Corporate Social Responsibility: Tax Perspective

What is CSR Expense?

Corporate social responsibility (CSR) is a self-regulating business model that helps a company be socially accountable—to itself, its stakeholders, and the public. By practicing corporate social responsibility, also called corporate citizenship, companies can be conscious of the kind of impact they are having on all aspects of society, including economic, social, and environmental.

CSR expense are the expenses made by an enterprise to self account for its social responsibilities. CSR expense made by an enterprise could stem from the constructive responsibilities assumed by it or it may be made as per the minimum required statutory allocation of the profit. 

Statutory CSR Expense v/s Constructive CSR Expense v/s Donation Expense

Statutory CSR Expense

Industrial Enterprises Laws mandate that medium and large industries or small and cottage industries with an annual turnover of over Rs. 15 Crores to allocate a certain amount towards discharging CSR. The amount so allocated shall be spent in accordance with an annual plan/program formulated and, in the areas prescribed. Statutory CSR expense is a minimum allocation of the profits for the expenditure in prescribed CSR areas. 

Constructive CSR Expense

Sometimes enterprise can make CSR expenses out of the commercial expediency as well. It is not necessary that all the CSR expense should be made from the statutory allocation. Enterprise may also engage in CSR activities that enhance society and the environment, instead of contributing negatively to them by means of operation. This may include both direct expenses made to the stakeholders of the society or the efficiencies and operations introduced within the enterprise that accounts to the organization’s responsibility to the society. 

The movement toward CSR has its impacts in several domains. For example, many companies have taken steps to improve the environmental sustainability of their operations, through measures such as installing renewable energy sources or purchasing carbon offsets. In managing supply chains, efforts have also been taken to eliminate reliance on unethical labor practices, such as child labor and slavery. 

Donation Expense

Although CSR programs have generally been most common among large corporations, small businesses also participate in CSR through smaller-scale programs such as donating to local charities and sponsoring local events. But does donation meet the definition of CSR expense under commercial expediency? And if it doesn’t meet the test of commercial expediency, will it be allowed for expense for tax deduction? A company could make a CSR expense that could be deductible for tax purpose even if it in appearance doesn’t meet the commercial expediency criteria. We will discuss this in the para below. 

Nature of CSR Expenses

The expression “commercial expediency” refers to those transactions/expenditures which are not required to be incurred under any provisions of the law. But it refers to such expenditure, a prudent businessman incurs for the purpose of business. Such expenditures might not have been incurred under any legal obligation, but the same are allowable as a business expenditure if it was incurred on grounds of commercial expediency. The “commercial expediency” depends upon the wisdom of the businessman. 

A businessman incurring cost for the raw materials and processing cost is a cost of expediency as it is required for the operation. In the same meaning, a donation made to a nearby health institution could also be commercially expedient if the employees of the enterprise regularly take the benefit from that institution or the enterprise has accepted a moral obligation to do so. So the test of the commercial expediency mostly depends on the nature and operation of the business and should be adjudged based on the nature of the business. 

So a distinction in the type of CSR expense may be relevant. We will discuss this further with the help of examples. A handicraft business makes a donation to a Professional Society of Mathematicians, a tax exempt entity. Its really hard to establish a relation of commercial expediency to this. Similarly a sole proprietor making donations to sporting clubs or a person with no permanent base available in the country making donation to the natural disaster occurring in that country. It is really hard to establish test of commercial expediency here. So how will the Income Tax Regulation treat such expenses? The default position of the Income Tax Regulations is that any expenses that are not directly related to the processes of the business are not eligible for expense deduction for tax purpose. Then there are additional provisions where upon fulfilling the certain parameter and criteria the company will be allowed to claim such expense for tax purpose. We will discuss this further in “Provision on Tax Deductions” below. 

