While adjudicating the validity of Section 76 of the Madras Hindu Religious and Charitable Endowments Act, 1951, which sought to charge religious institutions a percentage of their income for the services rendered to them by the government, the Constitution Bench of the Supreme Court in the famous Shirur Mutt case defined the term ‘tax’ as following:
“…a compulsory exaction of money by public authority for public purposes enforceable by law and is not payment for services rendered...It is said that the essence of taxation is compulsion, that is to say, it is imposed under statutory power without the taxpayer’s consent and the payment is enforced by law… The second characteristic of tax is that it is an imposition made for public purpose without reference to any special benefit to be conferred on the payer of the tax. This is expressed by saying that the levy of tax is for the purposes of general revenue, which when collected forms part of the public revenues of the State. As the object of a tax is not to confer any special benefit upon any particular individual, there is, as it is said, no element of quid pro quo between the taxpayer and the public…”
Thus, the elements for considering a levy as a tax are the following:
- It must be a compulsory exaction by a public authority.
- It should be for public purposes.
- It should be enforceable by law.
- It should not be charged as payment for any service that is rendered [by the public authority].
In the light of this judgment, it is important to note the changes brought about by the Companies Amendment Bill, 2019, passed by the Lok Sabha on Friday. The amendment brings about important changes in the Companies Act pertaining to Corporate Social Responsibility (CSR) under Section 135. Under the old provision, if the company was unable to spend the designated amount of 2% of the average net profit of the preceding three financial years, it had to merely report the reasons for the lack of expenditure to its shareholders in its annual report under Section 134 (3) (o). However, the new provisions of the amending Bill require that the designated CSR amount, if not spent, to be transferred to a Central fund specified under Schedule VII of the Act within 6 months or 3 years depending on whether the amount is related to an ongoing project or not. The new provisions also entail a fine ranging from fifty thousand to twenty-five lakhs along with possible prison of 3 years for defaulting company’s directors.
Juxtaposing the old as well as the newer provisions, it is evident that for all practical purposes the new provisions make the CSR liability a compulsory extraction as failure to make good on the liability would attract penal punishment and fine. This fulfills the primary condition laid out in the Shirur Mutt case on the exaction being compulsory in nature. Secondly, the Schedule 7 of the Company Act lists the purposes for which the fund can be expended, covering many social development goals such as eradication of hunger and poverty to reducing child mortality and promoting social business projects, etc. Admittedly, the Directive Principles of State Policy under part IV of our Constitution also espouse similar goals acting as guidance for state functioning. Thus, there is little doubt that the funds are being redirected for a public purpose even though the Shirur Mutt case didn’t set out a strict test for identifying a public purpose. Further, not only is the exaction not for any service being rendered on behalf of the government, but the government disregards the expenditure for CSR liability as business expenditure capable of deduction under Section 37 Income Tax Act, 1961. It has done so by way of an amendment brought about by Finance Act, 2014 adding the Explanation – 2 to the section, which specifically excludes expenditure under Section 135 as business expenditure. [Although the Tribunals have allowed deductions in DCIT vs National Seeds Corporation (6794/Del/2014), Kerala State Industrial Development Corporation Ltd. vs ACIT (142/Coch/2017) and Nalwa Steel Power Ltd. vs ACIT (7176/Del/2017), they have done so only of the ground that Explanation 2 was prospective in nature and not applicable to expenditures made before 2015]. Thus, had the government treated it for a service rendered, the deductions would have been applicable and could not have been disallowed by way of the said Explanation. It can, therefore, be safely inferred that the new CSR provisions fulfill the criteria of being a taxing provision.
This creates a philosophical disruption in the idea behind the conception of CSR. In 1970, the Nobel prize-winning economist Milton Friedman in his influential essay titled ‘The Social Responsibility of Business is to Increase its Profits’, had argued that the only responsibility of a corporate entity was towards its shareholders and this responsibility was to increase its profits. This dictum has since undergone a transformation by corporate entities having craved a market justification for social responsibility, arguing that such exercise expands the consumer base leading to long term profit, and results in better marketing adding a perceptive advantage in community. It can be argued, however, that government has had a different perception of CSR and corporate entities, which in their opinion accumulate substantial power through their business activities and have been known to exploit the local environment, resources as well as human labor. But for these purposes the government charges an exaggerated tax over their income, hoping to mitigate their damage by putting a cost on their activities and also regulating them through various labor and environmental laws/regulations. In such a situation, if a corporate entity chose not to acknowledge the benefits arising out of CSR, it could choose to do so and embrace the social effects arising out of it.
This had been largely the case in India, where the government charges one of the high effective corporate tax in the world, and had a voluntary CSR scheme in place. It makes sense as the government is already charging a cost for the effects that corporate entities have on the environment, labor market and resources. Yet, the government has now chosen to make CSR compulsory for justifications best known to it. If there is anything Laffer curve tells us, it is that when the effective tax rates become prohibitive, there would be a flight of the entities facing the burden of the tax, lowering the overall collections. In present circumstances when the issue of unemployment is ravaging the country, making CSR compulsory can turn costly for the government.