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Heightened Onus on Assessee to Prove Genuineness of Share Subscription Money Routed Through Web of Entities

The Hon’ble Mumbai Tribunal in the case of Leena Power Tech Engineers Pvt Ltd[1] has held that the onus (i.e. burden) is on the assessee to prove the ‘bonafides’ or ‘genuineness’ of the share application money credited in the books of accounts. The Tribunal further remarked that it would be superficial approach to examine assessee’s claim only on the basis of documents filed and overlook the unusual pattern in the documents filed by the assessee and pretend to be oblivious of the ground realities.  

Considering the fact that the monies were routed through complex web of entities, which failed to inspire any confidence about the genuineness of the investing company and made it looks like a shell company, the Tribunal upheld the additions made by the Assessing Officer (AO) in the hands of the assessee with respect to the receipt of share application money.

 

Facts – Leena Power Tech Engineer’s Pvt. Ltd.:

In the instant case, the assessee had received share application monies from Rohan Vyapar Private Limited (RVPL) and Manbhawan Commercial Pvt Ltd (MCPL). The equity shares were issued at 900% premium on the face value of Rs 10 each i.e. Rs 90 per share. The assessee had issued 3,78,290 equity shares to RVPL and accordingly received an amount aggregating to Rs 3,78,29,600. Similarly, the assessee had received an amount aggregating to Rs 4,35,00,000 from MCPL.

The case of the assessee was reopened by the Assessing Officer (‘AO’) on the basis of certain information received from the investigation wing which mentioned that the assessee has received share application money from RVPL which was subjected to routing through several layers and ultimately has its source in of huge cash deposits in one of the branches of ICICI Bank.

The transaction flow has been elaborated below for ease of reference.



Assessee’s Contentions: Relevant documentary evidence produced

The Assessee’s contentions have been summarized below:

The assessee contended that it had submitted all the relevant documentary evidence such as details of the subscribers to the share capital, share premium, bank statement, justification of share premium (computed on a scientific basis), share valuation by cash flow method, and ledger confirmation from the subscribers. The assessee further submitted that the Revenue had also issued a notice under section 133(6) of the Income-tax Act, 1961 (Act) which was duly replied along with the details of the transaction with the assessee, ledger account, return of income, audited balance sheet, etc. and accordingly it was contended that the assessee had discharged its initial onus cast upon it and now it is for the revenue authorities to prove otherwise.

It was further contended that the proviso to section 68[2] of the Act inserted with effect from 1 April 2013 cannot have retrospective operation. In this regard, reliance was placed on the ruling of Hon’ble jurisdictional High Court in the case of Gagandeep Infrastructure Pvt Ltd[3].

The Assessee further contended that the companies from which the assessee had received the share subscriptions were companies with proper net-worth and these companies were properly assessed to tax and have not been declared as shell companies by the Government or any official body and just because five levels below these companies, there are cash deposits in some bank accounts, the receipts cannot be rejected as lacking bonafide.

Accordingly, it was contended that the entries in the books of accounts of the companies subscribing to the shares cannot be brought to tax in the hands of the assessee.

Revenue’s Contentions: Assessee has failed to prove ‘Bonafides’

The primary contention of the Revenue was that the assessee has failed to prove the ‘bonafides’ of the share application money. Further, the Revenue further contended that the surrounding circumstance of the transaction clearly demonstrates that the transaction is not bonafide and the assessee is a beneficiary of a sophisticated money-laundering racket wherein the money is routed through multiple layering of accounts to the accounts of entities subscribing to the share capital of the assessee.

The Revenue further contended that it was the responsibility of the assessee to show the genuineness of the share application money received and merely producing PAN, income-tax returns, and financial statements of the subscriber do not prove that the transaction is bonafide. It was pointed out that there were hardly any overnight balances in the bank accounts of the companies subscribing to the shares of the assessee company, and all this indicates that these companies are merely conduit companies.

Issue Before the Tribunal:

The question which arose before the Tribunal was whether the learned Commissioner of Income-tax (Appeals) was justified in deleting the addition of Rs 8,13,29,600 as unexplained credit under section 68 of the Act in the hands of the assessee.

Mumbai Tribunal’s Ruling:

The Mumbai Tribunal observed and held as under:

At the outset, the Tribunal observed that there cannot be any dispute on the fundamental legal position that the onus is on the assessee to prove ‘bonafides’ or ‘genuineness’ of the share application money credited in the books of accounts and to prove the nature and source on the money to the satisfaction of the assessing officer.

The Tribunal placed reliance on the cases of Youth Construction Pvt Ltd[4], United Commercial and Industrial Co (P.) Ltd[5] & Precision Finance (P.) Ltd[6] and noted the kind of explanations which assessee is expected to provide:

  1. proof regarding the identity of the share applicants;
  2. their creditworthiness to purchase the shares; and
  3. genuineness of the transaction as a whole.

The Tribunal remarked that the onus of the assessee of explaining nature and source of credit does not get discharged merely by filing confirmatory letters, or demonstrating that the transactions are done through the banking channels, or even by filing the income tax assessment particulars.

The Tribunal further went on to add that, being a final fact-finding authority, it cannot be superficial in its assessment of the genuineness of a transaction and this call has to be taken not only in the light of the face value of the documents presented before the Tribunal but also in the light of all the surrounding circumstances, the preponderance of human probabilities and ground realities. The Tribunal placed reliance on the case of Durga Prasad More[7] wherein it was held that “If all that an assessee who wants to evade tax is to have some recitals made in a document either executed by him or executed in his favour then the door will be left wide open to evade tax. A little probing was sufficient in the present case to show that the apparent was not real. There may be a difference in subjective perception on such issues, on the same set of facts, but that cannot be a reason enough for the fact-finding authorities to avoid taking subjective calls on these aspects and remain confined to the findings on the basis of irrefutable evidence.”

The Tribunal further analyzed the financial statements of RVPL and observed that RVPL has earned only an interest income of Rs 1.13 lakhs and has not carried out any substantial activity during the relevant period. Further, the Tribunal found it difficult to believe that company handling investments in excess of Rs 10 crores and making such aggressive investments as buying shares for Rs 3.78 crores, at a huge premium of nine times the face value of shares, in the private limited and wholly unconnected companies, without any management control, will operate in such a modest manner. This defies logic and such transactions do not take place in the real-life world. The Tribunal also examined the bank account of RVPL and noted that there are series of transactions that do not inspire any confidence about the genuineness of the investing company but make it looks like a shell company acting as a conduit.

