India: Supreme Court denies tax deduction on incentives and freebies to medical practitioners
Deepesh Chheda and Saurabh Shah of Dhruva Advisors discuss a Supreme Court of India case and explain why pharmaceutical companies need to fully understand the MCI regulations to secure any tax deduction.
In a significant development in the case of Apex Laboratories Pvt. Ltd (‘the taxpayer’), the Supreme Court of India (‘the Court’) denied a tax deduction on expenses incurred by pharmaceutical and allied health sector industries for incentives and freebies to medical practitioners.
The taxpayer, consistent with the practice in the pharmaceutical industry, provided freebies such as hospitality, sponsorship of conferences and seminars, laptops, and similar benefits to medical practitioners to create awareness and enhance the brand recall value of their products.
The limited question for dispute was whether expenditure incurred by the taxpayer on such freebies is tax deductible. Section 37 of the Income-tax Act 1961 (‘the IT Act’) provides that an expenditure incurred wholly and exclusively for the purposes of business is tax-deductible, provided it is not incurred for any purpose which is an ‘offence’ or for any purpose which is ‘prohibited by law’.
The Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 (‘the MCI regulations’) prohibits medical practitioners from accepting gifts, hospitality, and so on from a pharmaceutical company. Censures and penalties are prescribed for violation of the MCI regulations. The Indian tax authorities (‘the Revenue’) disallowed this expenditure on the basis that such freebies are violative of MCI regulations and therefore prohibited by law.
However, the taxpayer contended that MCI regulations apply only to doctors and not to the company itself. It has been the taxpayer’s contention that punitive action could be taken against the doctors, but if the expenditure was for legitimate promotion of business, then it should not be disallowed for tax purposes.
The status of expenditure incurred by pharmaceutical companies in providing freebies and incentives to doctors and other medical practitioners has been a vexed issue with conflicting jurisprudence on both sides. The Court has put the controversy to rest by deciding the issue in favour of the Revenue by holding that the expenditure incurred was indeed violative of law and was not tax-deductible.
In a well-reasoned judgment, the Court held that pharmaceutical companies were fully aware of MCI regulations and knew that the doctors accepting freebies would violate the regulations. The act of giving freebies was held to be an act of commission. The Court held that doctors have a quasi-fiduciary relationship with their patients and their judgment of prescribing medicines cannot be influenced by receipt of freebies. The cost of such freebies is built into the cost of medicines which is ultimately borne by the patients.
The moral tenets aside, the Court held that it cannot aid a party in causing an illegal act to be committed. The Court also held that an act which could not have been done directly can also not be done indirectly. Accepting the argument that the MCI regulations applied only to doctors and not to pharmaceutical companies would be an exercise in cementing the practice of medical practitioners.
This judgment also legitimises the amendment to the IT Act by the Finance Act 2022, which clarifies that such expenditure is prohibited by law and therefore not allowable as a deduction. Given the Court’s judgment, the controversy over whether this amendment is retrospective or prospective is academic in nature, as the judgment is understood to clarify the law since its inception.
The judgment reaffirms that interpretation of law is not only an exercise in cementing, and that the interpretation cannot be carried out in a manner that would frustrate the intention of law.
Given the Court’s decision, there are several areas which companies may want to analyse further. Companies may face disallowances related to proceedings which may be pending at any level. While companies could defend themselves against penalty action, there could be challenges in defending against interest liability, which is consequential in nature. Companies should reassess their advance tax liability to minimise interest exposure.
Companies should also consider whether there is any need to revise the tax returns of earlier years. The facility to file an updated tax return, as provided in the Finance Act, 2022 can be explored to optimise tax costs.
Pharmaceutical companies have worked closely with medical practitioners to promote and facilitate health care awareness, which in a country like India has been historically very low. This has taken various forms, some of which may be legitimate and some that may not be so. Given that this has been an industry-wide practice, companies will need to closely examine which of the freebies would be hit by the MCI regulations, the documentation required for defending the legitimate payments made in the past, and how the situation needs to evolve in future.
For example, can the provision of in-clinic items with company logos, such as stationery items, face masks, sanitisers, and so on, be regarded as permissible under the MCI regulations? Is the gift of low-value items, such as those worth less than the MCI regulation limit of INR 1000 ($13), permissible? Is the sponsorship of conference fees for doctors permissible under MCI regulations?
Companies will need to iron out these issues and have a proper demarcation in place on what is and is not permitted, as per the MCI regulations, to secure their tax deduction to the extent permissible under the law. Companies will also need to suitably plan for proposed provisions providing for the deduction of tax at source.
Partner, Dhruva Advisors
Principal, Dhruva Advisors