Month: June

6.2    Brief facts of six categories of assessees [referred to para 2.1 of Part I of this write-up] before the Supreme Court in cases of Ahmedabad Urban Development Authority and connected matters [AUDA’s case] and the contentions raised by each one of them before the Court as well as the arguments of the Revenue are summarized in paras 3.1 to 3.3 of Part I of this write-up.

6.3    After considering the arguments of both the sides, the legislative history of the relevant provisions and amendments therein from time-to-time, the effect of Finance Minister’s speeches at the relevant time and relevant Circulars of the CBDT as well as the prior relevant judicial precedents dealing with respective provisions at the relevant time referred to in earlier Parts I & II of this write-up, the Court dealt with the effect of 2008 Amendment (including subsequent amendments in the said Proviso). The Court also explained the effect and implications of the provisions of section 11(4) & (4A) in the light of 2008 Amendment and concluded on the interpretation of Sec 2(15) which defines “Charitable Purpose” post 2008 Amendment in the context of GPU category object with which the Court was mainly concerned. These are summarized in paras 5.1 to 5.5.3 of Part II of this write-up.

ACIT(E) VS. AHMEDABAD URBAN DEVELOPMENT AUTHORITY (449 ITR 1 -SC)

7.2    In respect of the first category of assessees being statutory corporations, authorities or bodies, etc such as AUDA, the Court firstly held that statutory entities eligible for exemption under the erstwhile section 10(20A) prior to its deletion w.e.f. 1st April, 2003 can make a claim under section 11 r.w.s 2(15) of the Act as a GPU category charity. In this context, the Court also referred to its earlier decisions in the cases of Gujarat Industrial Development Corporation-GIDC [(1997) 227 ITR 414 (SC)] rendered in the context of section 10(20A) and Shri Ramtanu Co-op Hsg Society [(1970) 3 SCC 323 (SC) – five judge bench] and noted that in these cases the Court had taken a view that such industrial development corporations are involved in “development” and are not essentially engaged in trading and that is binding.

7.2.1    Similarly, the Court also noted its judgment in Gujarat Maritime Board [(2007) 295 ITR 561(SC) ] where the Board was earlier getting exemption under section 10(20) as Local Authority and the fact that section 10(20) was subsequently amended retrospectively to define Local Authority whereby the Gujarat Maritime Board ceased to be eligible to claim exemption under section 10(20). However, in that case also, the Court held that sections 10(20) and 11 of the Act operate in totally different spheres. Even if the Board is not considered as a Local Authority [due to this amendment], it is not precluded from obtaining registration under section 12A of the Act and claiming exemption under section 11. This was in the light of definition of the words’ Charitable Purpose’ as defined in section 2(15) which includes GPU category.

7.2.2    The Court then observed that rates, tariffs, fees, etc. as specified in the enactments and charged by statutory corporations for undertaking essential activities will not be characterised as ‘commercial receipts’. The reasons for the same were given by the Court as under [page 112]:

“….. The rationale for such exclusion would be that if such rates, fees, tariffs, etc., determined by statutes and collected for essential services, are included in the overall income as receipts as part of trade, commerce or business, the quantitative limit of 20% imposed by second proviso to Section 2(15) would be attracted thereby negating the essential general public utility object and thus driving up the costs to be borne by the ultimate user or consumer which is the general public…By way of illustration, if a corporation supplies essential food grains at cost, or a marginal mark-up, another supplies essential medicines, and a third, water, the characterization of these, as activities in the nature of business, would be self-defeating, because the overall receipts in some given cases may exceed the quantitative limit resulting in taxation and the consequent higher consideration charged from the user or consumer.”

7.2.3    In view of the above, the Court took the view that Statutory Corporations, Board, Authorities, etc.[by whatever name called] in the Housing Development, Town Planning, Industrial Development sectors are involved in advancement of object of general public utility and considered as Charities in the GPU category. Such entities may be involved in promoting public object and also in the course of pursuing their object may get involved or engaged in commercial activities. As such, it needs to be determined whether such entities are to be treated as GPU category Charities for claiming exemption. The Court also laid down certain tests [pages 118 to 120] to determine if the statutory corporations or bodies are GPU category Charities. These tests are broadly summarised herein – (i) whether state or central law or memorandum of association, etc. advances any GPU object, (ii) whether the entity is set up for furthering development or charitable object or for carrying on trade, business or commerce or service in relation thereto [i.e. Commercial Activity/Activities], (iii) rendering services or providing goods at cost or nominal mark-up, will ipso facto not be activities in the nature of Commercial Activities. However, if the amounts are significantly higher, they will be treated as receipts from Commercial Activities (iv) collection of fees, rates, etc. fixed by the statute under which the body is set up will not per se be characterised as ‘fee, cess or other consideration’ for engaging in activities in the nature of trade, commerce, etc. (v) whether statute governing the entity permits surplus or profits that can be earned and whether state has control over the corporation (vi) as long as statutory body furthers a GPU object, carrying on other activities in the nature of Commercial Activities that generate profits and the receipts from which are within the permissible limits as stated in the said Proviso to section 2(15), it will continue to be GPU category Charity.

7.3    Coming to the second category of assessees being statutory regulatory bodies/ authorities for which the sample case was of the Institute of Chartered Accountants of India (ICAI), the Court noted the relevant provisions of the Chartered Accountants Act, 1949 and held that ICAI is a Charity advancing GPU objects. In this context, the Court held as under [page 122]:

“…… As things stand, the Institute is the only body which prescribes the contents of professional education and entirely regulates the profession of Chartered Accountancy. There is no other body authorised to perform any other duties which it performs. It, therefore, clearly falls in the description of a charity advancing general public utility. Having regard to the previous discussion on the nature of charities and what constitutes activities in the ‘nature of trade, business or commerce’, the functions of the Institute ipso facto does not fall within the description of such ‘prohibited activities’. The fees charged by the Institute and the manner of its utilisation are entirely controlled by law. Furthermore, the material on record shows that the amounts received by it are not towards providing any commercial service or business but are essential for the providing of service to the society and the general public.”

7.3.1    The Court also noted that there are several other regulatory bodies that discharge functions otherwise within the domain of the State (including the one regulating professions of Cost and Work Accountants, Company Secretary, etc.). In this context, the Court further held as under [page 123]:
“…Therefore, it is held that bodies which regulate professions and are created by or under statutes which are enjoined to prescribe compulsory courses to be undergone before the individuals concerned is entitled to claim entry into the profession or vocation, and also continuously monitor the conduct of its members do not ipso facto carry on activities in the nature of trade, commerce or business, or services in relation thereto.”

7.3.1.1    The Court, however, added that if the consideration charged by regulatory entities such as annual fees, exam fees, etc. is ‘vastly or significantly higher’ than the costs incurred by the regulatory entity, the case would attract the said Proviso to section 2(15) of the Act. In this context, following observations of the Court are worth noting [page 123]:

“At the same time, this court would sound a note of caution. It is important, at times, while considering the nature of activities (which may be part of a statutory mandate) that regulatory bodies may perform, whether the kind of consideration charged is vastly or significantly higher than the costs it incurs. For instance, there can be in given situations, regulatory fees which may have to be paid annually, or the body may require candidates, or professionals to purchase and fill forms, for entry into the profession, or towards examinations. If the level of such fees or collection towards forms, brochures, or exams are significantly higher than the cost, such income would attract the mischief of proviso to Section 2(15), and would have to be within the limits prescribed by sub-clause (ii) of the proviso to Section 2(15).”

7.3.2    While deciding the matter of the Andhra Pradesh State Seeds Certification Authority and the Rajasthan State Seeds and Organic Production certification Agency [set-up under Seeds Act, 1966] also falling within the second category of assessees, the Court held that these entities tasked with the work of certification of seeds are performing regulatory function and do not engage in activities by way of trade, commerce or business, for some form of consideration.