The Tribunal also observed that the entities involved in the transaction only provide different layers to the transaction and de facto hide the true investor. The assessee was also unaware of the actual beneficial investor in his company.

Additionally, the Tribunal examined, in detail, the valuation carried out by the assessee on the basis of Discounted Cash Flow (DCF) method and rejected the same thereby holding that the share premium at which the shares are issued is wholly unrealistic.   

A similar analysis was also carried out by the Tribunal with respect to another investor ‘MCPL’.

In light of the above facts and circumstances, the Tribunal rejected the assessee’s contention and held that the transactions under consideration are not ‘bonafide’ and accordingly restored the additions made by the AO.

Our Observation:

The order of the Mumbai Tribunal has, indeed, widened the scope of ‘onus’ placed on the assessee to prove the genuineness of a particular transaction. Such ‘onus’ will not be deemed to be discharged by merely filing the documents before the tax authorities, but the assessee would have to go one step further to justify the rationale of such transactions in order to prove that the transaction has not been entered as a colorable device to defraud the Revenue. The judgment further emphasizes taking a holistic view of the matter based on the surrounding circumstances rather than just relying upon the documentary evidence. Having said this, one has to keep in mind that documentary evidence will always be the primary source of substantiation of a particular transaction.

Going forward, it would be interesting to see the repercussions of this judgment and whether the other Tribunal and lower tax authorities would adopt a similar path and undertake a holistic view of the matter in order to differentiate between the apparent and the real.’

References

[1] [TS-883-ITAT-2021(Mum)]

[2] It provides that where the assessee is a company (not being a company in which the public are substantially interested), and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless— (a) the person, being a resident in whose name such credit is recorded in the books of such company also offers an explanation about the nature and source of such sum so credited; and (b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be satisfactory.

 

[3] (2017) 80 taxmann.com 172 (Bom)

[4] [(2013) 357 ITR 197 (Del)]

[5] [1991] 187 ITR 596 (Cal)]

[6] [1994] 208 ITR 465 (Cal)]

[7] 1971) 82 ITR 540 (SC)

 

 

Image Credits: Photo by Nataliya Vaitkevich from Pexels

The order of the Mumbai Tribunal has, indeed, widened the scope of ‘onus’ placed on the assessee to prove the genuineness of a particular transaction. Such ‘onus’ will not be deemed to be discharged by merely filing the documents before the tax authorities, but the assessee would have to go one step further to justify the rationale of such transactions in order to prove that the transaction has not been entered as a colorable device to defraud the Revenue.

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The Messi Exit: A Legal & Financial Perspective

Behind the passions of the fans, tackled goals, swanky parties and brand endorsements, there is a lot that goes into structuring a football team/club, registration as well as the transfer of a player while maintaining sustainable finances. 

In response to multiple financial irregularities in clubs such as Deportivo La Coruña, Racing Santander, Valencia, Real Zaragoza, Real Mallorca, Albacete, Real Betis etc., the economic control framework was introduced in 2013 to keep clubs financially afloat and maintain competitive sustainability.

At a later stage, FFP (Financial Fair Play) came into effect against errant clubs for breach of regulations. Spain’s economic control- La Liga controls the fire before it can damage (to an extent) by setting a limit to the amount a club can spend, thereby making it easier to stay within limits and preventing the creation of unsustainable debts. 

What were the legal reasons for Messi’ s exit from Barcelona?

 

Recently Argentinean professional footballer Lionel Andrés Messi, popularly known as Leo Messi, decided to part ways with the Spanish football club FC Barcelona and join the French football club Paris Saint-Germain. Messi had been with the Spanish club for the last 21 years and their association came to an end on 30th June 2021, when they decided to move on.

Messi had agreed to a new five-year contract with Barcelona, however on 8th August 2021, the legendary football player announced his exit from the Spanish club, by signing a two-year contract with the French club Paris Saint-Germain, with the option of further extension up to a year. FC Barcelona announced that despite the agreement between the club and Messi, they were not able to honour the new contract due to the Spanish football league’s (LaLiga’s) financial fair-play rules. 

 

What is LaLiga Financial Fair-play Rule? 

 

Under the LaLiga fair play rule, each club is provided with a cost limit for each season, which includes the wages of the players, the coaching staff, physios, reserve teams, etc. Clubs have the flexibility to decide how the wages are distributed, as long as the overall limit is not breached. Factors taken into consideration for setting the financial cap are inclusive of expected revenues, profits and losses from previous years, existing debt repayments, and sources of external financing among others. In this case, the Catalan club could not accommodate Messi’s contract within the financial limit for the upcoming year, even though Messi was allegedly willing to take a 50% pay cut. 

Considering the fact that Messi is Barcelona’s record scorer with 751 goals and 10 La Liga titles, Messi’s exit could mean a heavy blow for the world’s most valuable[1] European football club. 

A football clubs’ main revenue is generated from TV broadcasting rights, matchday sales, and commercial revenue which includes sponsorship contracts, merchandising sales, and digital content that the club creates. It is too early to say whether Messi’s departure will have an impact on how Barcelona performs in the ongoing season. However, there is no question over how Messi has played an important role in bringing laurels to Barcelona over the past few years, which has garnered a significant fan following, not just for the footballer, but also for the club. Thus, his exit may likely cause a dip in the viewership and fan following which will directly affect the Club’s revenue.

Typically for a footballer, his contract with any club would include basic salary, signing-on fees, royalty fees, and objectives based on games. Apart from these, some of the other key element included in a contract is his image rights, merchandising right and licensing deals, which form a major portion of any footballer’s gross income. 

 

What are Image Rights? 

Image rights are the expression of a personality in the public domain. For an athlete, it will include their name, photo, and likeness, signature, personal brand, slogans, or logos, etc. Generally, football clubs try to extract a greater percentage from the image rights of a player, in a club capacity as compared to their personal capacity. Club capacity is usually when the image rights of the player are used in connection with or combined with his name, colours, crest, strip, logos identifying him as a player for his club. Personal capacity is usually when the player is appearing in and conducting activities outside his role as a player at the club. 

