CSR 2% Rule: When It Applies to Foreign Companies

India's CSR Mandate Is Not Just for Domestic Companies

Yes — the 2% Corporate Social Responsibility (CSR) rule under Section 135 of the Companies Act, 2013 applies to foreign-owned subsidiaries, joint ventures with Indian partners, and even branch offices and project offices registered under FEMA, if the entity meets any one of three thresholds in the preceding financial year: net worth of INR 500 crore or more, turnover of INR 1,000 crore or more, or net profit of INR 5 crore or more. Because the net profit threshold alone is enough to trigger the obligation, many IT services and consulting subsidiaries cross it — and become subject to mandatory CSR spending of at least 2% of average net profits — within their first 3 to 5 years of Indian operations.

India was among the first countries to make CSR spending a statutory obligation, when Section 135 came into force on April 1, 2014. Since the Companies (Amendment) Act, 2020, the sanction is monetary only: a penalty of up to INR 1 crore on the company and up to INR 2 lakh on each officer in default under Section 135(7). Section 135 carries no imprisonment.

This article goes beyond the existing overview in our CSR compliance guide for foreign-owned companies to focus specifically on when and how the 2% rule catches foreign companies off guard — particularly those in the first 3 to 5 years of Indian operations.

Which Foreign Companies Must Comply with the 2% CSR Rule?

The Three Threshold Tests

CSR becomes mandatory when a company meets any one of the following thresholds in the immediately preceding financial year:

The operative word is "any one." A foreign-owned private limited company in India with INR 5 crore (roughly USD 590,000 at INR 85 to the US dollar) in net profit but modest turnover and net worth still triggers the CSR obligation. Many IT services and consulting subsidiaries cross this profit threshold within their first 3 to 5 years of operation — often without realising that CSR compliance is now mandatory.

Types of Foreign Entities Covered

The CSR rules apply to multiple types of foreign entities operating in India:

• Indian subsidiaries of foreign companies: A wholly-owned subsidiary registered as an Indian private limited or public limited company is fully subject to Section 135 if it meets any threshold
• Joint ventures: Indian JV companies with foreign equity participation are treated as Indian companies for CSR purposes
• Branch offices: Foreign companies with branch offices in India registered under Section 380 are covered under Rule 3(1) of the Companies (CSR Policy) Rules, 2014
• Project offices: Foreign companies with project offices in India are similarly covered if they meet the financial thresholds

Rule 3(1) of the CSR Rules applies them to "every company including its holding or subsidiary, and a foreign company defined under clause (42) of section 2 of the Act having its branch office or project office in India, which fulfils the criteria specified in sub-section (1) of section 135 of the Act." This language leaves no room for interpretation — foreign presence in India, in any corporate form, is subject to CSR if thresholds are met.

There Is No Longer a 3-Year Tail

Older guidance says a company that falls below all three thresholds must keep complying for three consecutive financial years before it can stop. That was Rule 3(2) of the CSR Rules, and it was omitted by the Companies (Corporate Social Responsibility Policy) Amendment Rules, 2022 (G.S.R. 715(E), dated 20 September 2022). Applicability is now tested afresh each year against the immediately preceding financial year alone: a foreign subsidiary that crosses INR 5 crore of net profit in one year must comply in the next year, and if it falls below every threshold it is outside Section 135 for the year after that.

One tail does survive, and it is the one that catches foreign subsidiaries. The same 2022 notification inserted a proviso to Rule 3(1): a company holding any amount in its Unspent Corporate Social Responsibility Account under Section 135(6) must constitute a CSR Committee and comply with Section 135(2) to (6), whether or not it still meets any threshold. Money parked in that account keeps the obligation alive until it is spent or transferred.

How the 2% CSR Spending Is Calculated

Net Profit Under Section 198

The CSR obligation equals 2% of the average net profits of the company during the three immediately preceding financial years. Crucially, "net profit" for CSR purposes is calculated under Section 198 of the Companies Act — not the profit as per the tax return, and not the profit as per IFRS or US GAAP consolidated accounts.

Key adjustments to arrive at Section 198 net profit include:

• Exclude capital gains from the sale of undertakings or property
• Exclude premium received on shares or debentures
• Exclude profits from forfeited shares
• Add back provisions for taxation — income-tax is not a deductible item under Section 198(5)(a)

For foreign companies specifically, the net profit calculation is based on the profit and loss account prepared under Section 381(1)(a), read with Section 198. Any profit from overseas branches — whether operated as a separate entity or otherwise — is excluded from the net profit computation.

Practical Calculation Example

Consider a Singapore-owned Indian subsidiary providing technology services:

Average net profit = (3.8 + 7.2 + 9.5) / 3 = INR 6.83 crore. CSR obligation for FY 2026-27 = 2% of INR 6.83 crore = INR 13.67 lakh (roughly USD 16,100 at INR 85 to the US dollar).