7.4    With respect to the third category – trade promotion bodies, councils, associations or organisations, the Court at the outset stated that the predominant object test laid down in Surat Art’s case [ for this also refer to para 5.3.3 of Part II of this write-up] was in the context of section 2(15) applicable prior to the 2008 Amendment. In view of the 2008 Amendment, the Court held that the position had undergone a change and opined as follows [page 124]:

“In the opinion of this court, the change in definition in Section 2(15) and the negative phraseology – excluding from consideration, trusts or institutions which provide services in relation to trade, commerce or business, for fee or other consideration – has made a difference. Organizing meetings, disseminating information through publications, holding awareness camps and events, would be broadly covered by trade promotion. However, when a trade promotion body provides individualized or specialized services – such as conducting paid workshops, training courses, skill development courses certified by it, and hires venues which are then let out to industrial, trading or business organizations, to promote and advertise their respective businesses, the claim for GPU status needs to be scrutinised more closely. Such activities are in the nature of services “in relation to” trade, commerce or business. These activities, and the facility of consultation, or skill development courses, are meant to improve business activities, and make them more efficient. The receipts from such activities clearly are ‘fee or other consideration’ for providing service “in relation to” trade, commerce or business.”

7.4.1 After laying down the aforesaid ratio, coming to the facts of the assessee under this category – Apparel Export Promotion Council [AEPC], the Court held that its activities such as booking bulk space and renting it to individual Indian exporters, charging fees for skill development and diploma courses, market surveys and market intelligence aimed at catering to specified exporters involved an element of Commercial Activities. The Court then concluded as under [page 125]:

“In the circumstances, it cannot be said that AEPC’s functioning does not involve any element of trade, commerce or business, or service in relation thereto. Though in some instances, the recipient may be an individual business house or exporter, there is no doubt that these activities, performed by a trade body continue to be trade promotion. Therefore, they are in the “actual course of carrying on” the GPU activity. In such a case, for each year, the question would be whether the quantum from these receipts, and other such receipts are within the limit prescribed by the sub-clause (ii) to proviso to Section 2(15). If they are within the limits, AEPC would be – for that year, entitled to claim benefit as a GPU charity.”

7.5    The Court then proceeded to consider the cases of fourth category of assessees being non-statutory bodies. In respect of one such assessee – ERNET, the Court noted that it was a not-for profit society set up under the aegis of the Union Government with the objects of advancing computer communication in India, develop, design, set up and operate nationwide state of the art computer communication infrastructure, etc. After noting the activities of the assessee and also the fact that it’s project, funded through Government, support educational network and development of internet infrastructure in numerous other segments of the society, the Court felt that functions of ERNET are vital to the development of online educational and research platforms and held that its activities cannot be said to be in the nature of Commercial Activities. For this, the Court also noted that ERNET received fees to reimburse its costs and that the material on record did not suggest that its receipts were of such nature so as to be treated as fees or consideration towards business, trade or commerce.

7.5.1    In case of another assessee in this category – NIXI which was set-up under the aegis of Ministry of Information and Technology for production and growth of internet services in India, to regulate the internet traffic, act as an internet exchange, and undertake “.in” domain name registration. The Court also noted that NIXI is a not-for profit, and is barred from undertaking commercial and business activity and it charges annual membership fees of Rs. 1,000 and registration of second and third domain at Rs 500 and Rs. 250. Having regard to the findings on record and material available, an importance of country’s needs to have domestic internet exchange and other relevant facts, the Court rejected the Revenue’s contention that NIXI was involved in Commercial Activities.

7.5.2    GS1 India was another assessee in this category. GS1 codes were developed and created by GS1 international, Belgium which was not for profit under the Belgium Tax Laws. The coding system has been used worldwide and is even mandatory for some services/goods or adopted for significant advantages on account of its worldwide recognisation and acceptance. GS1 India is affiliated and was conferred exclusive rights relating to GS1 coding in India. The GS1 code provides a unique identification to a product with wide range of benefits such as facilitating tracking, tracing of the product, product recalls, detection of illegal trade, etc. The Revenue believed that GS1 India is a monopolistic organisation with an exclusive license in relation to bar coding technology which is admittedly used for fees or other consideration and it provides services mostly to business, trade, etc. On the other hand GS1 also claims that it performs important public function which enables not merely manufacturers but others involved in supplies of various articles by packaging, etc to regulate and ensure their identity.

7.5.2.1    Considering overall facts of GS1 India, the Court held that though GS1 undertakes activities in the nature of GPU, the services provided by it are in relation to trade, commerce or business. In this context, the Court opined as under [page 130]:

“In the opinion of this Court, GS1’s functions no doubt is of general public utility. However, equally the services it performs are to aid businesses manufactures, tradesmen and commercial establishments. Bar coding packaged articles and goods assists their consigners to identify them; helps manufactures, and marketing organizations (especially in the context of contemporary times, online platforms which serve as market places). The objective of GS1 is therefore, to provide service in relation to business, trade or commerce – for a fee or other consideration. It is also true, that the coding system it possesses and the facilities it provides, is capable of and perhaps is being used, by other sectors, in the welfare or public interest fields. However, in the absence of any figures, showing the contribution of GS1’s revenues from those segments, and whether it charges lower amounts, from such organizations, no inference can be drawn in that regard. The materials on record show that the coding services are used for commercial or business purposes. Having regard to these circumstances, the Court is of the opinion that the impugned judgment and order calls for interference.”

7.5.2.2    The Court also concluded that though GS1 India is involved in advancement of GPU, its services are for the benefit of trade and business, from which it receives significantly high receipts. Therefore, its claim for exemption was rejected in view of the amended provisions of section 2(15). However, with respect to claims to be made by GS1 in future, the Court observed that the same would have to be independently assessed if GS1 is able to show that it charges its customers on cost-basis or at a nominal markup.

7.6    In respect of state cricket associations falling within the fifth category, the Court firstly held that the claim of the associations will not fall within the ‘education’ limb in section 2(15) but will have to be examined under the last limb – GPU category. In this regard reference was made to the decision in Loka Shikshana Trust’s case [referred to in para 1.3.1 of Part I of this write-up] where it was held that ‘education’ would entail formal scholastic education. The Court then noted that the state associations apart from receiving amounts towards sale of entry tickets, also receive advertisement money, sponsorship fees, etc. from BCCI. The Court also noted the fact [in case of Gujarat as well as Saurashtra Cricket Associations] that the records reveal the large amount of receipts from such activities as against which the amount of expenditure is much lower leaving good amount of excess in the hands of such associations in the relevant year. The Court also observed that the activities of the cricket associations are run on business lines. It further noted that the expenses borne by the cricket associations did not disclose any significant proportion being expended towards sustained or organized coaching camps or academics. The Court also noted that broadcasting and digital media rights have yielded huge revenues to BCCI and the state associations are entitled to a share in the revenue of BCCI. The Court also noted the method adopted [auctioning such rights] by BCCI to obtain better terms, and gain bargaining leverage. The Court felt that these rights are apparently commercial.

7.6.1    Based on the above factual position, the Court directed the AO to decide the matter afresh and held as under [page 143]:

“In the light of these, the court is of the opinion that the Income-tax Appellate Tribunal – as well as the High Court fell into error in accepting at face value the submission that the amounts made over by BCCI to the cricket associations were in the nature of infrastructure subsidy. In each case, and for every year, the tax authorities are under an obligation to carefully examine and see the pattern of receipts and expenditure. Whilst doing so, the nature of rights conveyed by the BCCI to the successful bidders, in other words, the content of broadcast rights as well as the arrangement with respect to state associations (either in the form of master documents, resolutions or individual agreements with state associations) have to be examined. It goes without saying that there need not be an exact correlation or a proportionate division between the receipt and the actual expenditure. This is in line with the principle that what is an adequate consideration for something which is agreed upon by parties is a matter best left to them. These observations are not however, to be treated as final; the parties’ contentions in this regard are to be considered on their merit.”

7.7    In case of Tribune Trust, one of the assessees falling within the sixth category of private trust, the Court referred to the past litigation history of the assessee under the 1922 Act leading to the decision of Privy Council referred to in para 1.2.1 of Part I of this write-up and finding that the trust was established as Charity- GPU category and also noted the fact that the exemption was continuously allowed in this category under 1961 Act also including under section 10(23C)(iv) from assessment year 1984-85 onwards.

7.7.1    The Court then considered the facts of the case under appeal for the A.Y. 2009-10 in which the exemption was denied by the Revenue based on 2008 Amendment to section 2(15). The Punjab and Haryana High Court upheld the action of the Revenue by concluding that the income is derived by the Trust from the activities [publishing and sale of newspaper, etc.] which were based on profit motive. In doing so it had also noted that 85 per cent of the revenue of the Trust was from advertisements and interest.

