How to test CSR expenditure classification against permitted Schedule VII activities

Testing CSR expenditure classification means independently recomputing the mandated CSR obligation — two percent of average net profit for the preceding three financial years, computed under section 198 — then checking every item claimed as CSR spend against the activities actually permitted under Schedule VII and the specific exclusions in the CSR rules, since activities that benefit the company's own employees, that are undertaken in the normal course of business, or that amount to a contribution to a political party, do not qualify however they are labelled internally.

Why the classification test has to look past the label

Expenditure that is really marketing, employee welfare, or ordinary business development dressed up as community outreach is the most common finding in this area. The test is whether the activity, in substance, sits within a Schedule VII head and satisfies the rules' exclusions — not whether the client's CSR committee minuted it as CSR.

The testing sequence

1. 01Recompute average net profit for the preceding three years under section 198 independentlyThis is a defined computation with specific add-backs and deductions, not the reported net profit for those years — rebuild it rather than taking the client's figure.
2. 02Recompute the two percent mandated obligation for the year and compare to the obligation the client has disclosedA difference here changes every downstream conclusion about whether the company spent enough, so resolve it before testing individual items.
3. 03Obtain the full list of CSR projects and expenditure for the year, with supporting documentation for eachProject approval by the CSR committee and the board, the implementing agency or in-house execution, and actual utilisation certificates or expenditure records — not just the summarised ledger entry.
4. 04Test each project against the Schedule VII activity heads it is claimed underConfirm the activity genuinely falls within the specific head claimed — eradicating hunger, education, environmental sustainability, and so on — reading the actual project scope, not the project's title.
5. 05Test each project against the specific exclusions in the CSR rulesActivities undertaken in the normal course of business, benefiting only the company's own employees and their families, contributions to a political party, and activities outside India except for training of Indian sports personnel, are all excluded regardless of their Schedule VII framing.
6. 06Trace administrative overheads to the permitted capCSR administrative overheads are capped as a percentage of total CSR expenditure for the year — recompute this percentage and flag any excess.
7. 07Recompute the unspent CSR amount and trace its treatmentUnspent amounts relating to an ongoing project must be transferred to a specified unspent CSR account within the prescribed time and utilised within the following periods; unspent amounts not relating to an ongoing project must be transferred to a specified fund. Trace the actual transfer, the amount, and the timing against the requirement.