The Supreme Court on Tuesday held that pharmaceutical companies are not entitled to claim tax exemption on expenditure incurred in giving incentives to medical practitioners to promote their products and it would be considered as part of their income.
The Division Bench of Justice Uday Umesh Lalit and Justice S. Ravindra Bhat dismissed the petition filed by a pharmaceutical company aggrieved by a judgment of the Madras High Court, wherein the Division Bench upheld an order of the Income Tax Appellate Tribunal, which, in turn, upheld an order of the Commissioner of Income Tax (Appeals). The CIT(A) had partly allowed an appeal from an order of the respondent Deputy Commissioner of Income Tax, which partially allowed amounts claimed by pharmaceutical companies as “business expenditure” under Section 37(1) of the Income Tax Act, 1961.
The facts in brief are as follows: On August 1, 2012, the Central Board of Direct Taxes issued a circular, which clarified that expenses incurred by pharmaceutical and allied health sector industries for distribution of incentives to medical practitioners are ineligible for the benefit of Explanation 1 to Section 37(1), which denies the application of the benefit for any purpose which is an offence or prohibited by law.
After the circular was issued, on November 22, 2012, a pharmaceutical company was issued a notice under Section 142(1) of the IT Act, to explain why the expenditure of Rs 4,72,91,159 incurred towards gifting freebies such as hospitality, conference fees, gold coins, LCD TVs, fridges, laptops, etc. to medical practitioners for creating awareness about health supplement Zincovit, should not be added back to the total income of pharmaceutical company.
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The reason for only a partial allowance by the authorities below was that an amendment to the Medical Council Act, 1956 (now repealed) through the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002, published in the Official Gazette on December 14, 2009, disallowed medical practitioners from accepting emoluments in the form of inter alia gifts, travel facilities, hospitality, cash or monetary grants.
Acceptance of such freebies could result in a range of sanctions against the medical practitioners, from “censure” for incentives received up to Rs 5,000, to removal from the Indian Medical Register or State Medical Register for periods ranging from three months to a year. Therefore, only the expenses incurred till December 14, 2009 were eligible for the benefit of Section 37(1), and not for the entirety of Assessment Year 2010-2011, as claimed by the pharmaceutical company.
While considering the petition, the Bench observed that Section 37 is a residuary provision. Any business or professional expenditure which does not ordinarily fall under Sections 30-36, and which are not in the nature of capital expenditure or personal expenses, can claim the benefit of this exemption. But the same is not absolute. Explanation 1, which was inserted in 1998 with retrospective effect from 01.04.1962, restricts the application of such exemption for “any purpose which is an offence or which is prohibited by law”. The IT Act does not provide a definition for these terms. Section 2(38) of the General Clauses Act, 1897 defines ‘offence’ as “any act or omission made punishable by any law for the time being in force”. Under the IPC, Section 40 defines it as “a thing punishable by this Code”, read with Section 43 which defines ‘illegal’ as being applicable to “everything which is an offence or which is prohibited by law, or which furnishes ground for a civil action”. It is therefore clear that Explanation 1 contains within its ambit all such activities which are illegal/prohibited by law and/or punishable.
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The Apex Court was of the opinion that such a narrow interpretation of Explanation 1 to Section 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 Explanation 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.
Furthermore, the Court opined that 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, 195623 (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.
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 dolo malo 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, the Court held,
The 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.
“Interpretation of law has two essential purposes: one is to clarify to the people governed by it, the meaning of the letter of the law; the other is to shed light and give shape to the intent of the law maker. And, in this process the courts’ responsibility lies in discerning the social purpose which the specific provision subserves. Thus, the cold letter of the law is not an abstract exercise in semantics which practitioners are wont to indulge in. So viewed the law has birthed various ideas such as implied conditions, unspelt but entirely logical and reasonable obligations, implied limitations etc. The process of continuing evolution, refinement and assimilation of these concepts into binding norms (within the body of law as is understood and enforced) injects vitality and dynamism to statutory provisions. Without this dynamism and contextualisation, laws become irrelevant and stale”
-said the Court.
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Therefore in conclusion the Bench observed that the incentives (or “freebies”) given by pharmaceutical companies , 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., pharmaceutical company.
Read Order below:
33259_2019_2_1501_33618_Judgement_22-Feb-2022