7.7.1.1    Finally, the Court stated that though publication of advertisements is intrinsically linked with newspaper activity and is an activity in the course of actual carrying on of the activity towards advancement of the trust’s object, publishing advertisements is an activity in the nature of trade, commerce or business for a fee or consideration. The Court held that though the objects of the assessee trust fell within the GPU category, it would not be entitled to exemption under section 2(15) of the Act as the advertisement income received by the trust constituted business or commercial receipts and the same exceeded the limits laid down in the said Proviso to section 2(15).

7.7.2    The Court then considered the case of Shri Balaji Samaj Vikas Samiti, another assessee falling in the category of private trust wherein the assessee society was formed with the object of establishing and running a health club, arogya kendra; its object also included organization of emergency relief center, etc. Other objects included promotion of moral values, eradication of child labour, dowry, etc. The assessee had entered into arrangement with State agency to supply mid-day meals to students of primary schools in different villages through contracts entered into with some entity. Material for preparation of the mid-day meal was supplied by the Government and it was claimed that it only obtained nominal charges for mid-day meals. Registration application was rejected by the Revenue on the basis that it was involved in Commercial Activity. The Tribunal agreed with the assessee that the supply of mid-day meal did not constitute Commercial Activity and that it promoted object of GPU and directed grant of registration under section 12AA of the Act and this was affirmed by the Allahabad High Court. The Revenue had contended that assessee’s only activity for the relevant year was supply of mid-day meals which is not within its objects. The Supreme Court felt that there is no clarity with respect to whether the activity of supplying mid-day meal falls within the objects of the assessee and in the absence of this it is not possible for the Court to assess the activity in which the assessee was engaged to determine whether it falls in GPU category.

7.7.2.1    On the above facts the Court stated as under [page 147]:

“The first consideration would be whether the activity concerned was or is in any manner covered by the objects clause. Secondly, the revenue authorities should also consider the express terms of the contract or contracts entered into by the assessee with the State or its agencies. If on the basis of such contracts, the accounts disclose that the amounts paid are nominal mark-up over and above the cost incurred towards supplying the services, the activity may fall within the description of one advancing the general public utility. If on the other hand, there is a significant mark-up over the actual cost of service, the next step would be ascertain whether the quantitative limit in the proviso to section 2(15) is adhered to. It is only in the event of the trust actually carrying on an activity in the course of achieving one of its objects, and earning income which should not exceed the quantitative limit prescribed at the relevant time, that it can be said to be driven by charitable purpose.”

7.7.2.2    Despite the above, the Court ultimately decided not to interfere with the judgment of the High Court and held as under [page 147]:

“This court, in the normal circumstances, having regard to the above discussion, would have remitted the matter for consideration. However, it is apparent from the records that the tax effect is less than Rs.10 lakhs. It is apparent that the receipt from the activities in the present case did not exceed the quantitative limit of Rs.10 lakhs prescribed at the relevant time. In the circumstances, the impugned order of the High Court does not call for interference.”

8    After dealing with general interpretation of section 2(15) and cases of all the categories of assessees, the Court proceeded to give Summation of Conclusions which is worth noting.

8.1    In the context of general test to be applied under section 2(15), the Court broadly stated that the assessee pursuing object of GPU category should not engage in Commercial Activity as envisaged in the said Proviso to section 2(15). If it does so, then (i) such Commercial Activity should be connected [“actual carrying out…..” inserted w.e.f. 1st April, 2016 to the achievement of its GPU object; and (ii) receipts from such Commercial Activities should not exceed the quantitative limit provided from time to time[ currently, 20 per cent of the total receipts of the entity for the relevant previous year- w.e.f. 1st April, 2015]. Generally, charging of any amount for GPU activity, which is on cost-basis or nominally above the cost cannot be considered to be Commercial Activities as envisaged in the said Proviso. If such charges are markedly or significantly above the cost incurred by the assessee then the same would fall within the mischief of “cess, fees or any other consideration” towards the Commercial Activity. This position is clarified through illustrations [referred to in Para 5.5.2 of Part II of this write-up] by the Court which would also be relevant in this context. The Court has also summarised its conclusion on section 11(4A) of the Act and for all the six categories of assessees as well as on application of interpretation. Summation of Conclusions given by the Court deserves careful reading. However, due to space constraint and to avoid making this write-up further lengthy (which otherwise has already become lengthy extending to division in three parts, mainly on account of lengthy judgment dealing with six categories of assessees) the same is not reproduced here. The detailed Summation of Conclusions are available at pages 147 to 151 of the reported judgment which, as earlier mentioned , are worth reading to consider various implications arising out of the above judgment. In this context, useful reference may also be made to ‘Summation of Interpretation of section 2(15)’ appearing at pages 101 and 102 of the reported judgment.

CONCLUSION

9.1.1    In the context of Specific Objects category even if the said Proviso is not applicable, if Trust earns business profits it would be necessary to comply with the requirements of section 11(4A) to claim exemption under section 11. As such, the business should be incidental to the attainment of objective of the Trust [such as education, medical relief, etc]. The advantage in this category in respect of business profit could be that the limit of 20 per cent specified in the said Proviso would not be applicable. However, at the same time, it is advisable that the activity of education itself should not be carried on purely on commercial lines consistently yielding significant profit. In this context, the observations in the recent judgment of Madras High Court in the case of Mac Public Charitable Trust [(2023) 450 ITR 368] are worth noting. In this case, while dealing with the case of violation of the provisions of the Tamil Nadu Educational Institution [Protection of Collection of Capitation Fees Act, 1992 and cancellation of Registration under Income–tax Act, the High Court has elaborately discussed the concept of education with reference to various judgments and stated [page 462] that education can never be a commercial activity or a trade or a business and those in the field of education will have to constantly and consistently abide by this guiding principle. For this, the recent judgment of the Supreme Court [April, 2023] in the case of Baba Bandasingh Bahadur Education Trust [Civil Appeal No 10155 of 2013- for A.Y. 2006-07] delivered in the context of section 10(23C) (vi) should also be looked at.

9.1.2    In Specific Object category of education, the meaning of the term ‘education’ is equally relevant. The Supreme Court in LokaShikshana Trust’s case [(1975) 101 ITR 234] has given a narrower meaning of the term ‘education’ appearing in section 2(15) to say that it is process of training and developing the knowledge, skill, mind and character of students by formal schooling. As such, it means imparting formal scholastic learning in a systematic manner and the Supreme Court in its recent judgment in New Noble Education Society Trust’s case [448 ITR 592- considered in this column of BCAJ- January & February, 2023] has also followed this narrower meaning[refer para 5.5.1 of Part II of write-up on that case- BCAJ February,2023]. This meaning is also considered by the Court in AUDA’s case [at page 139- para 225] and that should be borne in mind. This should be equally applicable to the term education appearing in the definition of charitable purpose under section 2(15). For this useful reference may also be made to recent decision of Ahmedabad bench of Tribunal in the case of Gujarat Council of Science Society [ITA No 2405/AHD/2017, ITA No 260/AHD/2018 and ITA No 306/AHD/2019] vide order dtd 20/3/2023 for A.Ys 2013-14 to 2015-16. In this case, the Tribunal also took a view that prospective applicability of the judgment in New Noble’s case is only confined to cases involving the interpretation of the term “solely” and did not find any inconsistency with the same for the meaning /definition /scope of the term “education” as used in section 2(15). It may also be noted that the Bombay High Court in Laura Entwistle and Ors’s case- The Trustees of American School Bombay Education Trust [ TS- 102-HC-2023(Bom)] and the Orissa High Court in Sikhya ‘O’ Anu Sandhan’s case [TS- 04-HC-2023(Ori)] have taken a view that the judgment of the Supreme Court in New Noble’s case should operate prospectively and cannot be applied to earlier period. Of course, the issue of distinction drawn by the Ahmedabad Tribunal was not before the High Courts in these cases.

9.1.3    It is also possible that the Trust pursuing only the object of specific category, say education, may also carry out some incidental activities perceiving the same to be part of education or incidental to the imparting education. In such cases, on facts, a possibility of Revenue treating such other activity as GPU category and invoking the said Proviso can’t be ruled out. If ultimately the Revenue succeeds on this, the risk of losing total exemption under section 11 for that year remains by virtue of the provisions of section 13(8). Therefore, such Trusts will have to be cautious in this respect. Furthermore, if GPU category object is not part of its objects, some further issues may also need consideration [also refer to para 7.7.2.1 above].

