Chhavi Ghuliani, Manager, Partnership Development and Research, BSR

After years of debate, the Indian Parliament passed its first update of the country’s corporate law in more than 50 years, which includes several important provisions that modernize India’s corporate governance rules. The Companies Act 2013 requires that one-third of a company’s board comprise independent directors, and that at least one board member be a woman. It also requires companies to disclose executive salaries as a ratio to the average employee’s salary, and it allows shareholders to file class-action law suits.

The provision that has gotten the most attention is the so-called “2 percent” requirement, which made India the first country to mandate CSR. Complete details are available in the 294-page act; what follows are the five key points that all companies must know if they have business interests in India.

1. What is the 2 percent requirement?

The act requires that companies set up a CSR board committee, which must consist of at least three directors, one of whom must be independent. That committee must ensure that the company spends “at least 2 percent of the average net profits of the company made during the three immediately preceding financial years” on “CSR” activities. If the company fails to spend this amount on CSR, the board must disclose why in its annual report.

2. Who must follow this requirement?

The requirement will apply to any company that is incorporated in India, whether it is domestic or a subsidiary of a foreign company, and which has (1) net worth of Rs. 5 billion or more (US$83 million), (2) turnover of Rs. 10 billion or more (US$160 million), or (3) net profit of Rs. 50 million or more (US$830,000) during any of the previous three financial years. This means that about 8,000 companies will spend a combined total of up to Rs. 150 billion (US$2 billion) annually on CSR activities.

3. How will the requirement be enforced?

The board committee is responsible for reviewing, approving, and validating the company’s investments in CSR. Prior to each annual meeting, the board must submit a report that includes details about the CSR initiatives undertaken during the previous financial year. The board’s independent director helps ensure the credibility of this process. However, the act does not provide any guidance on what constitutes acceptable reasons for which a company may avoid spending 2 percent on CSR.

4. How does the act define “CSR”?

The act defines CSR as activities that promote poverty reduction, education, health, environmental sustainability, gender equality, and vocational skills development. Companies can choose which area to invest in, or contribute the amount to central or state government funds earmarked for socioeconomic development. While this definition of CSR is broad and open to interpretation, it clearly emphasizes corporate philanthropy rather than strategic CSR. The act does, however, specify that companies “shall give preference to the local area and areas around where it operates.”

5. Will this positively or negatively impact CSR in India?

In a country such as India, where one-third of the population is illiterate, two-thirds lack access to proper sanitation, and 400 million people still live on less than US$2 a day, the passage of the Companies Act should be hailed as a positive step forward in ensuring that business contributes to equitable and sustainable economic development.

But there are also a number of reasons to think it may not greatly improve CSR. Indian companies still equate CSR with corporate philanthropy rather than considering CSR as a holistic view of the impacts business has on society and the environment through its operations. By reinforcing this view, the bill could distract business leaders who are ready to embrace strategic CSR.

Also, by making CSR mandatory, companies may treat it as a “check the box” exercise rather than looking at ways to innovate and generate a return from doing social and environmental good. And most companies will comply by channeling funds to community organizations that are addressing one of the priority topics mentioned. There is no shortage of organizations that will be willing to accept these funds—there are an estimated 3.3 million NGOs in India—but few organizations have the capacity and the skill to effectively manage projects that can have a large-scale impact. In an effort to meet the spending obligations, companies may not do the right due diligence to select high-impact, credible organizations.

It’s too early to say what the real impact of this act will be, especially given that passing it and enforcing it are two different things. But with the controversy around the CSR provision, and the lack of specificity and detail, there is an opportunity for leading companies to influence the way the CSR mandate is interpreted. Given the immense need and tremendous business opportunity in India, this can only be a good thing.