Mr. S. Ramanujam, in his article, analyses the proposed amendment to section 37 and predicts the possible effects of the same on the Pharma Companies. The Finance Bill 2022 proposes to insert another explanation under sec 37(1) that will be Explanation No.3 to include the expenditure incurred by an assessee (i) for any purpose which is an offence or (ii) to provide any benefit or perquisite which is in violation of any law or rule or regulation or guideline or (iii) to compound an offence, in the the expression “expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law” under Explanation 1. The author highlights that, “The entire amendment in the clause (ii) is to overcome many ITAT judgments relating to pharma Industry trade practice, where freebies given to doctors, and inducing them to prescribe the products belonging to a particular company – like reimbursements of travel costs, gifts etc were held allowable”. The author points out that the companies are being penalised from getting its expenditure allowed for marginal faults, if any, of their own. The Author remarks that “a pragmatic business approach can result in prosperity for all rather than pinpointing compliance deficiencies all the time and penalising, both under the respective statutes as well as under the IT Act”.

Amendment to Sec 37: The bitter pill for pharma Industries:

Introduction: If one is an historian chronicling the insertions /enactments of different provisions contained in the Income Tax Act, one will recall many instances where sections were introduced to enable or disable some court judgments and also ended up with many humorous fall- outs too. Some of these sections are too well known to deserve a mention but keeping in mind the humour element, the author identifies sec 9(1) Explanation 1 clauses (c) and clause (d) as an illustration. To recall these instances, once, the international news agency Reuter and some other foreign agencies (like BBC) were asked to submit their accounts regarding the income earned by them from their Indian operations- of collecting news and views from India. Upon getting the notice from the ITO, these agencies filed a writ petition and Mr Palkhivala who represented them said that” if the notice is allowed to stand and these agencies withdraw from India, India will become a dark continent “. The government took notice of this criticism and excluded this type of income by enacting Clause (c). Similarly, the movie Gandhi brought the exemption clause (d) which was later fully utilised for making a James Bond movie! Coming specifically to the amendments made to sec 37, the author recollects the amendment made in the past, clarifying the meaning of the words ‘guest house “entertainment “etc to overcome certain judgments. There were other amendments too, to plug some issues created by a few judgments like ‘secret commission (paid to dye masters) which was allowed as trade practice, protection money paid to extortionists etc – allowed in the context of real estate companies etc. It is in this context, one should look at the new amendment proposed in the budget, -this time by adding another explanation under se c 37(1). For the benefit of readers, the said explanations extracted below:

(Since the new explanation 3 refers to explanation 1 under sec 37(1) in the income Tax act, the same is also extracted)

Explanation 1: For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or prohibited by law shall not be deemed to have been incurred purpose of the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure

Explanation 3. ––For the removal of doubts, it is hereby clarified that the expression “expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law” under Explanation 1, shall include and shall be deemed to have always included the expenditure incurred by an assessee, –– (I) for any purpose which is an offence under, or which is prohibited by, any law for the time being in force, in India or outside India; or

(ii) to provide any benefit or perquisite, in whatever form, to a person, whether or not carrying on a business or exercising a profession, and acceptance of such benefit or perquisite by such person is in violation of any law or rule or regulation or guideline, as the case may be, for the time being in force, governing the conduct of such person; or

(iii) to compound an offence under any law for the time being in force, in India or outside India.’.

Comments on newly inserted Clause (ii): One of the adulatory features of this year’s budget is the huge back ground information provided in respect of each amendment in the memorandum explaining the provisions. The entire amendment in the clause (ii) is to overcome many ITAT judgments relating to pharma Industry trade practice, where freebies given to doctors, and inducing them to prescribe the products belonging to a particular company – like reimbursements of travel costs, gifts etc were held allowable. The CBDT issued a circular stating that the acceptance of favours by doctors are against the code of Conduct prescribed by the medical Council and hence these are not to be allowed. However, despite this circular, many ITAT benches allowed this expenditure. The question is - is there any rationale that exists for their allowability?