9.2    In view of the ratio laid down by the Court in AUDA’s case, the meaning of `charitable purpose’ as applicable post 2008 Amendment in section 2(15) is now settled. In this regard, as stated in para 5.3.3 Part II of this write-up, the predominant object test laid down by the Supreme Court in Surat Art’s case no longer holds good post the 2008 Amendment. Likewise, `ploughing back’ of business income to `feed’ the charity is also not relevant. In this context, the expressions cess, fees, etc. [consideration] should be given purposive interpretation and accordingly, the same should be understood differently for various categories of assessees such as statutory bodies, regulatory authorities, non-statutory bodies, etc. [referred to in para 5.3.2 of Part II of this write-up]. Therefore, the Trust having GPU object will not satisfy the definition of ‘charitable purpose’ in section 2(15) in cases where such Trust carries on any activity in the nature of trade, commerce or business or any activity of rendering any service in relation thereto for consideration [i.e. Commercial Activity] even though its ‘predominant object’ is charitable in nature and even if business income from such activity is utilised to feed the charity. What is now relevant is the fact of undertaking Commercial Activity during the relevant year. However, in such an event, the Trust should ensure that it complies with the twin requirements[ w.e.f. 1st April, 2016 onwards] of relaxations provided [for earlier period also refer para 1.6 of Part I of this write-up] in the said Proviso so as to satisfy the definition of ‘charitable purpose’, namely, (i) the Commercial Activity should be undertaken in the course of actual carrying out of the GPU object [Qualitative Condition]; and (ii) the aggregate receipts from such activity do not exceed 20 per cent of the total receipts of the Trust of that previous year [Quantitative Condition]. In such cases, the Trust also needs to comply with the provisions of section 11(4A).

9.2.1    For the purpose of determining whether the Trust is carrying on any Commercial Activity, the Court has placed significant emphasis on the amount of consideration charged and has stated that generally if, the consideration charged is significantly more than the cost incurred by such Trust, that would fall in the category of consideration towards Commercial Activity and where the consideration charged is at cost or nominal mark-up on the cost incurred by the Trust it should not be regarded as towards Commercial Activity. This is the under lying broad principle for this purpose and this should be borne in mind in every case. At the same time, the fact of determination of mark-up charged is either nominal or significant is left open without any further guidance and this being highly subjective, may lead to litigation. Likewise, the Court has also not dealt with [perhaps rightly so] the meaning of ‘cost’ for this purpose and therefore, in our view, the same should be determined on the basis of generally accepted principles of commercial accounting.

9.2.2    For the above purpose, various explanatory illustrations given by the Court in the above case [referred to in para 5.5.2 of part II of this write-up] are relevant.

9.2.3    For all practical purposes, as a general rule, it is advisable to also maintain separate books of account in respect of each incidental activity carried on by the Trust pursuing any category of object [i.e. Specific, GPU or both] to meet with, wherever needed, the requirement of section 11(4A) so as to avoid possibility of any litigation on non-compliance of requirement of maintaining separate books of account contained in section 11(4A), whenever the same becomes applicable.

9.3    In view of the narrow interpretation of the term `incidental [used in provisions of section 11(4A)] made by the Court [referred to in para 5.4.3 Part II of this write-up] to claim exemption for profits of the incidental business, it would be necessary that the business activity should be conducted in the course of achieving GPU object to be regarded as incidental business activity and of course, the requirement of maintaining a separate books of account for the same also should be met to claim exemption under section 11. Interestingly, for this purpose, the Court has relied on 2008 Amendment with subsequent amendments and also stated that introduction of clause (i) in the said Proviso by amendment of 2016 is clarificatory. In this context, it is worth noting that the Supreme Court in Thanthi Trust’s case [referred to in para 1.4.2 of Part I of this write-up] while dealing with section 11(4A) has taken a view [post-1992 amendment] that business whose income is utilised by the Trust for achieving its charitable objects is surely a business which is incidental to the attainment of its objectives. The Court in AUDA’s case has distinguished this case on the ground [referred to in para 5.4.2 of Part II of this write-up] that in that case, the Court was dealing with a case of Specific Object category [education] and not GPU category object and the ratio of that case cannot be extended to cases where the Trust carries on business which is not held under trust and whose income is utilised to feed the charitable object. It is difficult to appreciate this distinction and both the judgments being of equal bench [three judges], some litigation questioning this view cannot be ruled out.

9.3.1    In the context of distinction between the provisions of section 11(4) and 11(4A), from the observations of the Court [referred to in para 5.4.1 of part II of this write-up], one may be inclined to take a view that if the business is held under trust, then the case of the assessee will fall only under section 11(4) and section 11(4A) would apply only to cases where business is not held under trust. The Court also noted that there is also difference between business held under trust and the business carried on by or on behalf of the trust. Normally, the business undertaking will be considered as held under the trust where it is settled by the donor or trust creator in the trustees. Referring to the test applied in J.K. Trust’s case [referred to in para 5.4.1 of part II of this write-up], the Court also noted that for a business to be considered as property held under trust, it should have been either acquired with the help of funds originally settled or the original fund settled upon the trust must have proximate connection with the later acquisition of the business. We may also mention that similar view is also expressed in the judgment [authored by justice R. V. Easwar] of Delhi High Court [by a bench headed by justice S. Ravindra Bhat- who has now authored the judgment in AUDA’s case] in the case of Mehta Charitable Prajnalay Trust [(2013) 357 ITR 560,572] in which Thanthi Trust’s case judgment has also been considered. It may be noted that observations of the Court [referred to in para 5.4.1] appear to be summarising the position noticed by the Court after referring to earlier judgments and may not necessarily seem to be expressing its view on such legal position. In this context, the judgment of the Supreme Court in Thanthi Trust’s case [referred to para 1.4.2 of Part I of this write-up] is worth noting wherein also business was held under trust and the Court has applied the provisions of section 11(4A).

9.4    Article 289(1) of the Constitution of India exempts property and income of a State from Union taxation. However, Article 289(2) of the Constitution permits the Union to levy taxes inter alia in respect of a trade or business of any kind carried on by, or on behalf of a State Government or any income accruing or arising in connection therewith. In view of this, judgment in AUDA’s case has held that every income of state entity is not per se exempt from tax. State controlled entities will have to evaluate whether the functions performed by them are actuated by profit motive or whether the same are in the nature of essential service provided in larger public interest. In this regard, the Court has laid down certain tests [referred to in para 7.2.3 above]. As clarified by the Court [refer para 5.3.3 of Part II of this write-up], statutory fees or amounts collected by state entities as provided in the enactments under which they have been set up will not be treated as business or commercial in nature. The same view emerges in respect of fees/cess etc. collected in terms of enacted law [by state or center] on amount collected in furtherance of activities such as education, regulation of profession etc. by regulatory authority/body.

9.5    The Revenue had filed a miscellaneous application before the Supreme Court seeking clarifications in the aforesaid decision of AUDA so as to enable it to redo the assessments in accordance with the Court’s judgment for the past and examine the eligibility on a yearly basis for the future. The Court in its order dated 3rd November, 2022 ([2022] 449 ITR 389 (SC)) disposed of the application and held that the appeals decided against the Revenue were to be treated as final. With respect to the applicability of the judgment to other years, the Court stated that the concerned authorities would apply the law declared in its judgment having regard to the facts of each such assessment year.

9.6     In view of the above judgment of the Court in AUDA’s case, the popular understanding that beneficial circular issued by the CBDT under section 119 are binding on the Revenue authorities in all cases has again come-up for questioning. In this case, the Court has opined [as stated in para 5.3 of Part II of this write-up] that such circulars are binding on the Revenue authorities if they advance a proposition within the framework of the statutory provision. However, if they are contrary to the plain words of a statute, they are not binding. Furthermore, the Court has also stated that such circulars are also not binding on the courts and the courts will have to decide the issue based on its interpretation of a relevant statute. As such, the debate will again start as to the binding effect of such circulars which are considered by the assessing officers as contrary to the plain words of the statue. It is unfortunate that on this issue, the debate keeps on resurfacing at some intervals and something needs to be positively done in this regard to finally settle the position on this issue to provide certainty.