Allocation of Statutory CSR Expense

Section 54 of Industrial Enterprise Act, 2076

दफा ५४(१): मझौला, ठूला उद्योग वा वार्षिक पन्ध्र करोड रुपैयाँभन्दा बढी कारोबार हुने घरेलु वा साना उद्योगले व्यावसायिक सामाजिक जिम्मेवारी बहन गर्ने प्रयोजनको लागि प्रत्येक आर्थिक वर्षमा वार्षिक खुद मुनाफाको कम्तीमा एक प्रतिशत रकम छुट्याउनु पर्नेछ ।

दफा ५४(२): उपदफा (१) बमोजिम छुट्याइएको रकम वार्षिक योजना तथा कार्यक्रम बनाई तोकिए बमोजिमका क्षेत्रमा खर्च गर्नु पर्नेछ ।

दफा ५४(३): उद्योगले उपदफा (२) बमोजिम प्रत्येक आर्थिक वर्षमा सम्पन्न गरेको कार्यक्रम र त्यस्तो कार्यक्रममा खर्च गरेको रकमको विवरण आर्थिक वर्ष व्यतित भएको छ महिनाभित्र सम्बन्धित उद्योग दर्ता गर्ने निकाय समक्ष पेश गर्नु पर्नेछ ।

दफा ५४(४): उपदफा (१) बमोजिम व्यावसायिक सामाजिक जिम्मेवारीका लागि छुट्टयाएको रकम आयकर प्रयोजनार्थ खर्च कट्टी गर्न पाइनेछ ।

Rule 37 of the Industrial Enterprise Rules, 2076

नियम ३७(१): मझौला वा ठूला उद्योगले ऐनको दफा ४८ को उपदफा (१) बमोजिम छुट्याएको रकम देहायको कुनै कार्य वा क्षेत्रमा खर्च गर्नु पर्नेछ:
(क) प्राकृतिक प्रकोप (बाढी, पहिरो, भूकम्प, आगलागी) रोकथाम तथा उद्दार सम्बन्धी कार्य, 
(ख) सामुदायिक स्वास्थ्य संस्थालाई औषधी तथा स्वास्थ्य सम्बन्धी उपकरण वितरण, स्वास्थ्य सम्बन्धी जनचेतना अभिवृद्धि, लगायतका स्वास्थ्य शिविर सञ्चालन स्वास्थ्य सम्बन्धी कार्य,
(ग) नेपाली कला, संस्कृति, पुरातात्विक धरोहरको संरक्षण तथा सम्बर्द्धन,
(घ) न्यून आय भएका, पिछडिएका, ग्रामीण महिला, अपाङ्गता भएका व्यक्ति तथा अल्पसङ्ख्यक, सिमान्तकृत समुदायका लागि सीपमुलक र आयमूलक कार्यक्रम,
(ङ) सामुदायिक विद्यालय तथा विश्वविद्यालयहरुका लागि छात्रवृत्ति, शैक्षिक उपकरणहरू तथा सामग्रीहरू वितरण लगायत शैक्षिक विकास सम्बन्धी कार्य
(च) प्रदुषण नियन्त्रण, फोहर मैला व्यवस्थापन, वृक्षारोपण, पानीको मुहान संरक्षण, वैकल्पिक ऊर्जाको प्रबर्द्धन लगायत वातावरण संरक्षण,
(छ) धुम्रपान, मद्यपान, सामाजिक विकृति सन्देशमूलक वृत्तचित्र निर्माण विसङ्गति विरुद्धका अभियान प्रसारण,
(ज) ग्रामीण खानेपानी आयोजना निर्माण, सडक, ढल, पाटी पौवा, वृद्धाश्रम, खेल मैदान, धार्मिक स्थल, सामुदायिक स्वास्थ्य भवन, सामुदायिक भवन आदि निर्माण तथा मर्मत सम्भार, अनाथ आश्रम निर्माण, पार्क निर्माण, ध्यानयोग केन्द्र निर्माण, बसपार्क तथा बस बिसौनी निर्माण जस्ता सार्वजनिक हितका लागि प्रयोग हुने भौतिक पूर्वाधार ।

