INTRODUCTION:

In this article, the author tries to discuss whether or not amounts paid by an assessee for any expenditure which is prohibited under any law other than the Act would be allowed as a deduction while computing taxable income in light of the Hon’ble Supreme Court judgment in Apex Laboratories’ case¹.

An amendment to the Medical Council Act, 1956 (now repealed and replaced with the National Medical Commission Act, 2019) and published in the Official Gazette on December 14, 2009 (“the amendment”) disallowed medical practitioners from accepting emoluments in the form of gifts, travel facilities, hospitality, etc. from pharmaceutical companies. Punishments ranged till removal of the name of the members from the Indian/State Medical Register. Relying on this amendment, the Central Board of Direct Taxes (“CBDT”), vide Circular dated August 01, 2012 (“the Circular”) clarified that expenses incurred by pharmaceutical and allied healthcare industries for distribution of freebies to medical practitioners are ineligible for benefit of Explanation 1 to Sec 37(1) of the Income tax Act, 1961 (“the Act”) – which denies application of benefit for any purpose which is an ‘offence’ or ‘prohibited by law’. From a conjoint reading of both the amendment and the Circular, a view was taken by CBDT that expenses on freebies only till December 14, 2009 were allowable as deduction.

WHAT DO THE COURTS SAY?

A.        In favour of the Taxpayer:

1.         In Max Hospital Pitampura vs Medical Council of India², the Hon’ble Delhi High Court held that the ‘Medical Council of India’ (“MCI”) did not have any jurisdiction to pass any orders against the appellant hospital and hence adverse observations made by the MCI against the hospital were quashed.

¹Special Leave Petition (Civil) No.23207 of 2019

 ²W.P. (C) No. 1334/2014 / ILR (2014) 1 Delhi 620, dated 10.01.2014. 

2.         In T.A. Quereshi vs Commissioner of Income tax, Bhopal³, the Hon’ble Supreme Court of India while allowing the appellant assessee to deduct the cost of heroin seized as a business loss, held as under:

“In our opinion, the High Court has adopted an emotional and moral approach rather than a legal approach. We fully agree with the High Court that the assessee was committing a highly immoral act in illegally manufacturing and selling heroin. However, cases are to be decided by the Court on legal principles and not on one’s own moral views. Law is different from morality, as the positivist jurists Bentham and Austin pointed out”.

(Emphasis supplied)

3.         Since CBDT Circular dated August 01, 2012 tended to disallow expenses from December 14, 2009, reliance can be placed on Director of Income-tax vs S.R.M.B. Dairy Farming (P.) Ltd.⁴, wherein it was held that beneficial circulars had to be applied retrospectively, however oppressive circulars could only be applied prospectively.

(Emphasis supplied)

Based on the above judicial precedents and non-binding nature of Circulars on the taxpayers, a view can be taken that since amendment to the Medical Council Act, 1956 is binding only on the medical practitioners and not on pharmaceutical companies, expenditure ought to have been allowed u/s 37(1) of the Act.

B.        In favour of Revenue:

1.         In Commissioner of Income-tax vs Kap Scan and Diagnostic Centre P. Ltd.⁵, the Hon’ble Punjab and Haryana High Court while disallowing benefit of commission paid to doctors engaged in private practice paid by assessee for referring patients to assessee’s diagnostic centre held as under

“It, thus, emerges that an assessee would not be entitled to deduction of payments made in contravention of law. Similarly, payments which are opposed to public policy being in the nature of unlawful consideration cannot equally be recognized. It cannot be held that businessmen are entitled to conduct their business even contrary to law and claim deductions of payments as business expenditure, notwithstanding that such payments are illegal or opposed to public policy or have pernicious consequences to the society as a whole.”

***

 ³(2007) 2 SCC 759

 ⁴(2018) 13 SCC 239

 ⁵(2012) 344 ITR 476

“If demanding of such commission was bad, paying it was equally bad. Both were privies to a wrong. Therefore, such commission paid to private doctors was opposed to public policy and should be discouraged. The payment of commission by the assessee for referring patients to it cannot by any stretch of imagination be accepted to be legal or as per public policy. Undoubtedly, it is not a fair practice and has to be termed as against the public policy.”

***

(Emphasis supplied)

A similar proposition was upheld by the Hon’ble Himachal Pradesh High Court in Confederation of Pharmaceutical Industry (SSI) vs Central Board of Direct Taxes⁶.

Further, in Commissioner of Income-tax vs Kap Scan and Diagnostic Centre P. Ltd.⁷, it was held that once receiving of such gifts have been held to be unethical obviously the corollary to this would also be unethical, being giving of such gifts or doing such acts to induce such Doctors and Medical Professionals to violate the Medical Council Act, 1956.

(Emphasis supplied)

C.        DECISION OF THE HON’BLE SUPREME COURT OF INDIA IN APEX LABORATORIES⁸ CASE

The Hon’ble Supreme Court of India while adjudicating upon the issue of allowability of freebies as an expense apart from taking into consideration the above case laws, also considered some other factors which are as follows:

1.         The well-established principle of interpretation of taxing statutes – that they need to be interpreted strictly – cannot sustain when it results in an absurdity contrary to the intentions of the Parliament. This was held in the following context – Explanation 1, which was inserted in 1998 with retrospective effect from April 01, 1962, restricts the application of such exemption for “any purpose which is an offence or which is prohibited by law”. The Memorandum to Finance Bill, 1998 elucidated the ambit of the proposed amendment to include “protection money, extortion, hafta, bribes, etc.” However, to restrict the interpretation only for these purposes would defeat the purpose of Explanation 1 to Sec 37 and hence has to be interpreted more widely to include all activities “which are prohibited by law”.

 ⁶(2013) 353 ITR 388

 ⁷supra (footnote 5)

 ⁸supra (footnote 1)

2.         The Hon’ble Supreme Court of India also took cognizance of the Report of the Parliamentary Standing Committee on Health and Family Welfare⁹  which asked the Government to take strict action on violations done by drug companies and since MCI did not have jurisdiction on drug companies, it suggested that parallel action be taken by DCGI and the Income Tax Department to penalize companies violating MCI rules by cancelling drug manufacturing licenses and/or disallowing expenses on unethical activities.       

D.        CONCLUSION:

The Hon’ble Supreme Court held that expenditure on freebies by pharmaceutical companies to medical practitioners was not allowable as a deduction u/s 37(1) of the Act as the same was ‘prohibited by law’.

E.         AUTHOR’S VIEWS:

The above-mentioned decision of the Hon’ble Supreme Court not only sets a precedent for inadmissibility of expenses towards activities prohibited by law but also upholds that when an expenditure is incurred for anything which may be allowed legally but is against public policy or against the interest of the public at large, it needs to be disallowed. This decision is in line with the amendment made by the Finance Act, 2022 by way of insertion of Explanation 3 to Sec 37(1) of the Act which states that expenses prohibited under any law, whether Indian or foreign, would not be allowed as a deduction.

⁹45th Report on Issues Relating to Availability of Generic, Generic-Branded and Branded Medicines, their Formulation and Therapeutic Efficacy and Effectiveness), dated 04.08.2010.