CSR Compliance: When the 2% Rule Applies to Foreign-Owned Companies

CSR in India Is Not Optional — It Is a Legal Mandate

India was the first country in the world to make Corporate Social Responsibility (CSR) spending a legal requirement. Section 135 of the Companies Act 2013, which came into force on April 1, 2014, requires qualifying companies to spend at least 2% of their average net profits on CSR activities listed in Schedule VII of the Act. This is not a voluntary guideline — it is a statutory obligation backed by a civil penalty under Section 135(7) of twice the amount that should have been transferred, or INR 1 crore, whichever is less, on the company, and one-tenth of that amount or INR 2 lakh, whichever is less, on each officer in default.

This article is part of our Complete Guide to Annual Compliance for Foreign-Owned Companies in India. Here we focus specifically on how the CSR mandate applies to foreign-owned subsidiaries and what compliance steps they must follow.

For foreign-owned companies operating in India, CSR compliance is frequently overlooked in the first few years of operation. Parent companies in the US, UK, or Singapore assume that a small Indian subsidiary with modest revenue does not need to worry about social spending. That assumption can be expensive. The thresholds that trigger CSR applicability are lower than most foreign investors expect, and the consequences of non-compliance have been enforceable as a hard-edged monetary penalty since the Companies (Amendment) Act 2020 came into effect in January 2021.

When Does the 2% CSR Rule Apply to Your Company?

The Three Threshold Tests

CSR becomes mandatory for any company — private limited, public limited, or foreign company — that meets any one of the following thresholds in the immediately preceding financial year:

The critical word is "any one." A foreign-owned subsidiary with INR 5 crore in net profit but only INR 50 crore in turnover and INR 10 crore in net worth still triggers CSR applicability. Foreign-owned IT and consulting subsidiaries frequently cross the INR 5 crore net profit threshold within a few years of starting operations, well before anyone in the group thinks of the Indian entity as large.

One amendment is pending, and it moves in the opposite direction to what is often reported. The Corporate Laws (Amendment) Bill, 2026 — introduced in the Lok Sabha on 23 March 2026, referred to a Joint Parliamentary Committee the same day, with the committee reporting on 3 August 2026 — proposes to raise the net-profit trigger from INR 5 crore to INR 10 crore (or such other sum as may be prescribed) and to let the Central Government exempt companies meeting prescribed conditions from the CSR provisions altogether. The Bill is still pending, so the INR 5 crore trigger above continues to apply; foreign subsidiaries sitting between INR 5 crore and INR 10 crore of net profit should plan on the current law and treat the Bill as relief that has not yet arrived.

Foreign Companies Operating in India

The CSR provisions apply equally to foreign companies with Indian operations. Under rule 3(1) of the Companies (CSR Policy) Rules 2014, the CSR rules apply to every company including its holding or subsidiary, as well as a foreign company defined under Section 2(42) of the Act having its branch office or project office in India and meeting the threshold criteria.

This means FDI-funded subsidiaries registered as Indian private limited companies are fully subject to CSR requirements, just like any domestic company. Branch offices and project offices of foreign companies registered under FEMA are also covered if they meet the thresholds.

Once Triggered, How Long Does CSR Apply?

Applicability is retested every year against the immediately preceding financial year. A company that crosses any threshold in one financial year must comply — constitute the committee where required, and spend — in the following financial year. If it is below all three thresholds in the immediately preceding financial year, Section 135 does not apply to it for the year in question. There is no multi-year lock-in: the obligation follows the preceding year's figures, which is why a single unusually profitable year produces exactly one year of CSR obligation, not four. What it does produce is a lagging spend calculation, because the amount is 2% of the average of the last three years' net profits.

Calculating the 2% CSR Spending Obligation

Average Net Profit Formula

The CSR obligation is calculated as 2% of the average net profits of the company during the three immediately preceding financial years. "Net profit" for this purpose is calculated under Section 198 of the Companies Act — not the profit shown in the tax return or the profit as per IFRS/US GAAP consolidated accounts.