नियम ३७(२): उपनियम (१) बमोजिम उद्योगले सामाजिक व्यावसायिक जिम्मेवारीका लागि छुट्याएको वार्षिक रकमको कम्तीमा पच्चीस प्रतिशत रकम उद्योगबाट प्रभावित क्षेत्रमा खर्च गर्नु पर्नेछ ।

नियम ३७(३): उद्योगले व्यावसायिक सामाजिक जिम्मेवारी वहन गर्नको लागि छुट्याइएको रकममध्ये बढीमा दश प्रतिशत रकम सम्बन्धित शीर्षकबाट कट्टा गर्न पाउने गरी उद्योग दर्ता गर्ने निकायले तोकेको नियम बमोजिमको कुनै कोषमा जम्मा गर्न सक्नेछ।

नियम ३७(४): उद्योगले व्यावसायिक सामाजिक जिम्मेवारी निर्वाह गर्दा स्थानीय तहको समन्वयमा सञ्चालन गर्नु पर्नेछ । 

Section 43 of the Industrial Enterprise Act, 2076

दफा ४३(७) कुनै उद्योगले दफा ५४ बमोजिम व्यावसायिक सामाजिक जिम्मेवारी बहन नगरेमा उद्योग दर्ता गर्ने निकायको सिफारिसमा मन्त्रालयले त्यस्तो उद्योगको वार्षिक खुद मुनाफाको एक दशमलव पाँच प्रतिशतले हुन आउने रकम जरिवाना गर्न सक्नेछ । त्यस्तो जिम्मेवारी एक आर्थिक वर्षभन्दा बढी अवधिमा बहन नगर्ने उद्योगलाई प्रतिवर्ष वार्षिक खुद मुनाफाको शून्य दशमलव पाँच प्रतिशतका दरले थप जरिवाना गर्नेछ । 

Allocation of CSR Expense

Many allocations are pegged to the net profit of an entity. The allocation of the statutory staff bonus, CSR expense and such. Is there any priority of the stakeholders for allocation of such expenses? Normally a Value Added Statement allocates and reports the value additions of the company to Employee, Director, Financial Institution, Government, Shareholders and the Company. This however is not an exhaustive list and not in a preferred order. So, there is no any priority for the allocation of the expenses. 

The meaning of “Net Profit” is yet another issue for discussion. Black’s Law Dictionary defines ‘Net Profit’ as ‘total sales revenue less the cost of the goods sold and all additional expenses. Similar definition is also provided by the Financial Reporting Standards. Also in normal conversations we hear people saying net profit is the revenue reduced by all expenses. So, net profit is the net increase in the net assets of the entity excluding any contribution made to or paid in by the equity participants. 

Also, another thing is that the 1% allocation of the CSR expense is applicable to “industry” whereas the 10% allocation of the bonus expenses is applicable to the “entity” as a whole. So, in that sense CSR should be allocated prior to allocation of statutory bonus, as a single entity may have multiple industries. 

Allocation of 10% Statutory Bonus Expenses

Section 5 of Bonus Act 2030 requires each profit making enterprise to allocate an amount equivalent to 10% of its net income (खूद मुनाफा) of one fiscal year for bonus to the employees. 

Net income, also called net earnings, is calculated as sales minus cost of goods sold, selling, general and administrative expenses, operating expenses, depreciation, interest, taxesemployee incentives and other expenses. So generally, net income means the income after deduction of all expenses, including bonuses and taxes. 

But, is net income as per Bonus Act 2030 same as general meaning of net income? No, the net income as per Bonus Act 2030 is not same as general meaning of net income. Net income as per Bonus Act 2030 means the net income before statutory bonus and taxes. This is further clarified in Indushankar Chini Mill Labor Uninon v. Inland Revenue Department. 