The amount is modest relative to the company's revenue, but the compliance machinery — forming a CSR committee, drafting a policy, identifying Schedule VII projects, maintaining documentation, and filing Form CSR-2 — requires disproportionate effort. This is where many foreign companies stumble.

The CSR Committee: Composition Rules for Foreign Entities

Indian Companies with Foreign Ownership

Section 135(1) requires a CSR Committee of three or more directors including at least one independent director; under the proviso, a company that is not required to appoint an independent director under Section 149(4) — which covers most foreign-owned private limited companies — needs only two or more directors on the Committee. For a typical foreign-owned subsidiary with two foreign nominee directors and one resident director, the committee can include any two of these three directors.

Foreign Companies (Branch/Project Offices)

For foreign companies operating through a branch or project office in India, the CSR Committee must comprise at least two persons — one must be a person resident in India authorised to accept notices on behalf of the company under Section 380(1)(d), and the other must be nominated by the foreign company.

Exemption for Smaller Obligations

If the CSR obligation does not exceed INR 50 lakh in a financial year, the company is not required to constitute a CSR Committee at all. The Board of Directors can discharge all CSR functions directly. This exemption is particularly useful for foreign subsidiaries that have just crossed the INR 5 crore net profit threshold.

Eligible CSR Activities: What Foreign Companies Can Fund

CSR expenditure must be directed toward activities listed in Schedule VII of the Companies Act. The MCA has clarified that this list is "illustrative and must be interpreted liberally." The most relevant categories for foreign companies include:

• Education and skill development: Promoting education, vocational skills, and livelihood enhancement — the most common choice for technology and consulting subsidiaries
• Healthcare: Preventive health, sanitation, safe drinking water, and contributions to the Swachh Bharat Kosh
• Environmental sustainability: Ecological balance, animal welfare, conservation of natural resources, and contributions to the Clean Ganga Fund
• Technology incubators: Contributions to incubators funded by the Central or State Government, or to IITs and other research institutions
• Rural development: Rural development projects and slum area improvement
• Disaster management: Relief, rehabilitation, and reconstruction activities
• Armed forces welfare: Contributions to war widows, veterans, and Central Armed Police Forces

Critical restrictions that foreign companies must understand: CSR funds cannot be spent on employee welfare, employee family benefits, or activities that directly benefit the company's workforce. CSR activities must benefit external communities. You also cannot count employee volunteer hours at market rates, donate company products at retail value, or disguise marketing expenditure as CSR.

Implementing CSR: Direct Execution vs Implementing Agencies

Foreign companies can implement CSR activities directly or through registered implementing agencies. Given that most foreign subsidiaries lack deep local networks and community relationships, partnering with an implementing agency is the practical approach.

Implementing Agency Requirements

An implementing agency must be:

• A Section 8 company, a registered public trust or a registered society that is registered under Section 12A and Section 80G of the Income-tax Act, 1961 (Rule 4(1)(a) and (d) of the CSR Rules); alternatively, an entity established by the Central or State Government, or under an Act of Parliament or a State legislature
• Registered with the MCA by filing Form CSR-1 and obtaining a unique CSR Registration Number
• Where the entity was not established by the company itself or by government, it must also have an established track record of at least 3 years in undertaking similar activities (Rule 4(1)(d))

Administrative Overhead Cap

Administrative overheads for CSR activities are capped at 5% of total CSR expenditure. This means if the CSR obligation is INR 15 lakh, only INR 75,000 can go toward project management, reporting, and administration. The rest must flow to the actual CSR projects.

Unspent CSR Amount: The Transfer Trap

The rules on unspent CSR amounts are where foreign companies most frequently face penalties. The framework is more complex than simply "spend 2% or pay a fine."

Ongoing Projects

If the company has identified a multi-year CSR project but has not spent the full obligation during the financial year, the unspent amount must be transferred to a special bank account called the "Unspent Corporate Social Responsibility Account" within 30 days of the end of the financial year. This amount must then be spent on the identified ongoing projects within three financial years from the date of transfer.

No Ongoing Projects

If the company simply has not spent the required amount and has no ongoing CSR project to attribute it to, the unspent amount must be transferred to one of the funds specified in Schedule VII — such as the Prime Minister's National Relief Fund (PMNRF) or the PM CARES Fund — within six months of the end of the financial year.

After 3 Years

If the amount transferred to the Unspent CSR Account remains unspent after three financial years, Section 135(6) requires the balance to be transferred to a Schedule VII fund within 30 days of the end of that third financial year. Failure to do so attracts the Section 135(7) penalty described below.

Excess Spend Carry-Forward

If a company spends more than the required 2%, Rule 7(3) lets it set the entire excess off against its CSR obligation for the immediately succeeding three financial years — there is no percentage cap on the excess. Two conditions apply: the excess must not include any surplus arising out of CSR activities, and the Board must pass a resolution to that effect. This is useful when a large one-time project — such as building a school or funding a water purification plant — exceeds the current year's obligation.

