In this article, I elaborate on one of the several changes introduced by Finance Act, 2023 to CGST Act, 2017. Section 17, CGST Act, 2017 was amended via Finance Act, 2023 to clarify that the goods or services or both used to comply with mandatory CSR obligations, i.e., CSR obligations under Section 135, Companies Act, 2013, would not be eligible for Input Tax Credit (‘ITC’). The amendment sought to achieve two objectives: first, it clarified law on a point which attracted contradictory opinions by authorities for advance rulings (‘AARs’); second, it tried to ensure that the tax treatment of mandatory CSR activities under CGST Act, 2017 aligns with that of IT Act, 1961. I suggest that while the former objective may have been fulfilled, the latter remains questionable since the tax policy vis-à-vis mandatory CSR is itself confusing under IT Act, 1961.
Confusion to Clarity: ITC on Mandatory CSR Activities
Section 16, CGST Act, 2017 states that a registered person shall be entitled to ITC charged on any supply of goods or services or both ‘which are used or intended to be used in the course or furtherance of his business’ and the said amount shall be credited to the electronic ledger of the person. As regards CSR, AARs were confronted with the question if CSR activities undertaken by a registered person should be understood ‘in the course of business’.
In Re: M/s Dwarikesh Sugar Industries Limited the applicant wished to know if it can claim ITC on expenses incurred to fulfil its mandatory CSR obligations. AAR endorsed the interpretation adopted in a pre-GST case, i.e., Essel Propack case and noted that since the applicant was ‘compulsorily required to undertake CSR activities in order to run its business’, CSR activities should be treated as incurred ‘in the course of business.’ (para 12) AAR emphasised the compulsory nature of CSR and reasoned that it should not be equated with gift, since the latter had a voluntary element.
In Re: M/s Adama India Pvt Limited the applicant relied on Re: M/s Dwarikesh Sugar Industries Limited and Essel Propack case to support the contention that ITC on its mandatory CSR activities should not be blocked. Curiously, AAR did not examine scope of the term ‘business’ or ‘in the course of business’ used in CGST Act, 2017, but instead relied on the Companies (CSR Policy) Rules, 2014 which defined CSR activities undertaken by a company to not include activities undertaken in pursuance of the normal course of business. But the definition of CSR under these Rules has a different purpose and context. And reliance on Companies (CSR Policy) Rules, 2014 would be understandable if the term ‘business’ was not defined or was unclear under CGST Act, 2017. Section 2(17), CGST Act, 2017 contains an elaborate definition of business to which AAR paid no attention.
In Re: M/s Adama India Pvt Limited, AAR also refused to refer to Essel Propack case reasoning that it was decided under pre-GST laws, but strangely it considered Companies (CSR Policy) Rules, 2014 as relevant to GST. While it may be reasonable to suggest that cases decided under pre-GST regime (in this case excise law regime) need not always be applicable in the GST regime; but, such a line of argument would only be persuasive if there was a marked difference in the applicable provisions in pre-GST and GST laws, which wasn’t the case as far the impugned issue was concerned. Even so, AAR should have examined the scope of ‘business’ under CGST Act, 2017 and the nature of mandatory CSR activities instead of referring to other legislative sources.
In Re: M/s Polycab Wires Private Limited, Kerala AAR held that goods distributed by the applicant for free – and shown as CSR expenses – were not eligible for ITC under Section 17(5)(h), CGST Act, 2017. While AAR did not state it expressly, it seemed to equate the applicant’s free distribution of goods – as part of its CSR Activities – to gift or free samples. While for the latter, ITC is expressly blocked under Section 17(5)(h), CGST Act, 2017, it was an error to equate gifts and free samples with goods distributed under the CSR initiative. The applicant distributed goods at the request of Kerala State Electricity Board and thus, it was not entirely out of the applicant’s volition nor was it a compulsory CSR activity under Companies Act, 2013. AAR avoided the tough question on how to best classify the impugned CSR activity.