Key adjustments to arrive at Section 198 net profit include:

• Exclude any profit from the sale of undertakings or property (capital gains)
• Exclude any profit from the sale of forfeited shares
• Exclude premium received on shares or debentures
• Exclude any amount of profit/loss arising from a change in carrying amount of an asset or liability recognised in equity
• Add back provisions for taxation and dividends paid

Practical Example for a Foreign Subsidiary

Consider a US-owned Indian subsidiary with the following net profits:

Average net profit = (4.2 + 6.8 + 8.5) / 3 = INR 6.5 crore. CSR obligation for FY 2026-27 = 2% of INR 6.5 crore = INR 13 lakh.

This is not a large amount, but the compliance machinery around it — forming a CSR committee, drafting a CSR policy, identifying eligible projects, ensuring the spend is within Schedule VII activities, maintaining documentation, and filing Form CSR-2 — requires disproportionate effort relative to the spend amount.

CSR Committee Formation for Foreign-Owned Companies

Composition Rules

Every company subject to CSR must constitute a CSR Committee of the Board. The composition requirements differ based on company type:

• Listed companies: Minimum 3 directors, at least 1 independent director
• Unlisted public companies: Minimum 3 directors, at least 1 independent director (if independent directors are required)
• Private companies: Minimum 2 directors (no independent director requirement)
• Foreign companies (branch/project office): Minimum 2 persons — one must be a person resident in India authorised to accept notices under Section 380(1)(d), and the other nominated by the foreign company

For a typical foreign-owned private limited company with 3 directors (two foreign nominees and one resident director), the CSR Committee can consist of any 2 of the 3 directors. The resident director is typically included for practical reasons.

Exemption from CSR Committee

If the CSR obligation does not exceed INR 50 lakh in a financial year, the company is not required to constitute a CSR Committee. The functions of the CSR Committee can be discharged by the Board of Directors directly. This exemption is useful for smaller foreign subsidiaries that have just crossed the applicability threshold.

Eligible CSR Activities Under Schedule VII

The CSR spend 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 key categories relevant to foreign-owned companies include:

• Education and skill development: Promoting education, vocational skills, and livelihood enhancement — often the easiest category for tech subsidiaries to support
• Healthcare: Preventive health, sanitation, safe drinking water, and contributions to Swachh Bharat Kosh
• Environment: Ensuring environmental sustainability, ecological balance, animal welfare, and conservation of natural resources
• Gender equality and women empowerment: Setting up homes, hostels, day-care centres, and women-focused programmes
• 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 development
• Sports: Training for rural, national, Paralympic, and Olympic sports
• Disaster management: Relief, rehabilitation, and reconstruction
• Armed forces welfare: Contributions to war widows, veterans, and Central Armed Police Forces

Foreign-owned companies cannot spend CSR funds for the benefit of their employees or their families. CSR activities must benefit external communities and cannot be used as an employee welfare programme.

Spending, Carry-Forward, and Unspent Amount Rules

What Counts as CSR Expenditure

CSR expenditure includes the actual cost of projects and programmes, subject to a 5% cap on administrative overheads. You cannot count employee volunteer hours at market rates, in-kind donations of company products, or marketing expenditure disguised as CSR.

Excess Spend Carry-Forward

The third proviso to Section 135(5) allows a company that spends more than its 2% requirement to set off the excess amount — not a fraction of it — against the requirement to spend in the succeeding three financial years, in the manner prescribed by the CSR Policy Rules. There is no 5% cap on the carry-forward; the 5% figure that circulates belongs to a different rule, the cap on administrative overheads. The set-off is useful for foreign subsidiaries that undertake a large one-time project — say, building a school — that exceeds the current year's obligation, and it requires a Board resolution.

Unspent CSR Amount — The Transfer Obligation

Where the money goes depends on whether the shortfall relates to an ongoing project. If it does, Section 135(6) requires the unspent amount to be transferred within 30 days of the end of the financial year to a special bank account called the "Unspent Corporate Social Responsibility Account" for that year, and spent on the project within three financial years; anything still unspent after that goes to a Schedule VII fund. If the shortfall does not relate to an ongoing project, the second proviso to Section 135(5) applies instead: the unspent amount goes straight to one of the funds specified in Schedule VII — the Prime Minister's National Relief Fund (PMNRF), the Clean Ganga Fund and the others listed there — within six months of the end of the financial year. Getting this distinction wrong is itself a Section 135(7) default.

This is a trap for foreign subsidiaries that "intend" to do CSR but never get around to identifying projects. The money must physically move to a separate bank account, and failing to transfer it is a violation that triggers penalties.

