Summary: The blog discusses the progressive shift in the implementation of CSR activities by foreign-owned and controlled entities, and how a Section 8 company limited by guarantee can serve as an alternative to the challenges faced by traditional Section 8 companies under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, and the Foreign Contribution (Regulation) Act, 2010.
Introduction
Corporate social responsibility (“CSR”) has evolved from a voluntary philanthropic activity to a mandatory legal requirement under the Companies Act, 2013 (“Companies Act”), in India. Companies now face strict scrutiny regarding their CSR expenditure and impact measurement. As CSR continues to evolve within the Indian business landscape, companies are progressively shifting from outsourcing their CSR activities to third parties and external organisations. Instead, they are choosing to drive these initiatives directly or channel them through their own foundations and trusts. This shift indicates that companies are increasingly leveraging in-house expertise to address social problems and create opportunities for employee participation, moving towards a more strategic and integrated CSR approach rather than simply outsourcing to third-party and external organisations.
Foreign direct investment in Indian companies is on the rise, with a 14% increase in FY 2024-25 compared to FY 2023-24.[1] This indicates an increase in foreign owned and controlled companies (“Foreign Controlled Entities”) commencing operations in India. While these Foreign Controlled Entities comply with sectoral conditionalities under the FDI Policy, they still come under political scrutiny if their expansion disrupts small businesses or traditional ways of doing business here. Such entitiesare directly undertaking CSR activities that aim to skill and uplift the affected class to improve their public perception and image.
For self-implementation of CSR activities, the Companies Act allows companies (including Foreign Controlled Entities) to undertake CSR activities through their wholly or partially owned companies, societies, or trusts. However, if an organisation opts for a company structure, it must establish itself as a company dedicated to advancing social, cultural, educational, sports, religious, or environmental issues. Additionally, all profits or income should be exclusively utilised (intended) to promoting such objects (“Section 8 Company”). Section 8 Companies are prohibited from distributing profits (if any) to their members.
Foreign Controlled Entities can opt to self-implement their CSR activities through a Section 8 Company. However, since CSR is not an investment, a question arises whether this constitutes Foreign Direct Investment (FDI) or downstream investment by such Foreign Controlled Entities.
Furthermore, contributions made by Foreign Controlled Entities may constitute ‘foreign contribution’ under the Foreign Contribution (Regulation) Act, 2010 (“FCRA”). Any entity receiving such foreign contribution requires FCRA registration or prior permission from the Government. Failure to comply may result in fines and criminal liability for both the donor and the recipient, including imprisonment of up to five years under Section 35 of the FCRA. If the donor and/ or recipient is a body corporate, the officers in charge of the conduct of the company’s business shall also be deemed to be guilty of the offence. The Ministry of Home Affairs (“MHA”), in 2016/17, had issued an FAQ[2], clarifying that infusion of foreign share capital in a Section 8 Company by Foreign Controlled Entities will be treated as ‘foreign contribution’. However, the MHA revised the FAQ in 2020 and omitted this item. This has resulted in lack of clarity on foreign capital infusion in Section 8 Companies and the requirement of registration or prior permissions under the FCRA. The Government of India has been strictly enforcing FCRA compliance in recent times, which has resulted in the cancellation of FCRA registrations and prior permissions for non-compliance. Therefore, without clear guidance, Foreign Controlled Entities incorporating Section 8 Company need to be cautious in their approach.
Is a Section 8 Company Limited by Guarantee a Possible Alternative?
The Companies Act permits incorporation of a company (including a Section 8 Company), which is limited by ‘guarantee’ instead of limited by shareholding. In a company limited by guarantee, members are only liable for the amount (often nominal) they have agreed to contribute toward the assets, costs, charges and expenses if the company is wound up. This is also a preferred form for incorporating Section 8 Companies in India, as the profits generated by such companies are required to be ploughed back into the company itself. Therefore, there is no scope for members to earn dividends if they become shareholders.
The Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“Non-Debt Rules”), which encompass sectoral limits and conditions prescribed by the ‘FDI Policy’, regulate foreign investment in India, including downstream investment by Foreign Controlled Entities. As of date, the Non-Debt Rules only envisage investment in entities incorporated in India by issuance of equity instruments. In other words, the Non-Debt Rules do not accommodate an Indian entity limited by guarantee (i.e., not having any share capital).
Any guarantee by a person resident outside India is subject to Foreign Exchange Management (Guarantees) Regulation, 2000 (“Guarantee Regulations”). In companies limited by guarantee, members effectively act as guarantors of the company’s debt, up to the agreed amount and bear liability to both the company and third parties. However, as the Foreign Controlled Entity will be a person resident in India, guarantees given by such entities may fall outside the scope of the Guarantee Regulation.
In companies limited by guarantee, there is no capital infusion. Therefore, it is possible that companies limited by guarantee may not be subject to Non-Debt Rules and may also avoid the interpretative challenges regarding capital infusion under FCRA.
Nevertheless, Foreign Controlled Entities will need to cautiously structure the initial contribution to a Section 8 Company for dealing with incorporation and setting up expenses to avoid classification of such contribution as ‘foreign contribution’. Further, where the Section 8 Company receives money from Foreign Controlled Entities towards discharge of CSR obligations, such arrangements will have to be carefully evaluated for applicability of FCRA and structured in a manner that ensures compliance with the CSR regime, while not overlooking the FCRA requirements (as applicable).
For further information, please contact:
Sindhushri Badarinath, Partner, Cyril Amarchand Mangaldas
sindhushri.badarinath@cyrilshroff.com
[1] https://www.pib.gov.in/PressReleasePage.aspx?PRID=2131716
[2] The said FAQ reads as under: “Whether infusion of foreign share capital in a company registered under Section 25 of the Companies Act, 1956 attracts the provisions of FCRA, 2010? Ans. Yes, infusion of foreign share capital in a company registered under Section 25 of the Companies Act, 1956 is treated as foreign contribution.”