Any player leaving the club would have an impact on the commercial revenue generated by the club in the form of sponsorship contracts, merchandising sales as well as digital content. This would be especially notable for a player like Messi, whose personal brand value boasts over 130 trademarks. Messi’s trademark portfolio consists of mostly a single class trademark in his home country of Argentina, with others filed or registered in China, Brazil, EU, Malaysia, UK, Spain, Canada, Chile, and the US. The most common goods and services represented in Messi’s trademark portfolio are class 25 (clothing and footwear), class 28 (games, toys, and sporting apparatus) and class 9 (computer software). Apart from the above classes, class 18 has been filed in multiple applications.

The trademark consists of either the word mark MESSI/LIONEL MESSI or his logo. This means that Barcelona will no longer be able to use the footballer’s name or logo for apparel and merchandise sales, which will directly impact its revenue as most clubs collect a portion of the sales revenue. Also, Messi’s exit means that the club will have no control over his image rights to attract corporate sponsorships. Further, Messi’s huge online presence, with over 276 million Instagram followers, which is more than double of Barcelona’s official account (100 million), will have a direct impact on any advertising or publicity that the club may generate. 

A player of Messi’s stature, brand, and persona is significant to any club. How the present scenario is played with the new club and how much impact Messi’s presence will bring to Paris Saint-Germain is yet to be seen. 

A football clubs’ main revenue is generated from TV broadcasting rights, matchday sales and commercial revenue which includes sponsorship contracts, merchandising sales and digital content that the club creates. It is too early to say whether Messi’s departure will have an impact on how Barcelona performs in the ongoing season.

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Intermediary Guidelines and Digital Media Ethics Code: Shifting Paradigm of Social & Digital Media Platforms

It has been just over six months since the IT (Intermediary Guidelines and Digital Media Ethics Code) Rules, 2021 (the “Rules“) have been notified. However, these six months have been nothing short of a roller coaster ride for the (Internet) Intermediaries and Digital Media platforms, especially Social Media platforms who have tried to muddle through the slew of compliance obligations now imposed through these eccentric Rules. Notwithstanding, some of them had to face the wrath of the Government and even Courts for the delay in adherence.

On this topic, we are trying to stitch together a series of articles covering the entire gamut of the Rules, including their objective, applicability, impact, and the key issues around some of the rules being declared unconstitutional, etc.

In our first article, we analyse the timeline, objectives, and applicability of these Rules through some of the definitions provided under the Rules and the IT Act.

Tracing the Roots of the Digital Media Ethics Code 

The initiation of this endeavour can be tracked down to July 26, 2018, when a Calling Attention Motion was introduced in the Rajya Sabha on the misuse of social media and spread of fake news, whereby the Minister of Electronics and Information Technology conveyed the Government’s intent to strengthen the existing legal framework and make social media platforms accountable under the law. Thereafter, the first draft of the proposed amendments to the Intermediary Guidelines, The Information Technology (Intermediary Guidelines (Amendment) Rules) 2018, was published for public comments on December 24, 2018.

In the same year, the Supreme Court in Prajwala v. Union of India[1] directed the Union Government to form necessary guidelines or Statement of Procedures (SOPs) to curb child pornography online. An ad-hoc committee of the Rajya Sabha studied the issue of pornography on social media and its effects on children and the society and laid its report recommending the facilitation of identification of the first originator of such contents in February 2020.

In another matter, the Supreme Court of India on October 15 2020, issued a notice to the Union Government seeking its response on a PIL to regulate OTT Platforms. The Union Government subsequently on November 9 2020, made a notification bringing digital and online media under the ambit of the Ministry of Information and Broadcasting, thereby giving the Ministry the power to regulate OTT Platforms.

On February 25, 2021, the Union Government notified the much-anticipated Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Rules, 2021, bringing various digital entities under its purview and imposing new compliances to regulate them.

 

Objectives of the Digital Media Ethics Code

The rising internet and social media penetration in India raises concerns of transparency, disinformation and misuse of such technologies. The Rules address these concerns and bring accountability to social and digital media platforms by mandating the setting up of a grievance redressal mechanism that adheres to statutory timeframes. The Rules also address the legal lacuna surrounding the regulation of OTT platforms and the content available on them and introduces a three-tier content regulation mechanism.

Key definitions and the applicability of the Digital Media Ethics Code

The Rules add on extensively to the 2011 Intermediary Guidelines and also introduce new terms and definitions. To understand the Rules and the compliances thereunder in a holistic manner, it becomes imperative to learn the key terms and definitions. This also addresses concerns of applicability of the Rules to different entities, as they prescribe different sets of compliances to different categories of entities.

Key definitions:

Digital Media as per Rule 2(1)(i) are digitised content that can be transmitted over the internet or computer networks, including content received, stored, transmitted, edited or processed by

  • an intermediary; or
  • a publisher of news and current affairs content or a publisher of online curated content.

This broadly includes every content available online and every content that can be transmitted over the internet.

Grievance as per Rule 2(1)(j) includes any complaint, whether regarding any content, any duties of an intermediary or publisher under the Act, or other matters pertaining to the computer resource of an intermediary or publisher as the case may be.

Intermediary has not been defined in the Rules, but as per S. 2(1)(w) of the IT Act, intermediary, with respect to any particular electronic record, is any person who on behalf of another person receives, stores or transmits that record or provides any service with respect to that record and includes telecom service providers, network service providers, internet service providers, web-hosting service providers, search engines, online payment sites, online-auction sites, online-market places and cyber cafes.

The first part of the definition lays down that an Intermediary with respect to an electronic record, is any person that receives, stores or transmits that electronic record on behalf of another person.

An entity becomes an intermediary for a particular electronic record if that record is received by, stored in or transmitted through the entity on behalf of a third party. However, as the clause does not use the term “collect” with respect to an electronic record, any data that entities may collect, including IP Addresses, device information, etc., do not fall within the definition’s purview. Hence the entities would not be considered as intermediaries for such data.

Moreover, the second part of the definition lays down that those entities that provide any service with respect to an electronic record would be intermediaries. However, what constitutes “service” has been a key point of discussion in prior cases. In Christian Louboutin Sas v. Nakul Bajaj[2], the Court not only held that the nature of the service offered by an entity would determine whether it falls under the ambit of the definition, but also went on to hold that when the involvement of an entity is more than that of merely an intermediary, i.e., it actively takes part in the use of such record, it might lose safe harbour protection under S. 79 of the Act.

