How much must a company spend on CSR? The 2% rule, worked through

A company covered by India’s corporate social responsibility (CSR) law must spend, in each financial year, at least 2% of its average net profit for the three immediately preceding financial years. A company that hasn’t yet completed three financial years uses the average of the years it has completed.

The arithmetic is simple. The mistakes come from the inputs: which profit figure to use, which years, what to do with a loss, and what counts as money spent. This guide works through each, with four worked examples, for finance teams, company secretaries and CSR heads. Whether a company is covered at all is a separate question, answered in which companies must spend on CSR.

The rule in Section 135(5)

Four things follow from the wording:

• It is 2% of net profit, not of turnover, revenue or profit after tax.
• It is an average of three years, not last year’s profit, even though coverage is tested on last year alone.
• It is a minimum. A company can always spend more.
• It is an annual duty. Each year has its own obligation, and its own deadlines for any money left unspent.

Step 1: find net profit for each year

Net profit for CSR is profit before tax, calculated under Section 198 of the Act. Section 198 adjusts the accounting profit: the FAQs of the Ministry of Corporate Affairs (MCA) say its main adjustments concern capital payments and receipts, income tax and the set-off of past losses (FAQ 3.1, General Circular 14/2021). Profit on selling an undertaking, for example, is a capital profit and is left out.

Rule 2(1)(h) of the Companies (Corporate Social Responsibility Policy) Rules, 2014 (the CSR Rules) then excludes two more items:

• profits of the company’s overseas branches, whether run as a separate company or otherwise; and
• dividends from other Indian companies that are covered by, and complying with, Section 135.

So you can’t take profit after tax from the annual report and apply 2% to it. Our guide to calculating net profit for CSR works through Section 198 line by line.

Step 2: average the three years

Add the three years’ net profits, divide by three, then take 2%.

When one of the years is a loss

The Act doesn’t say in so many words how to treat a year in which net profit under Section 198 was a loss. The common approach, and the one an average of three years’ “net profits” implies, is to include the loss as a negative figure. If the average comes out at nil or below, there is nothing to spend that year, though a company that met a test is still covered and must still report on CSR.

Companies younger than three years

A company that hasn’t completed three financial years is covered if it meets a test, and its obligation is 2% of the average of the years it has completed (FAQ 1.4). The MCA’s own example: a company incorporated in 2018-19 and covered for 2020-21 averages 2018-19 and 2019-20.

Step 3: adjust for surplus and set-off

The 2% figure is the base. The annual report on CSR, in the format in Annexure II to the CSR Rules, then works out the total CSR obligation for the year in three lines:

Surplus from CSR activities can never become business profit. Rule 7(2) says it must go back into the same project, into the company’s Unspent CSR Account (a special account for unspent ongoing-project money), or to a government fund named in Schedule VII within six months of the year’s end.

Set-off works the other way. A company that spent more than its requirement may, by board resolution, set off the excess against its requirement in up to the next three financial years (Rule 7(3)). Surplus can’t be part of that excess. Only excess spent from 2020-21 onwards qualifies, and anything unused after three years lapses, even if the company stops being covered (FAQs 3.7 and 3.8). Our guide to setting off excess spending has the details.

The four examples side by side:

Rounding and the board’s minimum

The law sets a floor, not a target, and nothing in it allows rounding down. Treat the figure as the least the board must approve, round the budget up, and consider planning a little above the minimum. A delayed tranche or a cost that turns out to be ineligible can otherwise leave the company short at 31 March, while genuine excess spending can be set off later.

The CSR committee recommends the amount and the board approves it, normally in the annual action plan. If the audited net profit differs from the figure used to plan, revise the plan formally (Rule 5(2) lets the board alter it during the year). See the CSR policy and annual action plan.

What counts as spent

Only money actually spent on eligible CSR activities counts towards the obligation.

Two rules matter most in practice. First, disbursing money isn’t spending it:

Second, money left over at the year’s end doesn’t roll forward. Unspent money for an ongoing project goes to the company’s Unspent CSR Account within 30 days, and other unspent money to a Schedule VII fund within six months; that six-month transfer, made on time, counts as compliance (FAQ 7.2). See unspent CSR money.

Some activities never count, however worthy: those in the normal course of business, those outside India (except training Indian sports personnel), contributions to political parties, activities designed only for the company’s own employees, sponsorship for marketing benefit and anything another law already requires. See what doesn’t count as CSR.

Common mistakes

• Applying 2% to turnover or profit after tax. The base is the Section 198 net profit, before tax.
• Using last year’s profit instead of the three-year average.
• Dropping a loss year without a reasoned, documented method.
• Forgetting surplus. Surplus from earlier CSR projects is added to the obligation.
• Setting off surplus, or excess from before 2020-21. Neither qualifies.
• Counting a late-March tranche as spent. Only what the agency has used by 31 March counts.
• Valuing volunteering or donated products. Neither can be counted.