9.7    Clause (46A) is inserted in section 10 by the Finance Act, 2023 to exempt any income arising to a body or authority or Board or Trust or Commission, not being a company, which has been established or constituted by or under a Central or State Act with one or more of purposes specified therein and is notified by the Central Government in the Official Gazette. The following purposes are specified in the said clause (i) dealing with and satisfying the need for housing accommodation; (ii) planning, development or improvement of cities, towns and villages; (iii) regulating, or regulating and developing, any activity for the benefit of the general public; or (iv) regulating any matter, for the benefit of the general public, arising out of the object for which the entity has been created. Therefore, statutory authorities /bodies, etc. can get themselves notified under this provision to avoid the potential litigation for claiming exemption under section 11 and in such cases, the above judgment in AUDA’s case will not be relevant.

9.8    Unlike the judgment of the Supreme Court in New Noble Education Society’s case [(2022) 448 ITR 598 – considered in this column in BCAJ January and February, 2023], the Court has not stated that the judgment in AUDA’s case will apply prospectively. Therefore, as per the settled position, this decision will act retrospectively and accordingly, will apply to all past cases also post 2008 Amendment. As such, post the above judgment in AUDA’s case, various benches of the Tribunal and Courts have started considering this judgment for deciding matters coming before them. Some of such cases are briefly noted herein.

9.8.1    The Supreme Court in Servants of People Society’s case [(2022) 145 taxmann.com 234 /(2023) 290 Taxman 127] vide order dated 21st October, 2022 summarily disposed of the SLP filed by the Revenue challenging the decision of the Delhi High Court [(2022) 145 taxmann.com 145] in terms of its decision in AUDA’s case by observing that the matter is fully covered by that judgment. In this case, it is worth noting that the assessee-society ran schools, medical centers and also a printing press and published a newspaper. The profits so generated were used for charitable purposes and, apparently, the activities of the assessee were not for profit motive. The Delhi High Court [seems to be for A.Ys 2010-11, 2012-13 to 2014-15] had held that the assessee was not involved in any trade, commerce or business and, therefore, the mischief of said Proviso to section 2(15) of the Act was not attracted. Interestingly, while dealing with the appeal of the Revenue in the case of the same assessee for a different assessment year [seems to be for A.Y. 2011-12 as mentioned in the High Court judgment reported in [(2022) 447 ITR 99], the Supreme Court in order dated 31st January, 2023 [(2023) 452 ITR 1-SC] noted that the Society was running schools, medical center, old age home etc. as well as printing press for publishing newspaper and further noted that the assessee society claimed exemption in respect of income from newspapers which included advertisement revenue of Rs. 9,52,57,869 and surplus of Rs.2,16,50,901. After noting these facts, the Court held that the law regarding interpretation of section 2(15) of the Act had undergone a change due to the decision in AUDA’s case for which the Court referred to its conclusion in AUDA’s case in relation to Tribune Trust’s case [referred to in para 7.7 above] and noted that in that case it was held that while advertisement is intrinsically linked with the newspaper activity which satisfies the requirement of carrying out such activity in the course of actually carrying on the activity towards advancement of object [referred to in clause (i) of the said Proviso– Qualitative Condition]but the condition of quantitative limit imposed in clause (ii) of the said Proviso has also be fulfilled. Accordingly, the Court remitted the matter to the AO for fresh consideration of the nature of receipts in the hands of the assessee and to re-examine as to whether the amounts received by the assessee qualify for exemption under section 11.

9.8.2    The Gujarat High Court in the case of GIDC [(2023) 442ITR 27] has followed the above judgment in AUDA’s case and confirm the view of the Tribunal granting the exemption to the assessee for A.Y. 2015-16. For this, the High Court has relied on the view taken by the Supreme Court in AUDA’s case[ being the first category of assessee therein] as well as on the general interpretation of the definition of ‘charitable purpose’ under section 2(15) post 2008 Amendment.

9.8.3    The Mumbai bench of Tribunal in case of The Gem & Jewellery Export Promotion Council [ITA Nos. 752/MUM/2017, 989/MUM/2019 and 2250/MUM/2019- Assessment Years 2012-13 to 2014-15] had an occasion to consider the assessee’s claim for exemption under section 11 which was denied by the AO by treating the activity of conducting exhibitions on a large scale [international as well as domestic] as Commercial Activities under the said Proviso and that was also upheld by the CIT(A).After elaborate discussion and considering the judgment of the Court in AUDA’s case[ including in relation to AEPC’s case referred to in paras 7.4 & 7.4.1 above], the Tribunal noted that the assessee had incurred a net loss from this activity of exhibitions conducted within and outside India in each year as revealed by the records. Factually, the assessee has charged consideration for conducting exhibitions/trade fairs slightly below the cost. As such, there being no mark-up on consideration charged from the exporters, in the broad principles laid down by the Court in AUDA’s case, this activity is beyond the preview of Commercial Activity as envisaged in the said Proviso and the assessee is entitled to claim exemption under GPU category objects.

9.8.3    In some cases, the Tribunal has decided the issue against the assessee following the law laid down in the above judgment in AUDA’s case such as : (i) Fernandez Foundation’s case[(2023) 199 ITD 37 – Hyd] wherein the assessee’s application for registration under section 12AA was rejected, inter alia, on the ground that the assessee was involved in activities which were in the nature of trade and provided medical facilities at market rates and, in fact, the amount charged by the assessee was far more than the amount charged by other diagnostics centers/hospitals for similar tests/ diagnostic/ treatment. The Tribunal upheld the order of CIT(E) and stated that assessee neither provided services at reasonable rate nor utilised its surplus for helping medical aid/facilities to the poor/needy persons at free of cost. Treatments were provided only to limited patients at a concessional rate which was a meagre portion of its total revenue earned. ITAT also referred to the decision of the Supreme Court in AUDA’s case and the observations made therein examining the issue of profit generated by charities engaged in GPU objects and observed that the CIT(E) was correct in holding that the assessee was charging on the basis of commercial rates from the patients and had failed to demonstrate that the charges/fee charged by it were on a reasonable markup on the cost; (ii) In Maharaja Shivchatrapati Pratishsthan’s case [(2023) 199 ITD 607], the Pune Bench of Tribunal rejected the claim of exemption under section 11 for A.Y. 2013-14 following AUDA’s case and stated that crux of the interpretation of the said Proviso to section 2(15) is to first examine the receipts of the assessee from pursuing GPU category object are on cost-to-cost basis or having a nominal profit on one hand or having a significant mark-up on cost on the other hand and the latter cases are a business activity but the former is non-business activity. Noting the fact on record that in this case the revenue from performing drama for various institutes/companies was Rs 1.96 crores and the cost for such performance was only Rs. 1.16 crores, the Tribunal took the view that profit elements in drama performance is more than 40 per cent of the gross receipts and that patently falls in the category ‘significant mark-up cases’ and hence business activity. Considering the significant margin on performing drama uniformly, the Tribunal took the view that this activity is in nature of business activity and ceases to fall within the domain of ‘chartable purpose’ as the business receipts exceeds 20 per cent of total receipts. The Tribunal also took the view that the contention of the assessee that the review petition has been filed in AUDA’s case is not relevant as that does not alter in any manner binding force of the judgment in terms of Article 141 of the Constitution of India.

9.9    As mentioned in para 7.1 above, the Court had divided the appeals before it into six categories of assessees and the Court has dealt and decided each category of assessee’s case [ as referred to in para 7.2 to 7.7.2.2 above] and also given summation of conclusions [as mentioned in para 8 above].In this concluding part of the write-up, we have only briefly dealt with the major general principles emerging from the judgment in AUDA’s case as mainly applicable to GPU categories of cases and not separately dealt with the Court’s conclusion of each category of assessees for the same reasons as stated in para 8.1 above. In all these cases, the decision of the Court is applicable for the assessment years in appeals and other year cases will have to be decided on yearly basis considering the facts in relevant year based on the law laid down by the Court in the above case.

9.10    If the exemption under section 11 is lost by the Trust in a given year on account of applicability of the said Proviso, then its taxable income now will have to be computed in accordance with the provision of section 13(10) read with section 13(11) introduced by the Finance Act, 2022 [w.e.f. 1st April, 2023] which, to an extent, brings certainly on this and give some comfort for determining tax liability. Furthermore, in our view, merely because the exemption is lost in a given year in such cases, the Registration granted to the Trust does not become liable to be cancelled.

