Allocation of CSR, Bonus and Taxes - In what order should this be calculated?

MaushamMishra

Several provisions across different acts stipulate the allocation of specific percentages of Net Profit, for various expenses. These provisions include:

According to Section 5 of the Bonus Act, 2030, companies are obligated to allocate 10% of their annual net profit for the distribution of bonuses to their employees.
Section 54 of the Industrial Enterprise Act, 2076 mandates that Medium and Large Scale Industries, as well as Cottage and Small Scale Industries with an annual turnover of Rs. 15 Crores or more, must allocate a minimum of 1% of their annual net profit each fiscal year for the purpose of fulfilling Corporate Social Responsibility.

Now, several questions arise in this context:

In what sequence should these expenses be computed?
Should CSR allocation come before Bonus allocation? Should profit be considered pre-tax or post-tax?

MaushamMishra

MaushamMishra In what sequence should these expenses be computed?

In this scenario, we can view things from the perspective of the authority levels held by three key players associated with CSR, Statutory Bonuses and Statutory Taxes: Corporate Social Responsibility (CSR), Employee Bonuses, and Government Taxes.

Starting with CSR, which deals with environmental matters, it holds the most important position among these stakeholders, even though it's not the most authoritative within the entire enterprise. Next, we should consider employee bonuses. While employees have more say in the company than environmental stakeholders, their authority is still lower than that of the government. Lastly, let's focus on taxes. Governments have the highest level of authority among these three stakeholders.

In summary, the hierarchy of authority among CSR Expenses, Employee Bonuses, and Government Taxes can be understood by looking at their respective roles and influence within the enterprise - a plausible perspective can be delineated based on the hierarchical echelon of authority maintained by the triad of stakeholders requiring the allocation of CSR Expenses, Employee Bonuses, and Government Taxes in that particular order.

MaushamMishra

MaushamMishra Should CSR allocation come before Bonus allocation? Should profit be considered pre-tax or post-tax?

Let us undertake a comprehensive examination of the prevailing subject matter, aiming to establish whether the term "net profit" pertains to pre-tax or post-tax profit. Within the jurisdiction of Nepal's legal framework, the existing regulations remain conspicuously silent on a precise definition of the term "net profit."

In conformity with conventional accounting principles, "net profit" entails the subtraction of cost of goods sold and diverse direct and indirect expenditures (inclusive of taxes) from sales.
In accordance with the elucidation presented by Black's Law Dictionary, "net profit" is denoted as the aggregate sales revenue subtracted by the cost of goods sold and all accompanying expenditures.

Under the prevailing legal structure in Nepal, the term "net profit" lacks explicit definition; however, contextual interpretations have been discerned for sundry applications within separate laws, premised upon the intent of the relevant provisions.

The term "net profit" is invoked within Section 91 of the Companies Act 2063, in the context of compensation, allowances, rewards, etc., for Directors, wherein it is explicitly delineated as "after payment of income tax." Further, under Section 105, pertaining to constraints imposed upon company directors concerning contributions, donations, or gifts, and under Section 143, concerning documents to be appended to a holding company's balance sheet with respect to its subsidiary company, references to the term "net profit" within the Companies Act 2063 are made in relation to accounts pertinent to shareholders. Particularly under Section 105, such a reference is linked to the computation of a sum that is not inherently business-related expenditure. Hence, within the compass of the Companies Act 2063, "net profit" has been construed as "profit after tax."
The definition of "Net Profit" is also delineated within the purview of the Income Tax Act, 2058, under Section 9(2)(b). Here, net profits emanate from the disposal of non-business taxable assets or investments of an individual, to be treated as investment income for tax imposition. Consequently, as per Nepal's income tax statutes, "net profit" signifies profit remaining after all charges/expenses but prior to taxation.
Moreover, "net profit" has undergone interpretation within the context of bonus computation. Section 5 of the Bonus Act 2030 stipulates that companies allocate 10% of their annual net profit for employee bonus distribution. For the Bonus Act's purposes, net profit is regarded as Profit before Taxes (PBT). A recent Supreme Court verdict in the case of इनदुशंकर चिनी उघोग लिमिटेड बिरुद्ध आन्तरिक राजस्व कार्यालय Case Number: 069-WO-0029 has further expounded that net profit, for the bonus allocation context, shall be construed as "profit before tax."

Given the diverse connotations ascribed to the term "net profit" within distinct scenarios, as deliberated above, an appropriate interpretation of the term for the allocation of funds towards Corporate Social Responsibility (CSR) under Section 54(1) of the Industrial Enterprises Act 2076 necessitates an evaluation of the nature of such allocation. Analogous to bonuses, CSR allocation represents a statutory expenditure for the entity, an obligatory cost essential for conducting its operations.

Furthermore, as per Section 54(4) of IEA 2076, the amount earmarked for CSR is accorded deduction as an expense for income tax purposes. This provision inherently implies that the sum allocated to CSR constitutes an outlay for the company, and all expenses must be accounted for prior to taxation. Hence, within this context, "net profit" should be construed as "profit before taxes" for the express purpose of allocating resources towards CSR in compliance with Section 54(1) of the Industrial Enterprises Act 2076.

MaushamMishra

MaushamMishra In what sequence should these expenses be computed?

Returning to the initial question of the sequence in which Bonus and CSR expenses should be deducted, it's noteworthy that Clause 18.13(1) of the Income Tax Directive 2066 provides relevant guidance. According to this clause, bonus is permitted to be deducted to a maximum limit of 10% of net profit, as outlined in the Bonus Act 2030. However, if the bonus is calculated prior to accounting for CSR expenses, there's a likelihood that the calculated bonus expense would exceed the 10% limit. Let's elucidate this through a case study:

Case Study: Assuming a hypothetical company's financial figures for a fiscal year:
Net Profit (Before Tax): Rs. 1,00,00,000
Bonus Calculation (10% of Net Profit): 10% of Rs. 1,00,00,000 = Rs. 10,00,000
Now, incorporating CSR expenses:
CSR Allocation (1% of Net Profit Before Tax): 1% of Rs. 1,00,00,000 = Rs. 1,00,000

If CSR is considered prior to calculating Bonus:
Available Net Profit for Bonus Calculation: Rs. 1,00,00,000 - Rs. 1,00,000 (CSR) = Rs. 99,00,000
Bonus Calculation (10% of Adjusted Net Profit): 10% of Rs. 99,00,000 = Rs. 9,90,000
However, If Bonus is calculated before CSR:
Bonus Expense: Rs. 10,00,000 (exceeding the permissible limit of 10%)

By following this sequence, the bonus expense remains within the 10% limit of the net profit as specified in the Bonus Act 2030. Therefore, considering CSR allocation before calculating Bonus helps in ensuring compliance with the prescribed legal limits and maintaining consistency with the provisions of the acts and regulations involved.

MaushamMishra

To gain a deeper understanding of Corporate Social Responsibility (CSR), I suggest delving into the article.
CSR Tax Perspective.