Thus, mathematically, amount separated for the distribution of bonus  = Net Income before Statutory Bonus and Taxes x 10%

View my another blog on: Tax Deduction of Statutory Bonus Expenses: Definitive Analysis

Utilization of Statutory CSR Expense

Does Industrial Enterprise Act, 2076 provide the time limit by which the allocated CSR amount should be expensed off?
(A) Where the industry fails to bear the CSR responsibility under Section 54, such industry will be fined 1.5% on the net profit. Does the application of this fine relieves the entity from bearing its CSR responsibility?  
(B) Where the industry fails to expense off the amount allocated for the CSR expense for more than one fiscal year, the industry will be fined 0.5% per annum on the amount of net profit . 

Others rules for utilization of CSR expense are as follows: 
1. Utilize in the areas prescribed for the CSR expense under Rule 37(1) of the Industrial Enterprise Rules, 2076
2. At least 25% of the allocated amount should be expensed in the areas affected by the industry
3. At maximum 10% of the amount can be expensed off by depositing in the funds prescribed by department of industry, province government or federal government under Rule 37(3)
4. The CSR programs should be conducted in coordination of the local level authorities. 

Provision on Tax Deductions

Tax Deduction of Statutory CSR Expense

Section 13 of the Income Tax Act, 2058 provides that any person may, for the purpose of computing his income from business or investment in any financial year deduct the following expenditures, subject to this Act:
(a) Made in that income year,
(b) Made by the relevant person, and
(c) Made in the course of earning income for the business. 

The default position of the Income Tax Regulations, as per Section 13 of the Income Tax Act, is that any expenses that are not directly related to the processes of the business are not eligible for expense deduction for tax purpose. Then there are additional provisions where upon fulfilling the certain parameter and criteria the company will be allowed to claim such expense for tax purpose. 

Income Tax Act, 2058 doesn’t have further tests for “commercial expediency”. Also there are not any qualifiers in Income Tax Act for the recognition of amount allocated for CSR as expense. Section 54(4) of IEA states that the amount allocated towards CSR will be allowed as a deductible expenditure for the purpose of income tax. Since the prevailing Income Tax Act, 2058 (2002) does not provide any specific provision for deduction of CSR expenditure, the tax deduction of the expenses will depend on if the expenses does or not qualify as CSR expense under IEA. There are always gaps between the facilities under the Income Tax Act and the Industrial Enterprise Act and this has been further discussed in my other blog: Business Concessions: ITA v. IEA

Tax Deduction of Constructive CSR Expense

Society is also a stakeholder to an enterprise. Creating shared value is based on the idea that corporate success and social welfare are interdependent. A business needs a healthy, educated workforce, sustainable resources, and an adept government to compete effectively. For society to thrive, profitable and competitive businesses must be developed and supported to create income, wealth, tax revenues, and philanthropy. There are deep developed linkages between business strategies and CSR and an most modern businesses acknowledges trade-offs between short-term profitability and social or environmental goals, but emphasizes the opportunities for competitive advantage from building a social value proposition into corporate strategy. 

So in view of the interdependency and sustainable business operation it is very common that enterprises are engaged in the social responsibility activities and operate programs or incur expenses that may not be directly benefiting the profitability of the company in short run but helps improve the sustainability, environment and overall welfare of the society in which it operates in a long run. Will such expenses be allowed for deduction for tax purpose? 

In an interesting case of Colgate Pamoliv Nepal Pvt. Ltd. v/s Large Taxpayer’s Service Office, the Revenue Tribunal decided that even Constructive CSR expense meets the expense deduction criteria under Section 13 of the Income Tax Act, 2058. 