9.11    At the time of 2008 Amendment, the possibility of an adverse view in many cases was perceived by many tax professionals as well as by some senior counsel and some trusts while claiming exemption under section 11, also started paying advance tax out of abundant caution. As such, the possibility of adverse judgment from the Supreme Court based on the clear language of the said Proviso was not ruled out. However, in this context, the judgment in the AUDA’s case seems to have gone far beyond the perception formed at that time. As such, the judgment, on an overall basis, is likely to create unending uncertainty and in large number of cases, possibly, give rise to long-drawn litigations. It was expected when this judgment was pronounced that the Government will make appropriate amendment in the said Proviso to make the law fair and reasonably workable but unfortunately, in the Finance Act, 2023 this has not been done except insertion of section 10(46A) [referred to in para 9.7 above] for the benefit of statutory authorities, etc. In the recent past, more so with the recent amendments in past few years, the feeling has started developing amongst those who are sparing time and resources for bonafide philanthropic purposes that the Charitable Trusts are, perhaps, treated in the most uncharitable manner in this respect and this is not a good sign for the nation. May be, in some cases, the Revenue may have noticed abuse of the exemption provisions. But the larger question is: is it fair to punish the entire community of charity by making such provision?

9.1 As mentioned in para 1.2 of Part I of this write-up (BCAJ May, 2022), the said Explanation to section 37(1) provides for disallowance of certain expenses. These are popularly known as illegal/prohibited expenses. As further mentioned in para 1.3 of Part I of this write-up, the MCI Regulations prohibit medical practitioners from aiding, abetting or committing any unethical acts specified in Clause 6 which, inter-alia, include receiving any gift, gratuity, commission etc. for referring, recommending or procuring of any patient for any treatment. The scope of this prohibition was expanded on 14th December, 2009 by inserting Clause 6.8 which, in substance, provided further restrictions prohibiting medical practitioners from accepting from any Pharmaceutical or Allied Health Care Industry (hereinafter referred to as Pharma Companies) any emoluments in the form of travel facility for vacation or for attending conferences/seminars, certain hospitality etc. (popularly known as freebies) referred to in para 1.4 of Part I of this write-up. The CBDT issued a Circular dated 1st August, 2012, clarifying that expenses incurred by Pharma Companies for distribution of freebies to medical practitioners violate the provisions of MCI Regulations and should be disallowed under the said Explanation to Section 37(1). The validity of this Circular was upheld by the Himachal Pradesh High Court (Confederation of Indian Pharma Industry’s case), as mentioned in para 4 of Part I of this write-up. As discussed in Part I of this write-up, Punjab & Haryana High Court (KAP Scan’s case) and Madras High Court (Apex Laboratory’s case) had upheld the disallowance of such expenses. The Mumbai bench of the Tribunal (PHL Pharma’s case – discussed in para 6 of Part I of this write-up) had taken a view that the MCI Regulations are not applicable to Pharma Companies, and based on that decided the issue in the favour of the assessee after considering the judgments of Punjab & Haryana High Court as well as Himachal Pradesh High Court. For this, the Tribunal also relied on the decision of Delhi High Court (Max Hospital’s case referred to in para 5 of Part I of this write-up) in which the MCI had filed an affidavit that it has no jurisdiction to pass any order against the Hospital and its jurisdiction is only confined to medical practitioners. Subsequently, the correctness of this decision of the Tribunal was doubted by one bench of Mumbai Tribunal (Macleod’s case), and it had recommended the constitution of a larger bench to decide the issue, as mentioned in para 7 of Part I of this write-up.

9.2 As discussed in para 8 of Part-I of this write-up, the Madras High Court in Apex Laboratories (P) Ltd. vs. DCIT LTU (Tax Case Appeal no. 723 of 2018) upheld the order of the Income-tax Appellate Tribunal (Tribunal) which had disallowed the assessee’s claim for deduction for A.Y. 2010-11 with regard to expenditure incurred for giving gifts/ freebies to doctors holding that such expenditure resulted in violation of the MCI Regulations and was hit by the said Explanation to section 37(1) of the Income-tax Act 1961 (‘the Act’).

APEX LABORATORIES (P) LTD. VS. DCIT LTU (2022) 442 ITR 1 (SC)

10.1 The correctness of the above referred Madras High Court judgment came up for decision before the Supreme Court at the instance of the assessee.

10.2 Before the Supreme Court, the assessee submitted that the MCI Regulations were enforceable only against the medical practitioners and prohibited doctors from accepting freebies. However, the MCI Regulations did not bind the pharmaceutical companies, nor did it expressly prohibit the pharmaceutical companies from giving freebies to doctors. The assessee, in this regard, placed reliance on the decision of the Delhi High Court in Max Hospital’s case and Rajasthan High Court in Dr. Anil Gupta vs. Addl. CIT [IT Appeal No. 485 of 2008] and submitted that as these decisions were accepted and were not further challenged in appeal, it was not open to re-consider the present issue in the assessee’s case.

10.2.1 The assessee also placed reliance on the Supreme Court decision in the case of Dr. T.A. Quereshi vs. CIT [(2006) 287 ITR 547] and on the Madhya Pradesh High Court decision in CIT vs. Khemchand Motilal Jain Tobacco Products (P) Ltd. [(2012) 340 ITR 99] to urge that the Revenue could not deny a tax benefit because of the ‘nature’ of expenditure. It was further submitted that the Memorandum explaining the provisions of the Finance (No. 2) Bill, 1998 and CBDT Circular No. 772 dated 23rd December, 1998 stated that the said Explanation to section 37(1) was introduced to disallow taxpayers from claiming “protection money, extortion, hafta, bribes, etc.” as business expenditure which showed that the intention of the Parliament was to bring only the ‘illegal’ activities which were treated as an ‘offence’ under the relevant statutes within the ambit of the said Explanation. It was submitted that as the Income-tax Act was not a social reform statute, it ought to be strictly interpreted more so when the act of giving gifts by a pharmaceutical company was not treated as ‘illegal’ by any statute.

10.2.2 The assessee also submitted that the CBDT circular No. 5/2012 dated 1st August, 2012 clarifying that any expense incurred by Pharma Companies for distribution of freebies to medical practitioners in violation of the provisions of MCI Regulations shall not be allowed as deduction u/s 37(1) of the Act; enlarged the scope of the MCI Regulations which was beyond its scope. In any case, it was urged that the CBDT circular could apply only ‘prospectively’ from the date of its publication on 1st August, 2012 and not ‘retrospectively’ from the date of publication of the MCI Regulations on 14th December, 2009.

10.3 On the other hand, the Revenue argued that the act of giving gifts by Pharma Companies to doctors was ‘prohibited by law’ being specifically covered by the MCI Regulations even though the same may not be classified as an ‘offence’ under any statute. Accordingly, the same would fall within the scope of the said Explanation to section 37(1). Revenue further submitted that the intention of the Legislature was to disincentivize the practice of giving gifts and freebies in exchange of doctors’ prescribing expensive branded medication as against generic ones, thereby burdening patients with unnecessary cost. Such an act of accepting gifts in lieu of prescribing a pharmaceutical companies’ medicine clearly amounted to professional misconduct on the doctors’ part and also had a direct bearing on public policy.

10.3.1 The Revenue further contended that in the present case, the medical practitioners were provided expensive gifts such as hospitality, conference fees, gold coins, LCD TVs, fridges, laptops etc. to promote its product which clearly constituted professional misconduct. It was also contended that scope of MCI Regulations was not limited to a finite list of instances of professional misconduct but was broad enough to cover those instances not specifically enumerated as well.

10.3.2 The Revenue also placed reliance on the Punjab & Haryana High Court’s decision in the case of Kap Scan & Diagnostic Centre (P) Ltd. [(2012) 344 ITR 476] and the decision of the Himachal Pradesh High Court in Confederation of Indian Pharmaceutical Industry [(2013) 353 ITR 388].

