Allowability of sales promotion expenses to pharmaceutical companies – Recent developments
Pharmaceutical companies have received some relief in the recent favorable decisions such as Aishika Pharma (P.) Ltd[i] which have allowed tax deduction of expenses in the nature of sales promotion, marketing and distribution expenses which would otherwise be outright disallowed by tax authorities due to Circular No. 5/2012 dated 1-8-2012 issued by the Central Board of Direct Taxes (‘CBDT’) which cites such expenses as inadmissible as per Section 37(1) of the Income-tax Act, 1961 (the ‘Act’).
The Medical Council of India, a regulatory body constituted under the Medical Council Act, 1956 which governs medical professionals amended the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 (the ‘MCI Regulations’) on December 10, 2009 whereby it inserted Clause 6.8 to Chapter 6. The clause deals with unethical acts by medical practitioners and prohibits medical practitioners from accepting any gifts, travel facility, hospitality and cash or monetary grants in the course of their relationship with pharmaceutical and allied health care sector industry.
Explanation 1 to Section 37(1) of the Act prohibits deduction of any expenditure which has been incurred by the assessee for any purpose which is prohibited by law or is an offence under any law. The pharmaceutical industry received a bitter pill to swallow when the CBDT issued Circular No. 5/2012, dated 1-8-2012 wherein it stated that pursuant to the amendment to MCI Regulations, expenses incurred by pharmaceutical and allied health care sector industry on freebies shall be disallowed.
The abovementioned circular was challenged by Confederation of Indian Pharmaceutical Industry (SSI)[ii] before the Hon’ble Himachal Pradesh High Court wherein the High Court upheld its validity, albeit with a rider. It clarified that if the assessee satisfies the assessing officer (‘AO’) that the expenditure is not in violation of the MCI Regulations, then it can legitimately claim a deduction. The onus therefore, is on the assessee to satisfy the AO as to the inapplicability of the circular in its case.
1. Inapplicability of the MCI regulations on pharmaceutical companies:
Section 37(1) of the Act allows deduction of expenditure incurred wholly and exclusively for business purposes of the assessee. As per Explanation 1 of the said section, expenses incurred for the purpose of an offence or which is prohibited by law is inadmissible. As per one view, the offence/violation of law should be committed by the person claiming the expenditure.
On the basis of this principle, it can be contended that the MCI Regulations are not applicable to the pharmaceutical industry altogether, but to registered medical practitioners under the MCI Act, 1956. This view is evident from the following:
1. The notified MCI Regulations clearly states that it is related to “registered medical practitioners”
2. This view was supplemented by the decision of the Hon’ble Delhi High Court In the case of Max Hospital v. MCI[iii] wherein the MCI in its affidavit admitted that its jurisdiction under the MCI Regulations is limited only to take action against registered medical professionals
3. Para 6.8.1 inserted by the MCI on December 1, 2016 lists the actions that shall be taken against medical practitioners (and not pharmaceutical companies) for violation of clause 6.8 of the MCI Regulations.
Once so established, it follows that there could be no violation of law which the entity is not governed by. Therefore, it is the medical practitioners who are prohibited from accepting freebies. There is no restriction whatsoever on the pharmaceutical companies.
These views have been upheld in the case of PHL Pharma[iv] by the Mumbai ITAT. The ITAT stated that, since a law being specifically applicable to a particular category of persons cannot be applicable to all other persons not so mentioned. Therefore, there being no violation of law by the pharmaceutical companies, there can be no disallowance of such expenses on gift articles, etc[v].
The Uniform Code of Pharmaceuticals Marketing Practices (UCPMP) – a code issued by the Department of Pharmaceuticals in 2014 deters the pharmaceutical industry from resorting to incentivizing doctors to prescribe their products through rewards such as gifts and free travel. However, the UCPMP is also voluntary in nature and therefore, there is no law currently in force which explicitly makes such activities illegal.
2. However, such expenses may be disallowable on the grounds of being ‘opposed to public policy’:
Inspite of the MCI regulations being inapplicable to the pharmaceutical industry, the expenses on sales promotion such as commission to doctors for referring patients or prescribing a specific company’s product against some incentive may still be disallowed on the grounds of being ‘opposed to public policy’ as has been done by the Hon’ble Punjab & Haryana High Court in the case of Kap Scan and Diagnostic Centre (P.) Ltd.[vi].
In this case, the Court, considering the express or implied contract with the medical practitioners (since sometimes the medical practitioners would agree to prescribe the products only against considerations such as gifts, travel facilities, etc) looked into Section 23 of the Contract Act which equates an agreement or contract as opposed to public policy, with an agreement forbidden by law.
The doctrine of public policy has time and again been considered by judicial forums to decide allowance of expenses and consequently disallowed expenses such as bribes or secret commission. The insertion of Explanation 1 to Section 37 by Finance Act 1998 codified this doctrine and disallowed expenses for purposes which are an offence or prohibited by law. Even though Explanation does not explicitly disallow expenses opposed to public policy, but while explaining the scope of the terms ‘prohibited by law’, the courts have given it a much wider connotation.
