Allowability of CSR expenditure - expectation from Budget 2022

Corporate Social Responsibility ('CSR') started out as a philanthropic pursuit, a voluntary act of kindness undertaken by the large corporate business houses. However, this pursuit had a transitory existence, as its voluntary nature was short-lived with the introduction of the Companies Act, 2013 ('CA, 2013').The CA, 2013 casted an obligation on companies that cross the threshold limits delineated under Section 135 of CA, 2013 to contribute a portion of their profits towards charitable causes.

The Revenue, always swift at tying up any loose ends, amended section 37(1)of the Income-tax Act, 1961 ('ITA') vide the Finance (No.2) Act, 2014, addressing the tax treatment of CSR spends. An explanation was inserted in Section 37(1), clarifying that any expenditure incurred towards CSR referred to in Section 135 of CA, 2013 other than expenditure referred to in Section 30 to 36 of ITA shall not be deemed to be incurred for the purpose of the business or profession. The mandate of CSR spends, coupled with the non-deductibility as per the amended tax laws, struck two consecutive blows to establishments. This led to Companies trying to claim a deduction of their CSR spends under section 80G of the ITA, and with it came a wave of litigation and controversy. Further, it is worth mentioning that in case of Companies opting for the concessional tax regime under section 115BAA or 115 BAB of the ITA, it is specifically stated that the deduction under section 80G of the ITA would not be applicable. Accordingly, the controversy of deductibility of CSR spends under section 80G of the ITA is prevalent in Companies that have not opted for the new tax regime.

In the ensuing paragraphs, this article discusses the brief provisions of CA, 2013, assertions of businesses plagued by litigation on the subject and how the Government can endeavor to put to rest the controversies surrounding CSR expenditure and its tax deductibility in a mutually beneficial manner.

Corporate Social Responsibility under the CA, 2013

According to Section 135 of the CA, 2013, CSR provisions are applicable to Companies which meets the prescribed thresholds. Such Companies are mandated to spend 2% of the average net profits of the preceding three years on CSR activities during the year. Schedule VII of the CA, 2013 stipulates some activities towards which CSR expenditure maybe incurred, which includes eradicating hunger, poverty and malnutrition, promoting education, promoting gender equality, empowering women, ensuring environmental sustainability, protection of national heritage, art and culture, etc., among others.

Fate of CSR expenditure under ITA

Explanation 2 to Section 37(1) of the ITA was inserted vide the Finance (No.2) Act, 2014 to disallow any CSR expenditure referred to in Section 135 of the CA, 2013 while computing the income under the head 'Profits and gains of business or profession'.

Rationale behind the insertion of Explanation 2 to Section 37(1)

The intent of the Parliament in bringing this amendment is given in the Explanatory Memorandum to the Finance (No.2) Bill, 2014. The essence of the justification given was that:

  1. CSR expenditure was an application of income, and could not be said to be incurred wholly and exclusively for the purposes of carrying on business as envisaged in Section 37 of the ITA.

  2. If CSR expenditure is allowed as a tax deduction, it would result in subsidizing the CSR contribution by around one-third due to reduced tax expense.

The Controversy - CSR vs 80G

Pursuant to the amendment, the tax authorities disallowed the CSR expenditure under Section 37(1) of ITA and at the same time disputed the claim of deduction under Section 80G of the ITA for donations which otherwise qualified for the said deduction. The tax authorities resisted such claim, arguing that the intention of the legislature was never to allow deduction for CSR expenditure, as this would result in subsidizing the CSR expenditure by one-third amount.

In some cases¹, the Income-Tax appellate authorities have allowed the deduction under Section 80G of the ITA and held that taxpayer cannot be denied the benefit of claim under Chapter VI-A, which is considered for computing total taxable income. If taxpayer is denied this benefit, merely because such payment forms part of CSR, it would lead to double disallowance, which is not the intention of the Legislature.

Taxpayer's have also taken a stance in support of their contention, that Section 80G of the ITA specifically mentions two instances viz., contributions towards Swachh Bharat Kosh and Clean Ganga Fund, where a deduction would not be allowed in case it is in pursuance of CSR as entailed in CA, 2013.

Further, various Tribunal shave upheld the above principle by applying the Latin maxim of 'expressio unis est exclusio alterius' which means that 'express mention of one thing excludes all others', and held that it can be safely inferred that when the legislature in particular has provided for only two specific exceptions for claiming deduction under Section 80G, then the legislature is impliedly permitting the other CSR contributions as a deduction under the other sub-clauses of Section 80G².

The rule of literal interpretation is that one has to interpret the statute prima facie based on what is stated in the statute; ergo, there is no room for any intendment in a taxation statute. Reading section 80G of the ITA in combination with the rules of interpretation, it is clear that only contributions made to Swachh Bharat Kosh and Clean Ganga Fund would not qualify for deduction under Section 80G of the ITA, provided they are in pursuance of CSR as entailed in CA, 2013.

Expectaton from Budget 2022

The Finance Bill, 2022 needs to bring certainty on the tax treatment on amounts contributed towards CSR. It should strike an equilibrium between the plight of the taxpayers and the Revenue. The Revenue cannot be expected to repeal the existing Explanation 2 to Section 37 of ITA considering the rationale given in the explanatory memorandum to the Finance (No.2) Bill, 2014 as this would have a subsidizing effect on the CSR expenditure. However, to appease the taxpayers, the Revenue may bring in a provision under Section 80G of the ITA where in a deduction of 50% may be allowed to the taxpayers without any qualifying limit. This would mitigate the subsidizing effect of CSR expenditure as mentioned in the Finance Bill (No.2) 2014 whilst simultaneously pacifying the distressed taxpayer.

Even considering the benefit to society that increased CSR expenditure would bring especially in view of the pandemic, it would be in the best interest of the Nation as a whole, to address the controversies surrounding the tax treatment of CSR expenditure under ITA.