New Companies Act will be a gamechanger
Initially, there were some misgivings about the new Companies Act, which replaces an outdated legislation with more streamlined rules. Apparently, Union Corporate Affairs Minister Sachin Pilot seems to have worked harder on industry captains to view the new law as an investment opportunity to create a better work environment, rather than as forced expenditure.
In the event, any misgivings have begun to thin out and company secretaries in corporate India have started to view Companies Act 2013 -- which has replaced the six-decade-old legislation governing the way corporates function -- as a godsend since it elevates them to a new plane of corporate governance. Also, there is the additional professional opportunity of secretarial audits coming their way.
The new rules -- effective 2014-15 -- also require listed firms to set up a CSR committee of their board members, which will include at least one independent director. However, the worry for company secretaries is that they will have to use their judgement more often. Minority shareholders will have reason to smile as the new law seeks to improve the redressal mechanism available to them. One can use class action law suits to seek justice for any wrongdoings by company promoters or their auditors or consultants.
At the end of the day, the corporate entity stands to benefit the most. For, the new company law will help catapult Indian firms to the international stage through the merger and acquisition (M&A) route. With the new company law, domestic companies can go ahead with their M&A activity abroad without facing legal hurdles in India by setting up overseas listing vehicles.
Industry body Ficci says that the new Company law will revolutionize the administration and management of businesses in times to come. Its President Naina Lal Kidwai hopes that there are "no inconsistencies in various laws since consistency and certainty in laws helps in effective functioning of business".
So, come April 1, 2014, all companies with turnover of Rs 1,000 crore and more -- or a net worth of Rs 500 crore and more or net profit of Rs 5 crore and more -- will have to spend at least 2 per cent of their three-year average profit every year on CSR activity. Effective next fiscal (2014-15), Pilot has made it amply clear that “this money would not come to the Centre. It is the companies’ money and they can spend in line with the decision taken by the CSR committee of their boards. But they must report the same.”
Many believe that this will not only boost corporate charitable activity in India but also gives companies varying tax benefits. Both tax and CSR consultants are now putting their heads together to chalk out a CSR strategy for India Inc which would also provide the best tax efficiency.
The fine print
For instance, writing a cheque towards the PM's National Relief Fund (PMNRF) would entitle the donor company to a deduction of the entire donation amount from its taxable profits. On the other hand, if a company has constructed a school building in a village, no tax benefit may be available — at least not without long-drawn litigation.
While both the donations towards PMNRF and promotion of education are activities that qualify as CSR spends under the new Companies Act, the tax benefits could vastly differ.
And, the new law does not stipulate penalties for non-compliance, though companies are required to justify any shortcomings in this regard. “It is no surprise that the imposition of such obligations has not been well received by a large section of the corporates,” says Shardul Shroff, managing partner of law firm Amarchand Mangaldas, who also points out, “While the new Act does give companies leeway in case they are unable to make such contributions, most companies fear the obligation will eventually snowball into becoming a mandatory provision.”
To make the industry feel comfortable with the new law, Pilot says that a few areas prescribed under the law are only suggestive in nature and should not be seen as a restrictive list. “We have left the canvas very wide as we thought it would not be proper to make it restrictive,” he says. Also, corporate entities were asked to give preference to their local area of operations for such CSR activities, while those not being able to spend the required amount would need to specify reasons for the same in their annual CSR reports.
As an immediate impact, the CSR economy in India will grow manifold, say experts. By one estimate, registered companies in India will spend Rs 18,000 crore on CSR activities alone, according to Pavan Kumar Vijay of Corporate Professionals Capital Pvt Ltd, a legal and financial services firm, who notes, “Companies will now be required to spend on structured activities rather than religious causes and the like, which would mean that there is big scope for CSR consulting, and we expect this activity to grow.”
What's more, the new company law also eases procedures for mergers and acquisitions within India. Without going to a court or tribunal, a holding company and a wholly-owned subsidiary can merge with just the Union Government’s permission. There will be faster decisions on approvals for M&As, making corporate restructuring smooth and efficient.
On a macro basis, the new Company Law is slimmer with 470-odd sections. But the subordinated legislation – Draft Rules – will be the real test on whether the new corporate framework is truly heralding a shift from control to self-regulation. Experts maintain that almost 75 per cent of the provisions in the new law are to be administered through the Rules, a clear pointer that Parliament and Indian law makers will have little to do regarding Company Law per se in coming years with most changes possible through the executive.
Another interesting facet of the new law is that it has defined “fraud” and dealt extensively with it. The earlier Companies Act did not define “fraud” or corporate misconduct. With an increase in corporate frauds in India, this may be the right approach as this law gives more statutory powers to the government’s investigative arm Serious Fraud Investigation Office (SFIO) to tackle corporate fraud.
Even as CSR spending envisaged in the new law is not specific to benefiting only employees of the company or their family members, it is seen as employee-friendly in some ways because it stipulates that firms must disclose the difference in salaries of directors and that of the average employee. In turn, this will protect the interests of shareholders as well as employees. To safeguard workmen, the new law also mandates payment of two years’ salary to employees in companies that wind up operations.
Based on available data, the new regulation would mean that the top 100 companies by annual net sales in 2012 will spend Rs 5,611 crore on CSR activities, compared with Rs 1,765 crore that they are spending now, according to a Forbes report. The state-run firms account for a significant portion of current CSR spending. So much so, that central public sector enterprises which were subject to CSR norms under separate guidelines, have now come within the purview of these new provisions.
Going by the Corporate Affairs Ministry's assessment: if every company that is qualified for doing CSR actually does so, then Rs 15,000-20,000 crore would be spent in a year on various projects such as environment, skill development, water and sanitation, with built-in safeguards to ensure they are not circumvented. Rajesh Dedhia, Director, Vantage Institute of Financial Markets, a listed BSE entity, observes that the CSR provisions could have a "cascading impact" on philanthropy.
Even in case of donations made to external agencies or a foundation set up by the company, it can be argued that it is a bonafide business expenditure which should be allowed fully as a deduction under section 37 of the I-T Act. Avers KPMG's co-head (tax) Punit Shah: "The Supreme Court, in case of a donation made by a company to a public welfare fund, had held that the donation was directly connected or related to the company's business. It resulted in a benefit to the carrying on of the business and was allowed as a business deduction. The same tenet should apply to donations under the company's CSR policy."