The definition also includes telecom service providers, network service providers, internet service providers, web-hosting service providers, search engines, online payment sites, online-auction sites, online-market places, and cyber cafes as intermediaries. In Satish N v. State of Karnataka[3], it was held that taxi aggregators like Uber are also intermediaries with respect to the data they store. Therefore, Telecom Service Providers like Airtel, Vi, Jio, etc., Network Service Providers like Reliance Jio, BSNL, MTNL, etc., Internet Service Providers like ACT Fibernet, Hathaway, etc., Search Engines like Google, Bing, etc., Online Payment gateways like Razorpay, Billdesk etc., Online Auction Sites like eBay, eAuction India, etc., Online Market Places like Flipkart, Amazon etc. are all considered intermediaries.

Social Media Intermediaries as per Rule 2(1)(w) is an intermediary which primarily or solely enables online interaction between two or more users and allows them to create, upload, share, disseminate, modify or access information using its services. This includes platforms like Tumblr, Flickr, Diaspora, Ello, etc.

Significant Social Media Intermediaries as per Rule 2(1)(v) is a social media intermediary having number of registered users in India above such threshold as notified by the Central Government. Currently, the threshold is 5 million users. Platforms that fall under this category would be Facebook, Twitter, Instagram, YouTube, Snapchat, LinkedIn, WhatsApp, Telegram etc.

News & current affairs content as per Rule 2(1)(m) includes newly received or noteworthy content, including analysis, especially about recent events primarily of socio-political, economic or cultural nature, made available over the internet or computer networks, and any digital media shall be news and current affairs content where the context, substance, purpose, import and meaning of such information is in the nature of news and current affairs content. Therefore, news pieces reported by newspapers or news agencies, shared online, on social media, or on digital media platforms are news & current affairs content. This includes contents of such nature created by any person and shared through social media platforms like WhatsApp, Facebook, Twitter etc. Digital content discussing news and the latest happenings will also come under the purview of this definition.

Newspaper as per Rule 2(1)(n) as a periodical of loosely folded sheets usually printed on newsprint and brought out daily or at least once in a week, containing information on current events, public news or comments on public news. Newspapers like The Hindu, Times of India etc. will fall under this category.

News aggregator as per Rule 2(1)(o) is an entity performing a significant role in determining the news and current affairs content being made available, makes available to users a computer resource that enable such users to access such news and current affairs content which is aggregated, curated and presented by such entity. This includes platforms like Inshorts, Dailyhunt etc.

Online curated content as per Rule 2(1)(1) is any curated catalogue of audio-visual content, other than news and current affairs content, which is owned by, licensed to or contracted to be transmitted by a publisher of online curated content, and made available on demand, including but not limited through subscription, over the internet or computer networks, and includes films, audio visual programmes, documentaries, television programmes, serials, podcasts and other such content. This includes movies and shows available on OTT platforms like Netflix, Prime Video, Disney+Hotstar etc.

Publisher of News and Current Affairs Content as per Rule 2(1)(t) includes online paper, news portal, news aggregator, news agency and such other entities, which publishes news and current affairs. This would include websites/apps such as The Wire, The News Minute, Scroll.in, Dkoding.in, The Print, The Citizen, LiveLaw, Inshorts etc.

While the Rules do not include the regular newspapers or replica e-papers of these newspapers, as they come under the Press Council Act, news websites such as Hindustantimes.com, IndianExpress.com, thehindu.com are covered under the Rules, and the Union Government clarified the same on June 10, 2021. The clarification stated that websites of organisations having traditional newspapers and digital news portals/websites of traditional TV Organisations come under the ambit of the Rules.

This does not include news and current affairs reported or posted by laymen or ordinary citizens online, as the scope is limited only to news publishing agencies.

Publisher of Online Curated Content as per Rule 2(1)(u) is a publisher who performs a significant role in determining the online curated content being made available and enables users’ access to such content via internet or computer networks. Such transmission of online currented content shall be in the course of systematic business or commercial activity. This includes all OTT platforms, including Netflix, Prime Video, Voot, Lionsgate, Disney+Hotstar, etc.

The Digital Media Ethics Code Challenged in Court

Part III of the IT Rules has been challenged by many persons in various High Courts. News platforms including The Wire, The Quint, and AltNews moved to the Delhi High Court, alleging that online news platforms do not fall under the purview of Section 87 of the IT Act, under which these Rules are made as the section is only applicable to intermediaries. Section 69A is also limited to intermediaries and government agencies. It is alleged that since such publishers are not intermediaries, they do not fall under the purview of the IT Rules.

A similar petition was moved by LiveLaw, a legal news reporting website before the Kerala High Court, alleging that the Rules violated Articles 13, 14, 19(1)(a), 19(1)(g), and 21 of the Constitution and the IT Act.[4] The petitioners contended that the Rules had brought Digital News Media under the purview of the Press Council of India Act and the Cable Television Networks (Regulation) Act, 1995, without amending either of the two legislations. They also alleged that the rules were undoing the procedural safeguards formed by the Supreme Court in the Shreya Singhal[5] case. In this regard, the Kerala High Court has ordered that no coercive action is to be taken against the petitioner as interim relief.

Recently, the Bombay High Court in Agij Promotion of Nineteenonea v. Union of India[6] delivered an interim order staying Rules 9(1) and 9(3), which provides for publishers’ compliance with the Code of Ethics, and the three tier self-regulation system respectively. The Court found Rule 9(1) prima facie an intrusion of Art. 19(1)(a).

Legality & Enforceability of the Digital Media Ethics Code

Even though six months have passed since the Rules came into force, the legality and enforceability of the Rules are still in question. While most intermediaries, including social media and significant social media intermediaries, have at least partly complied with the Rules, the same cannot be said for publishers of news and current affairs content and online curated content. This will have to wait until the challenges to its legality and constitutionality are settled by Courts.

References:

[1] 2018 SCC OnLine SC 3419.

[2] 2018 (76) PTC 508 (Del).

[3] ILR 2017 KARNATAKA 735.

[4] https://www.livelaw.in/top-stories/kerala-high-court-new-it-rules-orders-no-coercive-action-issues-notice-on-livelaws-plea-170983

[5] (2013) 12 SCC 73.

