No Tax Benefit from Freebies for Doctors
The Supreme Court has held that pharma companies cannot claim tax deductibility on expenditure made for freebies. How does this affect the companies?
TTWO RECENT developments on the tax front merit attention. The first is the judgement of the Supreme Court (SC) on the deductibility of expenditure incurred by pharma companies in providing freebies to medical practitioners; the other is a circular issued by the Central Board of Direct Taxes (CBDT), which interprets the Most Favoured Nation (MFN) clause found in several tax treaties.
The SC judgement was delivered in a case involving Apex Laboratories. Apex, consistent with the practice in the pharma industry, provided freebies such as hospitality, sponsorship of conferences/ seminars, laptops and the like to medical practitioners, inter-alia, to “create awareness” and provide for a brand recall value of their products. The question was whether expenditure incurred by Apex on such freebies is tax deductible. Section 37 of the Income-tax Act, 1961, provides that an expenditure incurred wholly and exclusively for the purposes of business is tax deductible provided it is not incurred for any purpose that is an ‘offence’ or ‘prohibited by law’. The Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 (MCI regulations) prohibits medical practitioners from accepting gifts, hospitality, etc., from a pharma company, with censures and penalties prescribed for any violation. The revenue authorities disallowed the expenditure on the basis that such freebies are violative of MCI regulations and therefore prohibited by law. But pharma firms contend that MCI regulations apply only to doctors and not to them. Action could be taken against the doctors, but if the expenditure was for the legitimate promotion of business, then it should not be disallowed. There was conflicting jurisprudence on this subject. The SC held that the expenditure incurred was indeed violative of law and was not tax deductible.
In its judgement, the SC held that pharma companies were fully aware of the 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 SC held that doctors have a quasi-fiduciary relationship with their patients and their judgement of prescribing medicines cannot be influenced by the 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 SC held that it cannot aid a party in causing an action of an illegal act. The SC also held that an act which could not have been done directly, can also not be done indirectly. Accepting an 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. The judgement also legitimises the amendment proposed to the IT Act by the Finance Bill, 2022, which clarifies that such expenditures are prohibited by law.
Given that the SC decision is understood to clarify the law since inception, there are several areas that companies may want to analyse further. They may face disallowances in respect of pending proceedings. While penalty action may be defendable, there could be challenges in defending interest liability, which is consequential in nature. Companies would need to reassess their advance tax liability such that interest exposure is mi
THE JUDGEMENT LEGITIMISES THE AMENDMENT PROPOSED TO THE IT ACT BY THE FINANCE BILL, 2022, WHICH CLARIFIES THAT SUCH EXPENDITURES ARE PROHIBITED BY LAW
nimised. They should also consider whether there is any need to revise the tax returns of earlier years. The facility of filing an updated tax return as proposed by the Finance Bill, 2022, can be explored to optimise tax costs.
The second interesting development is a CBDT circular dealing with the MFN clause in tax treaties. The MFN clause is inserted in many tax treaties to provide that if one of the treaty partners enters into a more beneficial treaty at a later point of time, the provisions of the beneficial treaty would apply to the current treaty. India has entered into tax treaties with several countries which are part of the Organisation for Economic Co-operation and Development (OECD) that provide for such an MFN clause. The issue became relevant in the context of the India-Netherlands tax treaty where the withholding tax rate for dividend was provided at 10 per cent. India entered into treaties with Slovenia, Lithuania, etc., where the withholding tax on dividend was 5 per cent. Those countries subsequently became OECD members and a question arose whether the lower tax rate prescribed in those treaties would apply to India’s treaty with the Netherlands basis the MFN clause. The matter was argued before the courts and it was held that the fact that these other countries were admitted as OECD members at a later date was not relevant. The lower rates prescribed therein would apply to other treaties where the MFN clause existed and there was no need for the CBDT to issue an express notification in this regard as the MFN provisions are self-operational. The court disregarded the contrary stand taken by the revenue authorities.
The CBDT recently issued a circular that says the benefit of a lower rate under the MFN clause would apply only if the other third country is a member of the OECD at the time of signing the treaty and India issues a separate notification accepting the beneficial provisions. Whilst the CBDT’s stand is not out of place, it applies only where tax treaties provide for a similar language. For example, the India-Belgium or Australia-Italy tax treaties specifically state that the MFN clause will apply only if the third country is a member of OECD at the time of signing of the treaty. Also, the India-Switzerland tax treaty categorically states that the countries would negotiate and issue a notification if the MFN clause gets triggered.
The blanket approach taken by the CBDT to import these conditions in every tax treaty despite there being no enabling provision or language is quite strange, unwarranted, and inconsistent with the interpretation given by the courts. Tax treaties are vehicles for promoting cross-border investments and trade, and such a restrictive approach, as has been taken by the CBDT, is not warranted. Sure enough, barely had the ink dried on the circular that the matter came up before the tax tribunal where the revenue authorities tabled the circular and the tribunal held that it was not binding on judicial authorities and in any case, it could not have a retrospective effect. The CBDT should seriously rethink its stand as it will be followed by the tax authorities, resulting in avoidable litigation.