Thus, as is evident, AARs were struggling to adopt convincing reasoning and were arriving at different conclusions regarding eligibility of taxable persons to claim ITC on their CSR activities. Nor were they meaningfully distinguishing between mandatory and voluntary CSR activities.
Ostensibly, to clear the confusion caused by contradictory advance rulings, Section 139, Finance Act, 2023 introduced the following clause to Section 17(5), CGST Act, 2017:
(fa) goods or services or both received by a taxable person, which are used or intended to be used for activities relating to his obligations under corporate social responsibility referred to in section 135 of the Companies Act,2013;
Section 17(5), CGST Act, 2017 enumerates the situations in which ITC is blocked, and the insertion of above clause in Section 17(5), CGST Act, 2017 means that goods or services or both used to fulfil mandatory CSR obligations will not be eligible for ITC.. And to this extent, the law on ITC vis-à-vis mandatory CSR activities is sufficiently clear post the enactment of Finance Act, 2023.
Clarity to Confusion: Mandatory CSR under IT Act, 1961
Blocking ITC for mandatory CSR via Section 17(5)(fa), CGST Act, 2017 superficially aligns with the tax treatment of mandatory CSR under IT Act, 1961. Section 37, IT Act, 1961 states that any expenditure – not being an expenditure of the nature described in Sections 30 to 36 – laid out or expended wholly and exclusively for the purpose of business or professions shall be allowed in computing the income chargeable under the head ‘Profits and gains of business or profession’. Section 37, IT Act, 1961 is a residual provision and allows an assessee to claim expenditure if some of the expenditure does not meet the requirements under specific heads, from Sections 30 to 36 of IT Act, 1961. The primary requirement under Section 37, IT Act, 1961 being that the expenditure should be for the purpose of business or profession. However, Explanation 2 to Section 37 clarifies that:
For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.
The above Explanation to Section 37 expressly disallows an assessee from claiming deductions on expenses incurred in fulfiling mandatory CSR obligations.
However, the confusion on mandatory CSR expenses and IT Act, 1961 is two-fold: first, if mandatory CSR expenses satisfy the requirements of Sections 30 to 36, an assessee can claim deductions. This implies that there is no across the board bar on claiming mandatory CSR expenses under the IT Act, 1961 but the prohibition is only under Section 37 resulting in an uneven tax treatment of mandatory CSR IT Act, 1961; second, Section 80G states that an assessee cannot claim deductions if the mandatory CSR money is contributed to the Clean Ganga Fund or the Swach Bharat Kosh Fund. There is no express prohibition against mandatory CSR money contributions to any other fund listed under Section 80G creating a confusion about the objective of partial disallowance for only two funds.
Conclusion
It is evident that the State does not view mandatory CSR activities as integral to or in the course or furtherance of business for tax purposes. The introduction of Section 17(5)(fa), CGST Act, 2017 reinforces the deeming fiction previously incorporated under Explanation 2, Section 37, IT Act, 1961. As far as these two provisions are concerned, mandatory CSR is not treated as an activity in the course or furtherance of business. The issue is partial bar against mandatory CSR expenses under IT Act, 1961. The limited scope of bar under both provisions – Section 80G and Section 37 only – raises the question as to why mandatory CSR is treated as business expense under other provisions. Reflection of a confused tax policy as far as IT Act, 1961 is concerned.
Finally, the reasons for denying tax benefits for mandatory CSR activities seem to be rooted in the State’s conception of CSR activities as a backstop to its own welfare measures. And since the denial of tax benefits is limited only to mandatory CSR activities, there is room to suggest that the State does not wish to ‘subsidise’ only some CSR activities, as tax benefits are not denied to voluntary CSR activities. ITC is not blocked for voluntary CSR activity neither is deduction of expenses barred – even partially – for voluntary CSR. Creating a ‘two-track’ tax policy vis-à-vis CSR expenses.