated
As the existence of net profits of the stipulated level is the sine quo none behind the trigger point for incurring CSR costs, in our view, the need to set up a CSR Committee merely upon satisfying either the net worth or turnover criteria should not legally arise unless the company has to incur CSR costs based on its net profits. Otherwise setting up a Committee merely to satisfy the requirement of law would serve no purpose as the committee would have no role to play in the absence of liability to incur costs. The Committee would be merely ornamental unless the company is conscious of its voluntary obligation to sub-serve the interests of the stakeholders in the Society regardless of whether it has a legal obligation to have CSR spends or not.
In our view, the MCA has gone on an overdrive and is trigger-happy in its endeavour to bring to book alleged contraventions of the provisions of CSR. There is indeed a case for the exercise of restraint in the matter and penal action should be initiated only where such action can be justified on grounds of law. It would not be out of place to state that the Company Law committee has had the foresight to recommend in paragraph 9.24 of its Report that as the requirements relating to CSR are new, all companies should be given the required flexibility for a reasonable period say five years to experience the implementation of this provision as otherwise, it would defeat the intent behind the provision. These observations of the Committee, we would add, have been made in the context of providing to companies the required flexibility over deciding on the areas to be earmarked for CSR activities and the manner in which such expenditure should be incurred, whether directly or through an accredited intermediary. Notwithstanding, the sentiment expressed should be applied in the good measure where even it comes to implementing other requirements relating to CSR. Otherwise, the corporate Sector which is already wilting under the overburden of a multitude of compliances called upon not only under the Act but under allied legislation may succumb, as it were, to the proverbial last straw which broke the camel’s back.