CSR Reporting and Filing Requirements

Annual Report Disclosures

The Board's Report (attached to the annual financial statements) must include a detailed CSR report in the prescribed format, covering:

• The CSR policy and its web link
• Composition of the CSR Committee
• Average net profit for the preceding 3 financial years
• Prescribed CSR expenditure (2% of average net profit)
• Details of CSR projects/activities undertaken, including implementing agencies
• Amount spent, unspent, and reasons for any shortfall

Form CSR-2 Filing

In addition to the Board's Report disclosures, companies must file Form CSR-2 with the Registrar of Companies as an addendum to Form AOC-4. This form captures details of CSR spending, implementing agencies, and impact assessment (if applicable). The requirement sits in rule 12(1B) of the Companies (Accounts) Rules 2014, which makes CSR-2 an addendum to AOC-4. The stand-alone CSR-2 filing windows belonged to the earlier years; the last of them, for FY 2023-24, was extended to 30 June 2025 by G.S.R. 317(E) dated 19 May 2025, and from FY 2024-25 onward CSR-2 goes in with AOC-4.

Impact Assessment

If the company's average CSR obligation over the preceding three financial years is INR 10 crore or more, it must undertake an independent impact assessment of its CSR projects. The cost of the impact assessment can be booked as CSR expenditure, capped at 2% of the total CSR expenditure for the financial year or INR 50 lakh, whichever is higher. Most foreign-owned subsidiaries will not hit this threshold unless they are large manufacturing or IT services operations.

CSR Implementing Agencies

Foreign-owned companies can implement CSR activities directly or through implementing agencies. If using an implementing agency, the agency must be:

• A Section 8 company, a registered public trust or a registered society — and, where the entity was not established by the company itself, it must hold registration under sections 12A and 80G of the income-tax law
• Registered with the MCA by filing Form CSR-1 and obtaining a unique CSR Registration Number
• Have an established track record of at least 3 years in carrying out similar activities

Since the MCA's July 2025 migration of company forms to Version 3 of the MCA21 portal, CSR-1 is filed as a web-based form rather than the older downloadable e-form. Confirm the current filing route and attachment list on the MCA portal before onboarding an agency, because an implementing agency without a valid CSR Registration Number cannot receive CSR funds.

For foreign subsidiaries without deep local networks, partnering with established implementing agencies is often the most practical approach to CSR execution. Organisations like the India CSR Network, CAF India, and established local NGOs can help identify projects aligned with Schedule VII activities.

Penalties for CSR Non-Compliance

The Companies (Amendment) Act 2020 replaced the earlier fine-and-imprisonment regime for CSR default with a civil penalty, adjudicated by the Registrar. The numbers come from Section 135(7):

There is no criminal exposure here — a point worth making to foreign directors who have been told otherwise — but the personal monetary exposure is real and is assessed on each officer in default separately from the company. A director on the board of an Indian subsidiary that fails to transfer unspent CSR amounts is personally liable for one-tenth of the untransferred amount, capped at INR 2 lakh, in an adjudication before the Registrar. Because the penalty is mechanical and the trigger is a missed bank transfer, it should be a standing agenda item, supported by compliance advisory updates.

Key Takeaways

• CSR applies to any company — including foreign-owned subsidiaries — that crosses any one of three thresholds in the immediately preceding financial year: INR 500 crore net worth, INR 1,000 crore turnover, or INR 5 crore net profit. The pending Corporate Laws (Amendment) Bill, 2026 would raise the net-profit trigger to INR 10 crore, but it has not been enacted.
• The obligation is 2% of average net profits (Section 198) over the preceding 3 financial years — not 2% of revenue or 2% of IFRS profit.
• Applicability is retested each year against the immediately preceding financial year — there is no multi-year lock-in — but the amount is 2% of a three-year average, so one exceptional year keeps feeding the calculation for three.
• Unspent amounts tied to an ongoing project go to an Unspent CSR Account within 30 days of year-end and must be spent within 3 years; unspent amounts not tied to an ongoing project go straight to a Schedule VII fund such as the PMNRF within 6 months of year-end.
• The penalty is civil, not criminal: up to INR 1 crore (or twice the shortfall, if less) on the company and up to INR 2 lakh (or one-tenth of the shortfall, if less) on each officer in default — no imprisonment since the Companies (Amendment) Act 2020.