The author has experienced a few instances where economically poor fresh medical graduates embark on their career in a semi urban town, battling all odds like power cut and other infrastructural deficiencies prevailing in that area, besides other serious issues like - lack of proper para medical staff to assist in their professional activities etc, all this happening at the beginning of their career. It is at this stage, the pharma companies with their freebies and persuasive representatives and literature, enlighten the doctors with new products flooding the market and how their products are superior to other competitors. Without this constant updating by known familiar faces throughout the year, the Doctors at rural places will be far removed from the happenings in the medical profession. The author had occasion to look at closely at some expenditure incurred by pharma companies under various heads like new product launch, sponsorship of medical conferences, coordinating between stockists, company officials and doctors etc. Inevitably there will be benefit flowing to all participants in these conferences. It is a common practice in all seminars organised by any industrial association, Chambers, professional body that there will be always a sponsor who will underwrite a particular expenditure apart from sponsoring memorabilia and in all these cases there are no ethical standards imposed by the respective bodies.

The net effect of this amendment is the company is penalised from getting its expenditure allowed even though, in a way the fault (if any) lies in the Doctor breaching his code of Conduct and ethics prescribed by their professional body! As far as code of conduct is concerned, there are many practices which are indulged by Corporate hospitals – notably over charging of patients (many such instances were witnessed during pandemic) or charging each patients depending on their ability to pay etc.

It is pertinent to point out here that the Mad HC in the case of Apex Laboratories Private Limited v DCIT dismissed the assessee’ s appeal against the ITAT Order which held that the expenditure incurred in violation of the Medical Council’s Code of Conduct and Ethics Rules are not tax deductible ( refer [TS-6293-HC-2019(MADRAS)-O] . This matter was challenged before the Hon’ble SC and the same is pending for adjudication [TS-5385-SC-2019-O] 

Looking at it from trade practices, the author has serious reservations about many other businesses as well – like insurance commission being shared between insurance agents with the insured -allowing the insured to claim the premium as a tax deduction in their hands as though it is paid by them, cash fees shared between advocates etc without receipts being passed on to the clients especially in lower and district courts. In the opinion of the author, with the ever-increasing population and the medical infrastructure along with many insurance companies operating in the field, though under IRDA, (but not following discipline in reimbursing genuine claims of the patients,) an upgrade of all the connected medico related issues and industry practices need to be streamlined. The author is of the view that, in the present circumstances, there should be a small % disallowance of these expenditure even though it may result in some benefit to the doctors – say 25% of the Expenditure incurred on identified expenditure like – Third party travel expenditure reimbursed by pharma companies and other similar related expenditure . If the law as proposed is enacted, ultimately the litigation will spiral more, that too on (alleged) (mis) classification of expenditure, which in the view of the author is avoidable!

Comments on Clause (III) This clause prohibits deduction of any expenditure incurred in compounding an offence under any law. The word compounding is explained as under:

“Compounding is a settlement mechanism by allowing the offender to pay monetary compensation in lieu of facing the penal consequences envisaged under the concerned statute. Though the intention of the law is good, one may not be able to confidently say, especially in running a business enterprise that he has ensured that he has not violated any law at all through his life. It is for this reason, most of the general laws enacted for common good contains compounding mechanisms whereby a person absolves himself by paying higher levies. This happens all the time both within India and outside India when the international trade begins. The law proposed now covers both within India and outside India. Keeping in mind the payment by way of compensation, one should not again penalise the party from claiming deduction of these levies.

 For Instance, under the Companies act, there are minor technical lapses which can be condoned by paying a fee. Similarly, under SEBI law one can enter into consent terms / compounding charges to get relieved of offences. These Instances arise due to various circumstances, sometimes beyond the control of the management. This amendment, in the opinion of the author, is a very harsh one considering the huge compliance regime to be followed by all business entities.

Conclusion: Entities engaged in trade and commerce need to face challenges all the time – the offences happening., many times due to neglect or negligence of the concerned officials or due to misdemeanour (like sexual harassment charges on key official) Sometimes there may be confusion regarding the applicability of law itself like face book / WhatsApp / twitter cases recently seen in India where the CEOs are hauled up before authorities. A pragmatic business approach can result in prosperity for all rather than pinpointing compliance deficiencies all the time and penalising, both under the respective statutes as well as under the IT Act .

The medical council has prescribed that as far as possible, only the generic names should be used by the doctors while prescribing medicines. Well, which do you want – Dolo 650 or paracetamol?

The answer is self-evident !