CSR Reporting: Form CSR-2 and Board's Report

Board's Report Disclosures

The Board's Report accompanying the annual financial statements must include a detailed CSR report covering the CSR policy, committee composition, average net profit for the preceding three years, prescribed expenditure, project details, amount spent and unspent, and reasons for any shortfall.

Form CSR-2 Filing

Companies must file Form CSR-2 with the Registrar of Companies annually. Rule 12(1B) of the Companies (Accounts) Rules, 2014 requires CSR-2 to be furnished as an addendum to Form AOC-4 (or AOC-4 XBRL, or AOC-4 NBFC (Ind AS)), so in practice it follows the AOC-4 deadline of 30 days from the AGM. The separate-filing windows that many advisers still cite were year-specific provisos, and the last of them — extended to 30 June 2025 by G.S.R. 317(E) dated 19 May 2025 — applied only to FY 2023-24. No such proviso exists for FY 2024-25 or later. CSR-2 was itself replaced with an e-Form by G.S.R. 357(E) dated 30 May 2025, with effect from 14 July 2025.

Impact Assessment

If the company's average CSR obligation over the three immediately preceding financial years is INR 10 crore or more, Rule 8(3) requires an impact assessment by an independent agency — but only of projects with outlays of INR 1 crore or more that were completed not less than one year before the study. The assessment cost can be booked as CSR expenditure, capped at 2% of total CSR expenditure for that financial year or INR 50 lakh, whichever is higher (Rule 8(3)(c) as substituted by the Companies (CSR Policy) Amendment Rules, 2022). Most foreign subsidiaries will not hit this threshold unless they are large-scale manufacturing or IT services operations.

Penalties for CSR Non-Compliance

The Companies (Amendment) Act, 2020 replaced the earlier scheme with a single monetary penalty in Section 135(7). It applies to defaults under Section 135(5) and Section 135(6):

Note what is not in the table: imprisonment. An imprisonment-and-fine version of Section 135(7) was drafted in the Companies (Amendment) Act, 2019 but never brought into force, and it was replaced before commencement by the monetary-penalty version in the Companies (Amendment) Act, 2020. Guidance that still describes three years' imprisonment for CSR default is out of date.

The exposure for foreign directors is personal but civil, not criminal. A director who is an "officer in default" of a subsidiary that fails to transfer unspent CSR amounts to the designated fund is personally liable for the Section 135(7) penalty — one-tenth of the amount, or INR 2 lakh, whichever is less — and the default is recorded against the company at the ROC. This risk should be tracked in board papers through annual compliance advisory processes.

Practical Steps for Foreign Companies to Comply

1. Assess applicability annually: Review net worth, turnover, and net profit against the three thresholds after each financial year-end. Also check whether anything remains in the Unspent CSR Account, which keeps the obligation alive on its own.
2. Calculate the obligation correctly: Use Section 198 net profit, not tax profit or IFRS profit. Compute the 3-year average.
3. Form the CSR Committee: Or confirm exemption if the obligation is below INR 50 lakh.
4. Draft a CSR policy: Board-approved policy outlining the activities the company will undertake from Schedule VII.
5. Identify an implementing agency: Partner with a registered NGO or Section 8 company. Verify their CSR Registration Number on the MCA portal.
6. Execute and document: Spend the amount during the financial year. Maintain detailed records of projects, beneficiaries, and expenditure.
7. Transfer any unspent amount: Move unspent amounts to the Unspent CSR Account within 30 days of year-end, or to a Schedule VII fund within 6 months if no ongoing project exists.
8. File Form CSR-2: File it as an addendum to Form AOC-4 with the ROC, within 30 days of the AGM.
9. Include CSR in the Board's Report: Attach the prescribed CSR annexure to the annual financial statements.

For FDI advisory support on structuring CSR compliance, especially for subsidiaries in their early years, professional guidance can help avoid the common pitfalls that lead to penalties.

Key Takeaways

• The 2% CSR rule applies to every company in India — including foreign-owned subsidiaries, branch offices, and project offices — that meets any one of three thresholds: INR 500 crore net worth, INR 1,000 crore turnover, or INR 5 crore net profit.
• For foreign companies, net profit is calculated under Section 198 read with Section 381, excluding overseas branch profits — not based on IFRS, US GAAP, or tax return figures.
• There is no 3-year tail: Rule 3(2) was omitted in September 2022, so applicability is tested each year against the immediately preceding financial year. But any balance in the Unspent CSR Account keeps Section 135(2) to (6) alive regardless of thresholds.
• Unspent amounts must be physically transferred — either to an Unspent CSR Account within 30 days of year-end or to a Schedule VII fund within 6 months. The money does not simply carry over.
• Penalties under Section 135(7) are monetary, not criminal: up to INR 1 crore on the company and up to INR 2 lakh on each officer in default. Section 135 carries no imprisonment.