10.4 After considering the rival contentions, the Supreme Court proceeded to decide the issue. The Court first referred to the provisions contained in the said Explanation to section 37(1) dealing with disallowance of illegal/prohibited expenses and stated that it restricts the allowance of deduction in respect of any expenditure for ‘any purpose which is an offence or which is prohibited by law’. The Court also dealt with the meaning of the words ‘offence’ as well as ‘prohibited by law’ and stated as under [Pg. 16]:

“…It is therefore clear that Explanation 1 contains within its ambit all such activities which are illegal/prohibited by law and/or punishable”

10.4.1    The Court also referred to the provisions contained in MCI Regulations Clause 6.8 as well as the fact that the MCI Regulations also provide the corresponding punishment for violation thereof by medical practitioners and noted that acceptance of freebies given by Pharma Companies was clearly an offence on the part of the medical practitioner which was punishable in accordance with the provisions of the MCI Regulations.

10.4.2 While referring to the view taken by the Tribunal in P.H.L. Pharma’s case that the MCI Regulations were inapplicable to Pharma Companies and the assessee’s contention that the scope of the said Explanation was restricted only to ‘protection money, extortion, hafta, bribes etc.’, the Court opined as under [Pg.19]:

“This Court is of the opinion that such a narrow interpretation of Expln. 1 to s.37(1) defeats the purpose for which it was inserted, i.e., to disallow an assessee from claiming a tax benefit for its participation in an illegal activity. Though the Memorandum to the Finance Bill, 1998 elucidated the ambit of Expln. 1 to include “protection money, extortion, Hafta, bribes, etc.”, yet, ipso facto, by no means is the embargo envisaged restricted to those examples. It is but logical that when acceptance of freebies is punishable by the MCI (the range of penalties and sanction extending to ban imposed on the medical practitioner), pharmaceutical companies cannot be granted the tax benefit for providing such freebies, and thereby (actively and with full knowledge) enabling the commission of the act which attracts such opprobrium.”

10.4.3 In the context of contention of the non-applicability of MCI Regulations to Pharma Companies and deductibility of such expenses (i.e. freebies etc.) in their assessments, the Court also referred to the judgment of the constitution bench in the case of P.V. Narasimha Rao [(1998) 4 SCC 626] delivered in the context of the Prevention of Corruption Act (P.C.Act), where the contention was rejected that P.C. Act only punished (prior to the 2018 amendment) the bribe-taker who was a public servant, and not the bribe-giver. In this regard, the Court held as under [Pg.21]:

“Even if Apex’s contention were to be accepted – that it did not indulge in any illegal activity by committing an offence, as there was no corresponding penal provision in the 2002 Regulations applicable to it – there is no doubt that its actions fell within the purview of “prohibited by law” in Explanation 1 to Section37(1).

Furthermore, if the statutory limitations imposed by the 2002 Regulations are kept in mind, Explanation (1) to Section 37(1) of the IT Act and the insertion of Section 20A of the Medical Council Act, 1956 (which serves as parent provision for the regulations), what is discernible is that the statutory regime requiring that a thing be done in a certain manner, also implies (even in the absence of any express terms), that the other forms of doing it are impermissible.”

10.4.4 Considering the expected approach of the Courts in the matters involving issues relating to immoral or illegal acts, the Court observed as under [Pgs. 22/23]:

“It is also a settled principle of law that no Court will lend its aid to a party that roots its cause of action in an immoral or illegal act (ex dolomalo non oritur action) meaning that none should be allowed to profit from any wrongdoing coupled with the fact that statutory regimes should be coherent and not self-defeating. Doctors and pharmacists being complementary and supplementary to each other in the medical profession, a comprehensive view must be adopted to regulate their conduct in view of the contemporary statutory regimes and regulations. Therefore, denial of the tax benefit cannot be construed as penalizing the assessee pharmaceutical company. Only its participation in what is plainly an action prohibited by law, precludes the assessee from claiming it as a deductible expenditure.”

10.4.5     Considering the relationship between medical practitioners and their patients and, in that context, explaining the effects of distributing such freebies to the medical practitioners on society in general, the Court observed as under [Pg. 23]:

“This Court also notices that medical practitioners have a quasi-fiduciary relationship with their patients. A doctor’s prescription is considered the final word on the medication to be availed by the patient, even if the cost of such medication is unaffordable or barely within the economic reach of the patient – such is the level of trust reposed in doctors. Therefore, it is a matter of great public importance and concern, when it is demonstrated that a doctor’s prescription can be manipulated, and driven by the motive to avail the freebies offered to them by pharmaceutical companies, ranging from gifts such as gold coins, fridges and LCD TVs to funding international trips for vacations or to attend medical conferences. These freebies are technically not ‘free’ – the cost of supplying such freebies is usually factored into the drug, driving prices up, thus creating a perpetual publicly injurious cycle…….”

10.4.6 In the above context, the Court also noted that the threat of prescribing medication that is significantly marked-up, over effective generic counterparts in lieu of such a quid pro quo exchange was also taken cognizance of by the Parliamentary Standing Committee on Health and Family Welfare as well as other studies in this regard. In this regard, the Court further stated that the High Court decisions in the case of Kap Scan & Diagnostic Centre (P) Ltd. and Confederation of Indian Pharmaceutical Industry (supra) had correctly referred to the importance of public policy while deciding the issue before it.

10.4.7 The Court also held that agreement between the pharmaceutical companies and the medical practitioners in gifting freebies for boosting sales of prescription drugs was violative of section 23 of the Contract Act, 1872, which provides that the consideration or object of an agreement shall be unlawful if the Court regards it as immoral or opposed to public policy, in which event, the agreement shall be treated as void.

10.4.8 With respect to the date of applicability of the CBDT Circular No. 5/2012, the Court stated that as the Circular was clarificatory in nature, the same would take effect from the date of implementation of the MCI Regulations i.e. 14th December, 2009.

10.4.9 The Court distinguished the decisions relied upon by the assessee. With respect to Dr. T.A. Quereshi’s decision, the Court stated that the same dealt with a case of business ‘loss’ and not business ‘expenditure’. Khemchand Motilal Jain Tobacco Products (P) Ltd.’s decision was distinguished as the assessee in that case was not a willful participant in the commission of an offence or activity prohibited by law whereas Pharma Companies misused a legislative gap to actively perpetuate the commission of an offence.

10.4.10  The Supreme Court also rejected the assessee’s plea that the taxing statutes had to be construed strictly and observed as under [Pg. 28]:

“Thus, pharmaceutical companies’ gifting freebies to doctors, etc. is clearly “prohibited by law”, and not allowed to be claimed as a deduction under s. 37(1). Doing so would wholly undermine public policy. 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…..”

10.4.11     While dismissing the appeal of the assessee, and deciding the issue in favour of the Revenue, the Court finally concluded as under [Pgs. 30 & 31]:

“ In the present case too, the incentives (or “freebies”) given by Apex, to the doctors, had a direct result of exposing the recipients to the odium of sanctions, leading to a ban on their practice of medicine. Those sanctions are mandated by law, as they are embodied in the code of conduct and ethics, which are normative, and have a legally binding effect. The conceded participation of the assessee – i.e., the provider or donor- was plainly prohibited, as far as their receipt by the medical practitioners was concerned. That medical practitioners were forbidden from accepting such gifts, or “freebies” was no less a prohibition on the part of their giver, or donor, i.e., Apex.”

CONCLUSION

11.1 In view of the above judgment of the Supreme Court, the issue now stands fairly settled that any expenditure incurred by a Pharma Company for giving gifts/ freebies to medical practitioners in violation of MCI Regulations falls within the ambit of the said Explanation, and will not be allowed as deduction u/s 37 of the Act. Further, such claim of expenditure will be disallowed from the date of publication of the MCI Regulations i.e. 14th December, 2009 and that the CBDT Circular dated 1st August, 2012 is merely clarificatory and would also take effect from 14th December, 2009. In view of this, the view taken by the Tribunal in many cases that this Circular will apply prospectively and approved by the Bombay High Court in Goldline Pharmaceutical’s case [(2022)441 ITR 543] would no longer hold good. In light of the Supreme Court decision, the reference to Special bench by the Tribunal in the case of Macleods Pharmaceutical’s case (supra) will be rendered infructuous.

