The Companies Act 2013 exists for the regulation of corporate landscape in India. It is like a compass that guides the companies throughout the process of setting up, governance and dissolution. It is an act that outlines everything that a company needs to follow to legally operate in India. So, if you are running a company that comes under the purview of Companies Act 2013, then understanding the nitty-gritty of this Act is crucial for you.
But, if you are not someone who runs a company, then why should you care about it? This is where the Section 198 of the Act comes into picture. This section is not just about corporate affairs, but it also impacts the NGO funding landscape in India, in turn impacting the millions of people who benefit from the activities of various non-governmental organisations. Therefore, understanding the section 198 of Companies Act 2013 is essential for you, dear readers.
Companies Act 2013: A Basic Understanding
Before we begin talking about Section 198 of the Act, let us quickly look at what this Act encompasses. It came into effect on September 12, 2013, replacing the old Companies Act, 1956. The new Act was brought into place because of the changing corporate landscape in the country and globally, and the need for relevant legislation.
Why Section 198 Matters?
Now, the Companies Act 2013 talks focuses on a variety of aspects related to functioning of a corporation. However, in this article, we will focus on section 198 because of its significance for companies, NGOs, and common people. First of all, section 198 is extremely important for the companies because it tells the leadership and the stakeholders to “know their net profits.” It shapes dividend decisions, expansion plans and financial strategies of the companies.
At the same time, this section also highlights the Corporate Social Responsibility (CSR) of these companies. The 2 per cent of net profits that a company makes fuel its CSR initiatives. This is where the NGOs come in because a big chuck of this CSR amount is routed to reliable NGOs as partners to these companies. Through their partner NGOs, the companies ensure that their money goes for a greater purpose of helping the people and society. Therefore, section 198 ensures that many NGOs that are doing good work do not run out of funds and continue to contribute to the society.
Additionally, section 198 also ensures accountability for these CSR activities that the companies undertake because it ensures that they report results of these activities. Lastly, there is a indirect impact on the people of this section as some consumers may make their buying decisions based on what kind of CSR activities a company is undertaking. The social impact of this can also not be ignored as it can be translated into better schools, safer environment and much more.
Understanding Section 198 of Companies Act 2013
Now that we have a basic understanding of what section 198 is and how it impacts companies, NGOs and people; let us take a deeper look at what it consists of. To begin, we can say that section 198 is not just a set of rules but a guide that points the companies towards a responsible citizenship.
Imagine a boardroom with senior leadership of a company huddled together and discussing something important. What is the agenda of this meeting? To compute their net profits and decide the future trajectory of the company based on that. The first thing that is you need to remember from is PAT or Profit After Tax. This is what serves as the foundation of net profit calculations of a company.
Once you calculate PAT, section 198 instructs the companies to deduct certain items like:
- Premium profits – gains from shares or debentures.
- Forfeited shares.
- Undertakings and immovable property – when a company sells an entire business unit or a piece of land, those profits (of capital nature) step out of the spotlight.
- Unrealised gains.
Apart from these, there are some highlighted non-permissible deductions in the section which are added back to the calculation. These are voluntary compensation, losses of capital nature, etc. After all the calculations are done, a three-year average profit is calculated. It is the 2% of this amount that becomes the CSR corpus of an organisation. It is the company’s pledge to the society. The calculations are complex and it has been presented here in a simplified manner. To understand them better, you can visit the official website of Ministry of Corporate Affairs.
Why Companies Must Grasp Section 198?
While we have talked about its impact on NGOs and public too, the biggest impact of section 198 is on the companies. This is why they must grasp every aspect of it carefully. This is because of the various reasons:
- Legal compliance and accountability – companies must understand Section 198 to comply with the law. It’s not a mere checkbox; it’s a legal mandate. Non-compliance can lead to penalties, reputational damage and shareholder discontent.
- Strategic decision-making – from dividend distribution to expansion plans, companies rely on accurate net profit figures. Section 198 shapes these decisions.
- Beyond profit margins – the 2% CSR corpus is extremely important for the companies because they have the mandate to report their CSR activities annually. Therefore, companies must try to either implement projects that bear results or partner with NGOs that provide good results. Section 198 ensures this transparency for public and shareholders of the company. It is because of this that the companies regularly monitor and evaluate the impact of their CSR projects, which further translates into meaningful work on the grassroots.
Looking beyond profits
So, next time we look at the profit figures of a company, we must see it from the lens of Section 198 of Companies Act 2013 as well. The profit that companies make is not just a number, but also a promise for the society as a 2% share of that profit has to go to CSR activities. The public can ask important questions like what work is a company doing under its CSR initiative and what impact it is creating. This can help in ensuring accountability.