• कम्पनिको व्यवसाय सुचारु रुपले सञ्चालन गर्न वरिपरीको समुदायको विकास गर्ने कार्य गर्ने कम्पनीको निति अन्तर्गत खर्च गरिएकोले सो खर्च चन्दा सरह नभएको, 
• स्थानिय विद्यालयका जेहेन्दार विद्यार्थीहरुलाई उपलब्ध गराएको छात्रवृत्तिको रकम र आवधिक रुपमा स्थानिय क्षेत्रमा सञ्चालन गरि आएको स्वास्थ्य परिक्षण क्लिनिक तथा औद्योगिक क्षेत्र भित्रको शिशु स्याहार केन्द्रलाई गरेको सहयोगको रकम र सम्बन्धित सञ्चालन गर्ने कार्यले सामाजिक हित, प्रचार प्रसार समेत हुने भएकाले यी कार्यहरुले व्यावसायिक प्रयोजन नै पुरा गर्ने भएकाले, 
• कम्पनी स्थापना र सञ्चालन भएका क्षेत्रका जनसाधारणको हितमा हुनुका साथै यस्ता कार्यले स्थानिय समुदायमा कम्पनी प्रति सकारात्मक धारणा अभिबृद्धि गराई कम्पनीको सञ्चालनमा सहयोग पुर्याउने हुन्छ । यसले कम्पनीको व्यवसायमा दिगो मद्दत गरिरहेको हुने, 
यस परिप्रेक्ष्यमा हेर्दा पुनरावेदक कम्पनीले स्थानीय तहमा
• विद्यार्थीहरुलाई उपलब्ध गराएको छात्रवृत्ति, स्थानिय समुदायमा सञ्चान गरेको स्वास्थ्य शिविर तथा शिशु स्याहार केन्द्रलाई गरेको सहयोग सम्बन्धमा भएको खर्च कट्टा गर्न नपाउने र त्यस्तो खर्च कम्पनीको आम्दानीमा समावेश गरी कम्पनीबाट कर अशुल गर्नुपर्ने भन्न मिल्ने देखिदैन । 

Link to the full text of the case. 

Now lets look at the provisions under Income Tax Act, 2058 that provides for the deduction of the expenses of the company, that normally do not meet the qualification under Section 13 of the Act but are treated to be wholly/partly expedient to the commercial expense or fulfills the social responsibility objective of the company and are thus allowed for deduction under tax, subject to certain parameters and caps: 

Donation Reduction as per Section 12

A person may claim to have their taxable income for an income-year reduced by gifts made by the person during the year to an exempt organization approved by the Department. The amount of reduction shall be minimum of (i) Actual Amount, (ii) Rs. 100,000, or (iii) 5% of the Adjusted Taxable Income

Donation Reduction as per Section 12Kha

A person may claim to have their taxable income for an income year reduced by contribution made during any income year to the Prime Minister Disaster Relief Fund or the Reconstruction Fund established by GON. The amount of the reduction shall be the entire amount of the contribution. 

Donation Reduction as per Section 12Ka

A company can claim reduction in an income year in calculating the taxable income the lower of amount of Rs. 1,000,000 or 10% of assessable income out of the expenditure incurred with prior approval from the Department for Conservation and Promotion of Ancient, Religious and Cultural Heritage situated in Nepal and for the construction of physical infrastructure of sports. The amount of reduction shall be the minimum of (i) Actual Amount, (ii) 1,000,000 or (iii) 10% of Assessable Income

Pollution Control Costs under Section 17

A person’s income for an income-year from any business, shall be deducted by pollution control costs to the extent incurred by the person during the year in conducting the business but shall not exceed 50% of the adjusted taxable income from all businesses conducted by the person. Any excess cost, or a part thereof, for which a deduction is not allowed as a result of the above limitation can be capitalized in the beginning of the subsequent income year and may be depreciated in accordance with depreciation rules.

Clarification: For the purpose of this section, pollution control costs means costs incurred by a person with respect to a process or an asset that seeks to control pollution or otherwise protect or sustain the environment.

Research and Development Costs under Section 18

A person’s income for an income-year from any business, shall be deducted by research and development costs to the extent incurred by the person during the year in conducting the business but not exceeding 50% of the adjusted taxable income from all businesses conducted by the person. Any excess cost, or a part thereof, for which a deduction is not allowed as a result above limitation can be capitalized in the beginning of the subsequent income year and may be depreciated in accordance with depreciation rules.

Clarification: For the purpose of this section, research and development costs means costs incurred by a person for the purposes of developing the person’s business and improving business products or process.