[6] Agij Promotion of Nineteenonea v. Union of India, WRIT PETITION (L.) NO.14172 of 2021.

Image Credits: 

Photo by Jeremy Bezanger on Unsplash

 

Even though six months have passed since the Rules came into force, the legality and enforceability of the Rules are still in question. While most intermediaries, including social media and significant social media intermediaries, have at least partly complied with the Rules, the same cannot be said for publishers of news and current affairs content and online curated content. This will have to wait until the challenges to its legality and constitutionality are settled by Courts.

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India Needs New Regulations - But Simplification of Compliance is Just as Critical

In earlier posts, I have touched upon the need for Indian laws to be updated to better reflect the current environment and foreseeable changes to it brought about by various forces, primarily technology-led innovation. This is not just because of the need to plug legal loopholes that are exploited to the nation’s detriment but also with the objectives of streamlining compliance and better enforcement.

 

Recently, the union government did exactly this when it announced a new set of rules to govern the operations of drones in India. A new draft of the Drone Rules, 2021, now out for public consultation, will, when approved and notified, replace the UAS Rules, 2021, which were announced in March 2021. The fact that the government has come out with a new set of rules within 4 months of issuing the earlier version is a welcome sign of change, as it signals recognition of a rapidly-changing environment as well as the importance of timely and appropriate responses.

Changes are aimed at simplification and less regulatory control

The new rules are remarkable for other reasons as well. At about 15 pages in length, the new rules are only a tenth of the earlier rules. The changes are not limited to the form; there are substantive changes too. The new rules seek to do away with a large number of approvals (e.g., Unique Authorization Number, Unique Prototype Identification Number etc.).  Licensing for micro drones for non-commercial use has been done away with. Recognizing the immense potential for drones to revolutionize our society and economy, the government proposes to develop “drone corridors” for cargo delivery. Prior authorization of drone-related R&D organizations is being removed. A drone promotion council is to be set up, in order to create a business-friendly regulatory regime that spurs innovation and use of drones. All this augurs well for the development of a robust drone ecosystem in India.

Implementing the “spirit” of underlying regulations is vital

The change to the drone rules is a welcome step- just as the consolidation of 29 of the country’s labour laws into four Codes during 2019 and 2020 was. But rationalization becomes futile if there is no element of reform- e.g., doing away with requirements that have outlived their utility or need significant changes to remain relevant in the current environment? There were many expectations around the Labour Codes, but in the months that followed, it is fair to say that there was also much disillusionment amongst industry stakeholders because sticky issues, such as the distinction between “employees” and “workers”, payment of overtime, role of facilitator-cum-inspector etc., remained.

Simplifying compliance is necessary to improve “ease of doing business” further

The World Bank’s 2020 “ease of doing business” report ranks India 63rd; we were ranked 130 in 2016. The 2020 report considered three areas: business regulatory reforms (starting a business, paying taxes, resolving insolvency etc.); contracting with the government, and employing workers. 

But there are miles to go before we sleep. To ensure that India’s entrepreneurial energies and creative intelligence are directed to areas that will be critical in the years to come- e.g., space, AI, robotics, electric vehicles, clean energy etc. all need new regulations or revamp of existing legislations and rules. But this alone will not suffice. Implementing the spirit, and not just the letter of the law and rules and the simplification of regulatory compliance are important angles that government must pay attention to. These are going to be key determinants in improving our “ease of doing business”.

 

Technology is a necessary enabler but it is not sufficient

All regulatory filings- whether for approvals or compliance- should ideally be enabled in digital format. Digital dashboards in the government and other regulatory bodies should facilitate real-time monitoring. Only exceptions or violations should need further actions. To be sure, the government has initiated some steps in this direction- e,g., “faceless” interactions between business and the Income Tax authorities with the intention to reduce human interventions and thus, the possibility of corruption. But if the underlying income tax portal itself is not working properly, as was widely reported soon after it was launched, the desired outcomes will not be achieved.

Moreover, it is not just about having the right technology platforms in place. It is equally critical to bring about a mindset change in the administrative machinery that helps political leadership formulate policy and thereafter, enable implementation and performance monitoring.

Given India’s large domestic market and attractiveness as a base for exports, we as a nation stand on the threshold of a phase of significant economic growth. Many Indian entrepreneurs are establishing businesses overseas; this means that the benefits of jobs, tax revenues and IPR creation all move to other jurisdictions. The longer anachronistic and irrelevant laws remain on our books, and the harder regulatory compliance remains, the more we stand to lose. In a world where global investment flows, trade and supply chains are facing significant change under the influence of numerous forces, it would truly be unfortunate if India loses out largely because of continued difficulties in regulatory compliance.

Image Credits: Photo by Medienstürmer on Unsplash

The longer anachronistic and irrelevant laws remain on our books, and the harder regulatory compliance remains, the more we stand to lose. In a world where global investment flows, trade and supply chains are facing significant change under the influence of numerous forces, it would truly be unfortunate if India loses out largely because of continued difficulties in regulatory compliance.

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Tax Alert: Clarifications on Section 194Q-TDS on Purchase of Goods

The Central Board of Direct Taxes (CBDT) introduced a new Section 194Q in Finance Act, 2021, which is effective from 01st July 2021, for withholding tax at source on payments made for the purchase of goods.

The provision of Section 194Q states that:

  • Any person, being a Buyer, having a turnover or gross receipts exceeding INR 10 crores during the preceding financial year;
  • While making payment of any sum to any resident (Seller) for purchase of any goods of the value, where the aggregate of such value exceeds INR 50 lakhs in the previous year
  • Shall at the time of credit of such sum to the account of the Seller or at the time of payment, whichever is earlier, deduct an amount equal to 0.1% percent as income tax.

The above provision is not applicable, where:

  • Tax is deductible under any other provision of the Act; or
  • Tax is collectible under the provision of section 206C of the Act, other than transactions covered u/s. 206C(1H) therein.

The CBDT has received several representations with respect to practical challenges that may arise in the implementation of section 194Q. To address the difficulties that may arise, the CBDT has issued Circular No 13[1] of 2021 providing various clarifications regarding section 194Q.