11.2 The above judgment in Apex Laboratories’ case was followed by the Calcutta High Court in the case of Peerless Hospitex Hospital and Research Center Ltd. vs. Pr. CIT [(2022) 137 taxmann.com 359 (Calcutta)]. In this case, the assessee was engaged in the business of running a multi-speciality hospital. It had claimed deduction in respect of fee paid to doctors for referring patients to the assessee’s hospital which was allowed during the course of original assessment proceedings. The Assessing Officer issued a notice u/s 148 of the Act, after 4 years [A.Ys. 2011-12 & 2012-13] seeking to disallow the said expenditure on the basis that the expense was prohibited by law and was therefore disallowable as per Explanation 1 to section 37(1). Following the above judgment of the Supreme Court and after giving detailed reasonings, the High Court held that such expenses are not deductible. The High Court also noted that no such provisions restricting Pharma Companies is made in the law and expressed a wish that the Central and State governments take note of this legislative gap and make appropriate law to penalize them also for participating in such activities. Finally, the High Court, on the facts of the case of the assessee, also took the view that re-opening on the same material is a mere change of opinion and quashed the notices issued u/s 148 as conditions for issuance of such notices were not met in this case.

11.3 While upholding the disallowance of expenditure on such freebies, the Supreme Court also referred to the legal position that technically, MCI Regulations are not applicable to the Pharma Companies making them punishable for resultant violation on the part of medical practitioners. According to the Court, the expenditure is hit by provisions of the said Explanation 1 to section 37(1). It appears that the only consequence (apart from the corporate governance issue, if any, more so as such acts of the assessee are also held as being opposed to public policy) for the Pharma Companies for such acts will be to suffer disallowance in their tax assessments. As such, the tax cost will be the extra cost for the Pharma Companies for the past as well as for the future in such cases. The Supreme Court rightly noted [refer para 10.4.5 above] that such freebies are really not free, and the cost thereof is usually factored in the cost of drugs price. In future, in the absence of any specific provision for punishment, some Pharma Companies may follow this practice for this tax-cost also, further driving prices up. If this happens, the poor patients may have to bear this additional cost also and that would be a sad day. Perhaps, the Calcutta High Court may have expected the Government to take note of this legislative gap keeping such unintended consequences in mind.

11.4 Since the Court has upheld the disallowance in the hands of Pharma Companies for its participations in such activities leading to violations of MCI Regulations by the medical practitioners, the effect of this judgment will not necessarily be limited to Pharma Companies and may extend to other sectors/situations also wherever such practices/participation is found.

11.5 While dealing with the provisions of the taxing statute, the normal rule is to apply the principle of ‘strict interpretation’. The Supreme Court in this case has rejected the contention of the assessee for applying such a rule in this case and stated that this principle cannot sustain when it results in an absurdity contrary to the intention of the Parliament [refer para 10.4.10 above].

11.6 In the cases of Pharma Companies distributing freebies to medical practitioners [as well as in other similar cases], the law is now made clear by the Supreme Court and therefore, in such cases, the same is covered within the ambit of Explanation 1 [Pre – 2022 amendment], and accordingly, it should apply even to earlier years. In view of this, the Tax Auditors of Pharma Companies etc. will have to be extremely cautious while reporting on particulars contained in clause 21(a) of Form No. 3CD for A.Y. 2022-23 also, more so with the 2022 amendment.

11.7 The question of disallowance of expenditure arises in cases where it is found that such expenditure is in violation of some provisions of law etc. treating the same as illegal/ prohibited expense as envisaged in the said Explanation 1 to section 37(1) [read with the effect of amendment by Finance Act, 2022, at least from the A.Y. 2022-23]. If the expenditure is not found to be in such violation in the hands of the recipient, the issue of disallowance in the hands of the Pharma Companies should not arise. The Supreme Court has rejected the view of non-applicability of the said Explanation 1 to section 37(1) taken by the Tribunal in PHL Pharma’s case [refer para 10.4.2 above] on the ground that such narrow interpretation based on the non-applicability of MCI Regulations to Pharma Companies, is not correct. However, interestingly, the Tribunal in that case, has further given finding of facts [refer para 6.4 of Part I of this write-up] with regard to the nature of various expenses incurred by the assessee in that case. The issue would arise that whether such findings could be considered as the Tribunal taking the view that, on facts, such expenses do not result in any violation of MCI Regulations in the hands of the recipients. The Revenue may look at this finding to show that the Tribunal only clarified that these are primarily business expenses eligible for deduction u/s 37(1), and observation that they are purely business expenditure and is not impaired by the said Explanation 1 to section 37(1) is generic, considering the context of such observations.

11.7.1 It also seems to us that every expenditure incurred by the Pharma Companies for certain distribution/providing facilities to medical practitioners should not necessarily be regarded as violating MCI Regulations resulting into disallowance thereof as illegal/prohibited expenses. As such, when normal medical conferences/seminars are organized by Pharma Companies, more so if organized domestically, purely for educational/knowledge spreading purposes amongst the medical practitioners, the expenditure for the same, ipso facto, should not necessarily be considered as illegal / prohibited expenses resulting into disallowance. In this respect, the reference [in para 10.4.5 above] of ‘funding of international trips for vacation or to attend medical conferences’ by the Supreme Court will have to be read in context and should not be construed in the manner that expenditure for all medical conferences now falls into this prohibited category, more so when they are domestically held. It also seems that the distribution of free samples by the Pharma Companies to the medical practitioners in the normal course of business to prove the efficacy of the product should also not be viewed as falling into this prohibited category. Of course, all these are subject to a caveat that freebies granted under the guise of seminar/ conferences etc., to medical practitioners can always be questioned for this purpose. Ultimately, the assessee has to satisfy the authority that the expenditure is not in violation of the MCI Regulations as held by the Himachal Pradesh High Court [refer para 4.4 of Part I of this write-up] in Confederation of Indian Pharma Industry’s case. This judgment is approved by the Supreme Court in the above case.

11.8 Finance Act, 2022 has inserted Explanation 3 in section 37 of the Act with effect from 1st April, 2022 to clarify that the expression “expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law” used in Explanation 1 to section 37 shall include and be deemed to have always included inter-alia any expenditure incurred by an assessee to provide any benefit or perquisite in any form to a person whether or not carrying on business or exercising profession where acceptance of such benefit or perquisite by such person is in violation of any law or rule or regulation or guideline which governs the conduct of such person. The new Explanation 3 also specifically expands the scope of the existing provision contained in Explanation 1 to include violation of foreign laws. Considering the language of the amendment of the Finance Act, 2022, the debate is on as to whether this extended scope of illegal/ prohibited expense will apply retrospectively or only from the A.Y. 2022-23. The majority view prevailing in the profession seems to be that the same should apply prospectively, though the Revenue may contend otherwise. As such, the litigation for the past years on the applicability of this expanded scope also cannot be ruled out.

11.9 While the issue of taxability of such freebies for recipients was not before the Supreme Court in the above case, the CBDT in its said Circular dated 1st August, 2012, in para 4, has also clarified that the value of freebies enjoyed by the medical practitioners is also taxable as business income or income from other sources, as the case may be, depending on facts of each case and Assessing Officers have been asked to examine the same in cases of such medical practitioners etc, and take an appropriate action. It may also be noted that for this purpose, it is not relevant whether the receipts of such benefits violates the MCI Regulations or not. In view of this, more so with the provisions of section 28(iv), the Tax Auditors will also have to be extremely cautious while reporting on particulars contained in clause 16 of Form No. 3CD. This will make the task of Tax Auditors more difficult as practically, hardly it may be feasible for the Tax Auditors to find about the receipt of such benefit/ perquisite by the assessee unless the assessee himself declares the same.

11.10 It is also worth noting that the Finance Act, 2022 also inserted new section 194R [w.e.f. 1st July, 2022] which provides for deduction of tax at source (TDS) in respect of any benefit or perquisite provided to a resident and therefore, that also will have to be considered by the assessee and Tax Auditors from the next year i.e., A.Y. 2023-24. Of course, this may help the Tax Auditors of recipients of such benefits to find out the instances of receipts of any such benefit or perquisite.

11.11 The larger and the most relevant issue which may still need consideration: is it fair to leave the determination of the violations of all such laws/regulations etc. to the Assessing Officer by interpreting these laws/regulations etc.? Is he really equipped to carry out this difficult task?

One thing seems certain that we are again heading for long drawn litigations on these provisions, more so in post-2022 amendment era. We do not know for whose benefit? Perhaps, one more bonanza for the profession?