An analogy may be drawn to cases involving disallowance of bribe paid to private persons. In such cases the Courts[vii] have disallowed such expenses even though not explicitly disallowed by any legislation on the grounds that merely because the Parliament has not passed any legislation barring such transactions does not mean that they are not immoral. Therefore, the courts have upheld disallowance on grounds of an action being opposed to public policy over the technical aspect of absence of an express provision in the law.
The term ‘public policy’ has not been defined in the Contract Act but in general parlance would mean matters concerning or in the interest of the public at large. Encouraging prescriptions by doctors with an intention to favor a particular company and the ‘cut-practice’ by diagnostic centers is definitely detrimental to patients and public at large who bear the brunt of high fees and expensive medicines.
Even though UCPMP is currently voluntary in nature, it is expected to be followed in its true spirit by the pharmaceutical companies. This is evident from its introductory paragraph which states that its ineffective implementation would prompt the government to introduce a legislation to curb such practices. As per some recent news reports[viii], such a legislation is already in the works and is expected would include a Rs. 1,000 cap on the value of giveaways, a blanket ban on freebies such as cruise and vacations and even cancellation of the doctor’s license.
3. Principal purpose of expenses:
Not all expenses incurred towards sales promotion shall be ‘opposed to public policy’. This has also been recognized in the case of Confederation of Indian Pharmaceutical Industry (SSI) [supra] wherein it was held that the assessee can substantiate his case on facts as to why such expenses do not qualify as ‘freebies’ and do not fall under the purview of the MCI regulations.
A pharmaceutical company incurs several expenses such as on organizing seminars, discussion panels for doctors, lectures, awareness campaigns, distribution of articles embossed with brand name, etc.
As far as allowability on the basis of being a ‘freebie’ is concerned, the judicial forums have examined the principal purpose of the expenses or the motive behind these expenses as a test to examine whether it would qualify as a ‘freebie’.
The term ‘freebie’ has been examined by the Mumbai ITAT in the case of M/s. Solvay Pharma India Ltd. The term has not been defined either in the Act or the MCI regulations. The ITAT looked into the ‘purpose’ of the expenditure incurred which was not to give something free of charge but to market its products and disseminate knowledge. Since the act of giving something free of charge is incidental to the main objective of product awareness, it was allowed as an expense.
Where the main purpose of promotional activities such as organizing seminars is to make the doctors aware of its products and it’s the research work the company has undertaken and updating them of the latest developments in the therapeutic areas, distributing free samples to prove efficacy and establish trust of the doctors, the expenses were held to be allowable and would not qualify as a ‘freebie’[ix].
As against this, in the case of Liva Healthcare Ltd[x], the Tribunal disallowed expenses on overseas tours of doctors since the activities at the seminar were primarily for the entertainment of doctors and their spouses (which included activities such as cruise travels to island, gala dinner, cocktails, entertainment etc.) rather than being for knowledge enhancement or knowledge sharing oriented. Since these expenses were primarily for maintaining good relations with doctors in lieu of the doctors recommending the company’s products, these expenses were disallowed being in violation of the MCI Regulations. Similarly, in the case of M/s. OCHOA Laboratories Ltd.[xi], sponsorship of doctors for attending such conferences was held to be akin to a commission to them against the consideration of prescriptions of the company’s products and therefore, disallowable.
New product development by pharmaceutical companies requires extensive research for many years, extensive medical trials and ultimately dissemination of knowledge regarding the product, its usage and benefits and side effects. In the competitive industry therefore, expenses on sponsoring seminars is necessary for brand promotion.
What distinguishes each of these cases is the intent of such expenses. Expenses on small value gift articles embossed with the company’s name or sponsoring seminars on a particular therapeutic area are primarily for brand awareness and therefore, have been allowed by the Tribunals being wholly and exclusively for business purpose. On the other hand, expenses directed towards incentivizing medical practitioners is clearly detrimental to the patients, opposed to public policy and therefore, disallowable.
The Hon’ble Himachal Pradesh High Court in the case of Confederation of Indian Pharmaceutical Industry (SSI)[xii] considering the fact that the MCI Regulations being in the interest of public upheld the validity of the circular and endorsed the view of the CBDT while also putting the onus on the companies to prove the allowability. In the recent cases decided by the ITAT, inapplicability of the MCI Regulations to pharmaceutical companies as well as the purpose of such expenses has been given primacy to. These can be taken as guidelines by the industry along with the UCPMP so that the expenses are not disallowed.
As the saying goes, a spoonful of sugar helps the medicine go down, having regard to the highly competitive nature of the industry, a codified set of rules for the industry should be enacted which would not only rationalize such expenses and meet ethical standards but also enable companies to promote their products in the right way and serve their purpose as well.
[i] 106 taxmann.com 192 (Delhi – Trib.)
[ii]  353 ITR 388/ 44 taxmann.com 365 [CWP No. 10793 of 2012-J.]
[iii] [WPC 1334/2013, dated 10-1-2014]
[iv]  78 taxmann.com 36 (Mumbai – Trib.)
[v] Similar views have been expressed in the following cases:
[vi]  344 ITR 476/25 taxmann.com 92
[vii] J.K. Panthaki & Co.  22 taxmann.com 49 (Karnataka)
[ix] Similar view was initially expressed in the following cases:
[x]  161 ITD 63/73 taxmann.com 171
[xi] ITA No. 4114/Del/2009
[xii]  353 ITR 388/ 44 taxmann.com 365