194Q is not applicable in the following situations:

As per the Circular, ambiguity is removed on the applicability of section 194Q in a number of cases. CBDT has clarified that section 194Q is not applicable in the following situations:

  • Transactions relating to securities and commodities, which are carried through recognized stock exchanges, including exchanges that are located in the International Financial Service Centre.
  • Transactions in electricity, renewable energy certificates, or energy certificates traded through registered power exchanges.
  • Payments by non-resident Buyers unless if the purchase of goods is not effectively connected with the Permanent Establishment / fixed place of business of such non-resident in India.
  • On purchase of goods from a Seller whose income is exempt from tax. Similarly, it is clarified that tax collection at source (TCS) provisions under section 206C (1H) of the Act would not be applicable if the Buyer’s income is exempt from tax. However, these exemptions would not be applicable if only part of the Seller’s/Buyer’s income is exempt.
  • In the year of incorporation of the Buyer, the threshold of INR 10 crore would not be satisfied.
  • Transactions, where either payment or credit for the transaction happened before 1st July 2021.
  • TDS would not be applicable on the GST amount if the GST amount is separately indicated in the invoice. However, in the case of advance payments, the TDS under section 194Q will have to be discharged on the entire amount, as it is not possible to identify the GST component.

Calculation related clarifications

  • It has been clarified that for calculating the threshold of INR 50 lakhs in respect of a particular Seller, the transaction for the whole FY 2021-22 shall be considered, starting from 1st April 2021 and not from 1st July 2021.
  • For computing threshold of INR 10 crore in respect of the Buyer, only business turnover or gross receipts from business activities is to be considered. As such, turnover or gross receipts from non-business activities would not require to be taken into consideration.
  • In case of purchase returns, the TDS deducted on such purchases under section 194Q shall need to be adjusted against subsequent purchases from the same Seller, if the money is refunded by the Seller to the Buyer. However, no adjustment will be required in cases where the purchase return is replaced by goods by the Seller.

The interplay between sections 194O, 194Q, and 206C(1H) of the Act:

  • If Section 194O is applicable on any particular transaction, then Section 194Q shall not be applicable;
  • If both section 194O and section 194Q are applicable, then section 194O will prevail;
  • Section 206C(1H) is not applicable if TDS is deductible u/s. 194O or Sec 194Q;
  • If both sections 194O and 206C(1H) are applicable, then 194O shall prevail. Even if TCS is collected by the Seller still tax deduction responsibility of the E-commerce operator under section 194O cannot be condoned; this is because the prescribed tax rate under section 194O is higher than the prescribed tax rate u/s. 206C(1H);
  • If both sections 194Q and 206C(1H) are applicable, then section 194Q shall prevail. However, for ease of business, if TCS under section 206C(1H) has already been collected by the Seller then section 194Q would not be applicable; this is because the prescribed tax rate for deduction under section 194O and the prescribed tax rate for collection under section 206C(1H) are the same.

Comments:

This Circular is an extremely welcome one and has several important clarifications that have been issued by the CBDT before the enactment of the provisions of sections 194Q and 206C(1H). The Circular provides clarity vis-à-vis the scope of the relevant provisions, calculation of thresholds, interplay between overlapping provisions etc.

However, there are still some niggling doubts that prevail, requiring further clarity. For instance, while calculating the threshold of turnover or gross receipts of INR 10 crore w.r.t the Buyer, whether the amount considered should include or exclude the GST component.  

Also, it would help if it is prescribed for the Seller to obtain a “no deduction” declaration from the Buyer w.r.t TDS under section 194Q, in a situation where both sections 194Q and section 206C(1H) are jointly applicable on the same transaction and tax has already been collected and paid under section 206C(1H) by the Seller.

References

[1] Circular No 13 of 2021 dated 30th June 2021 (F No. 370142/26/2021 – TPL

 

Image Credits: Photo by Kelly Sikkema on Unsplash

This Circular is an extremely welcome one and has several important clarifications that have been issued by the CBDT before the enactment of the provisions of sections 194Q and 206C(1H). The Circular provides clarity vis-à-vis the scope of the relevant provisions, calculation of thresholds, interplay between overlapping provisions etc.

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Restoring value through tenancy reforms

The phenomenon of urbanisation, accompanied by the aspirations of the masses looking to make an ascend out of and above their life circumstances, dawns with transformation of landscapes. The harbours of the coast often become a passageway to opportunities. Settling the chaos of the opportunities in the city of Mumbai post the Second World War led to unique tenancy model in the city which sheltered its migrant population that would not otherwise be able to afford a shelter to call its own and ever since, rent control laws continue to bear the blame for much of an unlocked value of premises in the city despite the initial righteous intention of tenancy reforms.

Righteous Intention v. Regressive Implementation

The Maharashtra Rent Control Act, 1999 stands as a successor of the Bombay Rents, Hotel and Lodging House Rates Control Act, 1947, which was enacted as social welfare, as well as regulative legislation with a bonafide intention of protecting tenants from exploitation by and tyranny of landowners and from the spurt in rentals. The aforesaid situation did not change much with the enactment of the Maharashtra Rent Control Act, 1999 as the provisions of this substituted legislation were nothing but old wine in a new bottle. It carried forward the pros and cons of the erstwhile Bombay Rents, Hotel and Lodging House Rates Control Act, 1947 without rationale a and, as a result, rented premises in Mumbai city continue to fetch lower rental returns than prevalent market value or become a subject matter of long-lasting litigation/s. This situation has adversely impacted the rental market in the city of Mumbai and people are caught between the adverse demand and low yielding supply of the premises to be meant for rentals.

Against this background, yet another tenancy reform, the Model Tenancy Act, 2021 as approved by the Union Cabinet in the first week of June 2021 (“the Model Act”) is now being viewed as a great catalyst towards boosting the rental market as it may stimulate the market by promising secured higher rental returns to the landowners (which includes premises’ owner) and as an affirmative driving force addressing most of the concerns of its predecessors.

Rationalising the Expectation

While the disputes arising out of decades-old tenancies continue to keep their memories alive in the Small Causes Courts and further in the appellate courts, the prevailing skepticism that premises owners have lately clung to as a result of the pandemic over letting out their premises, shows the unreliability of the current rent control laws and eviction proceedings under the Maharashtra Rent Control Act, 1999. However, the enactment of the Model Act too depends on the adaptation of the provisions by the States to suit their indigenous tenancy models.

