The ministry of corporate affairs (MCA) proposes to mandate companies to spend two percent of their average net profit for the past three years on fulfilling their corporate social responsibilities (CSR) even if their group makes consolidated net loss. If a company fails to spend the amount, it will have to explain the reason for it in its annual report.

According to the draft rules under the newly enacted Companies Act, on which feedback is invited till October 8. The new companies law, which was recently passed by parliament and also got the president's assent, will replace the current companies Act, 1956 once the rules are notified.

The draft rules propose various other strict criteria to ensure spending of the money on social development. For instance, activities which are exclusively for the benefit of employees of the company or their family members shall not be considered as CSR activity. And all companies will have to report the details of their CSR initiatives in the directors’ report and in the company’s website.

The first set of draft rules, covering 16 of the total 29 chapters of the Act, was released by the ministry of corporate affairs on Monday.

The companies Act mandates companies having a net worth of Rs 500 crore of more; or a turnover of Rs 1000 crore or more; or a net profit of Rs 5 crore or moreto have a CSR spend of at least two percent of their average net profit of past three years.

The CSR committee to be constituted under the new companies Act, 2013, shall prepare the CSR policy of the company and would specify the projects and programmes that are to be undertaken. It would also specify modalities of execution in the areas chosen and implementation schedules for the same.

The draft rules explain that ‘net profit’ would mean net profit before tax as per books of accounts and shall not include profits arising from branches outside India. Also, 2% CSR spending would be computed as 2% of the average net profits made by the company during every block of three years. For the purpose of first CSR reporting the net profit shall mean average of the annual net profit of the preceding three financial years ending on or before March 31, 2014. The reporting of this would be done on an annual basis commencing from FY 2014-15. Also, the tax treatment of CSR spend will be in accordance with the IT Act.

It also says that CSR activities may generally be conducted as projects or programmes (either new or ongoing) excluding activities undertaken in pursuance of the normal course of business of a company. And CSR projects/programmes of a company may also focus on integrating business models with social and environmental priorities and processes in order to create shared value. The CSR policy of the company should provide that surplus arising out of the CSR activity will not be part of business profits of a company.

It also says that the CSR committee shall prepare a transparent monitoring mechanism for ensuring implementation of the projects or programmes proposed to be undertaken by the company. A company may also implement its CSR programmes through trusts, societies, or section 8 companies operating in India, which are not set up by the company itself. Such spends may be included as part of its prescribed CSR spend only if such organizations have an established track record of at least three years in carrying on activities in related areas.

Companies can also collaborate or pool resources with other companies to undertake CSR activities and any expenditure incurred on such collaborative efforts would qualify for computing the CSR spending.