The State of Maharashtra has already cleared its stand in favour of protecting the interest of the tenants enjoying protection under the prevailing rent control regime.[i] Further, the prospective applicability of the Model Act is an important consideration while assessing the extent of the change to be expected out of the Model Act. Hence, it is required that the thrust of the reforms be maximised where it can be currently realised from the very stage of entering into a rental agreement, while the process of working out the reforms into the indigenous tenancy models continues to be unravelled by the State government.

One of the reforms that is hoped for is an overhauled dispute resolution process for rent and tenancy related matters. The Model Act seeks to nail the long lasting tenancy litigation by proposing a three-tier adjudicatory system being the Rent Authorities, Rent Courts and Rent Tribunals vested with exclusive jurisdiction to try and adjudicate disputes falling under the scope of the Model Act which does not extend to “question of ownership or title”.[ii] The essential condition to be met to seek relief through the Rent Authorities or the Rent Courts and Rent Tribunals is to have a rental agreement that is duly identified with a unique identification number by the Rent Authority set-up for a district under the Model Act.[iii]

An overview of the role to be played by the authorities/courts to be constituted under the Model Act is as tabulated below:

 

Matters related to the eviction of tenants are to be adjudicated upon by the Rent Courts, which may try and dispose off the matter based on the terms and conditions stipulated in the agreement entered between the disputing parties or on the basis of an application/documents made/placed before it.

Eviction of a tenant may be sought on the following grounds under the Model Act:

  • Non-payment of arrears of rent and other related charges for a period of two consecutive months despite being served a notice by the landowner as stipulated under the Model Act.
  • Abandonment of the premises (part or whole) by the tenant without the consent of the landowner.
  • Misuse of the premises includes the use of additional space by the tenant, causing damage to the premises, or carrying out activities that cause a public nuisance or are illegal.
  • Carrying out repair and alterations to the tenanted premises.[i]
  • Bonafide requirement by the legal heirs of a deceased landowner during the subsistence of the tenancy agreement.[ii]

It is noteworthy that the Model Act also provides for the interest of landowners who have let out vacant land as a part of the tenanted premises, to enable the landowners to undertake construction on the vacant land by causing severance of the vacant part of the land from the tenanted premises. In order to give effect to such severance of vacant land, the landowner may make an application before the Rent Court, if the landowner is unable to obtain possession of the vacant land from the tenant. The Rent Court may, on being satisfied with the willingness of the landowner to commence construction on the vacant land without causing undue hardship to the tenant, direct severance of vacant land or make other such orders that it may deem fit.[iii]

Restoring Value

The Model Act once again comes in as a tenancy reform with noble intent at a time when restoring the value of constructed properties that are vacant as a fallout of the current circumstances is vital for the recovery of the real estate market. While the applicability of the Model Act to the premises that have been trapped under old rental agreements and arrangements is subject to its enactment by the State, the assurance, that continues to gleam through is the balance that can be brought about by having a watertight rental agreement as per the Model Act. The Model Act accords primacy to the rental agreement executed between the landowner and tenant and strives to ensure its absolute enforcement.

Execution of new rental agreements pertaining to residential and commercial premises as per the provisions of the Model Act, as may be notified by the State government, will be the first step for landowners who seek better returns on their premises along with a more balanced set of landowner-tenant obligations. The challenge here remains to convince existing tenants to agree to the shift.

Taking a lesson from the quandary arising out of the existing rent control legislation, it is important that the implementation of the Model Act should be directed towards giving full effect to the balanced set of rights and obligations of tenants and landowners as currently envisaged therein. The pitfall to be avoided is the misuse of the autonomy given to the landowners and tenants while putting the provisions of the Model Act, that place reliance on the rental agreement to steer the course of the tenancy, into practice. It is only when the fine balance of responsibilities created under the Model Act are replicated in rental agreements, that the potential positive socio-economic impact of the Model Act will be of aid to the collective advancement towards the goal of ‘Housing for All’.

References

[i] Naresh Kamath, Maharashtra to Partially Adopt Central Model Tenancy Act, HINDUSTAN TIMES (June 3, 2021),
https://www.hindustantimes.com/cities/mumbai-news/maharashtra-to-partially-adopt-central-model-tenancyact-101622743211971.html.

[ii] The Model Tenancy Act, 2021, §40.

[iii] The Model Tenancy Act, 2021, §4(4)(a).

[iv] The Model Tenancy Act, 2021, §10.

[v]The Model Tenancy Act, 2021, §20(3).

[vi] The Model Tenancy Act, 2021, §32.

[vii ] The Model Tenancy Act, 2021, §35(7).

[viii] The Model Tenancy Act, 2021, §35(8)

[ix] The Model Tenancy Act, 2021, §38(3)

[x] The Model Tenancy Act, 2021, §37.

[xi]The Model Tenancy Act, 2021, §35(2).

[xii]The Model Tenancy Act, 2021, §21.

[xiii]The Model Tenancy Act, 2021, §22(2).

[xiv]The Model Tenancy Act, 2021, §27.

 

Image Credits: Photo by Sasun Bughdaryan on Unsplash 

 It is only when the fine balance of responsibilities created under the Model Act are replicated in rental agreements, that the potential positive socio-economic impact of the Model Act will be of aid to the collective advancement towards the goal of ‘Housing for All’.

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Intensifying Social Accountability of Corporates in India

In a bid to make companies progressively accountable in the social panorama, the government has been modifying the provisions of Corporate Social Responsibility (“CSR”) ever since its introduction. Amendments have been made in section 135 of the Companies Act, 2013 (“the Act”), The Companies (Corporate Social Responsibility) Rules (“the Rules”) and Schedule VII (“Schedule”) of the Act by the Ministry of Corporate Affairs (“MCA”), from time to time.

While the earlier amendments to section 135 of the Act and the Rules were mostly clarificatory in nature or were relating to the inclusion of certain activities relating to COVID – 19 as the contribution made towards  CSR, the amendments to section 135 of the Act inserted by the Companies (Amendment) Act, 2019 and the Companies (Amendment) Act, 2020 and notification of The Companies (Corporate Social Responsibility) Amendment Rules, 2021 (“the Amended Rules”), both effective from January 22, 2021, has brought about a radical change in the treatment of unspent CSR amount, among other amendments, which is dealt with in this write-up.

  1. CSR applicability extended to newly incorporated companies as well:

Sub-section (5) of section 135 provides that every company crossing the threshold limits prescribed in section 135(1) has to necessarily spend at least 2% (two percent) of the average net profits of the company made during the immediately preceding three financial years. By way of inclusion to section 135 (5), newly incorporated companies that cross the threshold limits prescribed under section 135(1) of the Act have also been brought within the ambit of compliance with CSR provisions.

  1. Compliance in respect of unspent CSR amount:

A brief outline of the amendments relating to the treatment of unspent amount is provided below:

 

  1. Penalty for non-compliance of sub-sections (5) or (6) of section 135 of the Act:

The newly-inserted sub-section (7) of section 135 of the Act deals with a penalty for non-compliance of provisions of sub-section (5) or (6). It is pertinent to note that the provisions of Companies (Amendment) Act, 2019 had prescribed for imprisonment for a term extending to three years, apart from a fine that may be imposed, on the failure of a company to comply with the provisions of sub-sections (5) or (6) which relates to transfer of unspent amount other than ongoing project and transfer of amount towards ongoing project respectively.

Understandably, there were apprehensions over the proposed implementation of penal provision with imprisonment for CSR activity, and after deliberations, the provision was replaced with a provision in the Companies (Amendment) Act, 2020 which provides only for penalty without imprisonment for non-compliance of sub-section (5) or (6) of section 135 of the Act.

Penalty for the company – twice the amount required to be transferred by the company to the Fund specified in Schedule VII / unspent CSR account (or)

INR 1,00,00,000/- (Indian Rupees One Crore only), whichever is less.

Penalty for every officer of the company who is in default –

one-tenth of the amount required to be transferred by the company to such Fund specified in Schedule VII / unspent CSR account (or) INR 2,00,000/- (Indian Rupees Two Lakhs only), whichever is less.

  1. Power to give general or special directions:

As per sub-section (8) which has been inserted, the Central Government may give general or specific directions to a company or a class of companies, as necessary, which are required to be followed by such company/class of companies.

  1. Constitution of CSR Committee:

CSR committee is not required to be constituted by a company, where the amount it has to spend towards CSR activities is not more than INR 50,00,000/- (Indian Rupees Fifty Lakhs only) and the functions of the CSR committee shall be discharged by the Board of Directors of the company.

  1. Other notable changes in Amended Rules:
  • Registration under sections 12A and 80G of the Income Tax Act, 1961 has been made mandatory for CSR implementation entities (Rule 4(1) of the Amended Rules).
  • Every CSR implementation entity has to file Form CSR – 1 and obtain CSR registration number compulsorily from April 01, 2021 (Rule 4(2) of the Amended Rules).
  • Chief Financial Officer or any person responsible for financial management shall certify that the funds disbursed have been utilized for the purposes and manner as approved by the Board (Rule 4(5) of the Amended Rules).
  • In case of ongoing project(s), the Board shall monitor its implementation and shall make necessary modifications, as required (Rule 4(6) of the Amended Rules).
  • The CSR Committee shall formulate and recommend an annual action plan in pursuance of its CSR policy to the Board comprising the particulars as specified in Rule 5(2) of the Amended Rules, which may be altered at any time during the financial year, based on a reasonable justification.
  • Surplus earned from CSR activities shall be ploughed back into the same project or transferred to the “unspent CSR account” and spent as per the CSR policy and annual action plan or shall be transferred to the Fund specified in Schedule VII of the Act but shall not form part of the business profit of a company (Rule 7(2) of the Amended Rules).
  • The CSR amount may be spent by a company for the creation or acquisition of a capital asset, which shall be held by a CSR implementation entity specified in Rule 4, which has CSR registration number, or beneficiaries of the CSR project or a public authority (Rule 7(4) of the Amended Rules).
  • Annual report on CSR to be in the format specified in Annexure-II of the Rules, in respect of board’s report for the financial year commencing on or after April 01, 2020 (Rule 8 (1) of the Amended Rules).
  • Companies having an average CSR obligation of INR 10,00,00,000/- (Indian Rupees Ten Crores only) or more in the three immediately preceding financial years has to undertake an impact assessment of CSR projects, having an expenditure of INR 1,00,00,000/- (Indian Rupees One Crore only) or more and which have been completed not less than one year before undertaking the impact study, through an independent agency (Rule 8(3) of the Amended Rules).

Ambiguities in the recent amendments:

  1. Whether unspent amounts of previous years have to be transferred?

Although, it has been specifically provided in some of the Amended Rules (viz., implementation of CSR provisions through specified entities, reporting of CSR as provided in Annexure provided in the Amended Rules) that the said amendments are applicable on or after April 01, 2021, the time period from which the provisions relating to the transfer of unspent CSR amount to “unspent CSR account” / Fund is applicable, i.e. whether the unspent CSR amounts relating to the past financial years (from the date of applicability of the CSR provisions to the company) are required to be transferred to the “unspent CSR account” / Fund or only the CSR amount remaining unspent as on March 31, 2021, has to be transferred, has not been explicitly provided in the Act or the Amended Rules.

  1. Whether the outstanding amount of provision created for the unspent amount must be transferred?

The amended provisions do not stipulate whether unspent CSR amounts of the previous financial years have to be transferred to the designated account / Fund in case a company has created a provision in the books of accounts for such unspent amount for the relevant financial years.

The foregoing matters require suitable redressal by the MCA in the form of clarifications or FAQs or amendments to the existing provisions, which will offer a much-needed clarity on these matters.

Conclusion:

With the recent amendments, the CSR provisions have undergone a paradigm shift from “Comply or Explain” to “Comply or Pay” regime as they provide for penalties on failure to transfer unspent CSR amount to the specified account / Fund, whereas earlier, providing reasons for not spending CSR amount was considered adequate compliance. Hence, the said amendments have placed additional responsibilities on corporates.  Having introduced the concept of penalty, it is only appropriate that the MCA addresses the obscurities arising from the amendments at the earliest so that corporates are not caught off-guard in complying with the CSR provisions.

Image Credits: Photo by Tim Marshall on Unsplash

the CSR provisions have undergone a paradigm shift from “Comply or Explain” to “Comply or Pay” regime as they provide for penalties on failure to transfer unspent CSR amount to the specified account / Fund, whereas earlier, providing reasons for not spending CSR amount was considered adequate compliance.