Case Law Details
Medley Pharmaceuticals Ltd Vs DCIT (ITAT Mumbai)
ITAT Mumbai held that deduction u/s 80IB of the Income Tax Act, in respect of increased business income due to addition on account of concealed production, is not allowable.
Facts- The assessee is a company engaged in the business of manufacturing and selling of pharmaceutical products. For A.Y. 2010-11, the assessee filed the return of income declaring a taxable income at Rs.81,83,793/- after claiming deduction u/s. 80G and 80IB amounting to Rs.30,20,66,215/-. For A.Y. 2011-12, the assessee offered taxable income of Rs.24,38,48,900/- after claiming deduction u/s. 80G and 80IB amounting to Rs.11,96,35,535/-.
The case was selected for scrutiny and the statutory notices were duly served on the assessee. AO concluded the assessment by making a disallowance of Rs.19,73,90,622/- for AY 2010-11 towards concealed sales arising out of concealed production. AO made a similar disallowance for A.Y. 2011-12 for an amount of Rs.17,30,96,446/-.
Aggrieved, the assessee filed appeal before the CIT(A), who confirmed the above addition made by the AO. The Ld.CIT(A) also did not accept the submissions of the assessee that the addition made should be allowed as deduction u/s. 80IB for the reason that Form 10CCB was not filed for the enhanced income and, therefore, the addition made cannot be allowed as deduction u/s. 80IB of the Act.
Conclusion- Respectfully following the said decision of the coordinate bench, we see no reason to interfere with the decision of the CIT(A) in rejecting the claim of the assessee that 80IB deduction be allowed in respect of increase in the business income due to addition on account of concealed production. This ground is dismissed.
FULL TEXT OF THE ORDER OF ITAT MUMBAI
These two appeals are against the order of the Commissioner of Income-tax (Appeals)-17, Mumbai dated 31/12/2018 for the assessment years 2010-11 and 2011-12.
2. The issues contended are common in both the appeals and hence, they were heard together and are disposed off through this common order. The common grounds raised by the assessee in both the appeals are with regard to the following issues:-
(1) Alleged concealed sales arising out of alleged concealed production;
(2) Allowing 80IB exemption in respect of increased business income due to addition on account of alleged concealed production.
(3) Disallowance of sales promotion expenses; and
(4) Not allowing 80IB deduction in respect of disallowed sales promotion expenses.
2. The brief facts of the case are that the assessee is a company engaged in the business of manufacturing and selling of pharmaceutical products. The assessee has manufacturing facilities at 5 locations in Jammu. For the assessment year 2010-11, the assessee filed the return of income declaring a taxable income at Rs.81,83,793/- after claiming deduction under sections 80G and 80IB amounting to Rs.30,20,66,215/-. For A.Y. 2011-12, the assessee offered taxable income of Rs.24,38,48,900/- after claiming deduction under sections 80G and 80IB amounting to Rs.11,96,35,535/-. The case was selected for scrutiny and the statutory notices were duly served on the assessee. The Assessing Officer concluded the assessment by making a disallowance of Rs.19,73,90,622/- for AY 2010-11 towards concealed sales arising out of concealed production. The Assessing Officer made a similar disallowance for A.Y. 2011-12 for an amount of Rs.17,30,96,446/-. Aggrieved, the assessee filed appeal before the CIT(A), who confirmed the above addition made by the Assessing Officer. The Ld.CIT(A) also did not accept the submissions of the assessee that the addition made should be allowed as deduction under section 80IB for the reason that Form 10CCB was not filed for the enhanced income and, therefore, the addition made cannot be allowed as deduction under section 80IB of the Act.
3. During the course of appellate proceedings, a functional note was submitted by JCIT of circle 10(2)(2) to bring to the attention of the Ld.CIT(A) that in assessee’s case for A.Y. 2012-13 while completing the assessment, the doctors’ freebies were disallowed based on the circular issued by the CBDT. The CIT(A) , therefore, called on the assessee to explain why similar payments made for the years under consideration cannot be disallowed under section 37(1). The assessee made a detailed submission before the Ld.CIT(A) and submitted that the assessee has incurred certain sales promotion expenses which include amount spent on doctors’gift, travelling expenses, etc. The assessee also submitted that the CBDT circular No.5 / 2022 which is issued in August, 2012, is not applicable in assessee’s case for the reasons that the impugned expenses were incurred earlier to the circular. The assessee also submitted a break up of promotion expenses wherein the assessee has segregated the amount between the expenses which are incurred as per the norms and others. The assessee further submitted that the expenses are incurred towards the normal business of the assessee. Every day there are new developements taking place around the world in the area of medicine and therapeutic, hence, in order to provide correct diagonosis and treatment of patients, it is imperative that the doctors should keep themselves updated with the latest developments in the medicine and the main objects of the conference and seminars is to update the doctors of the latest development which is beneficial in treating the patients as well as the pharmaceutical companies. The CIT(A) did not accept the submissions of the assessee. Accordingly, the CIT(A) disallowed a sum of Rs.7,00,00,520/- for A.Y. 2011-12 and a sum of Rs.6,09,51,421/- for A.Y. 201011. The CIT(A) also rejected the claim of the assessee that the enhanced disallowance made towards sales promotion expenses should be allowed as a deduction under section 80IB of the Act. Aggrieved, assessee is in appeal before the Tribunal.
4. Concealed Sales arising out of concealed production
4.1 During the course of assessment, the Assessing Officer called on the assessee to provide the products’ samples of type 10 major manufactured products of the assessee. The Assessing Officer, after perusing the details submitted, was of the view that the assessee has shown particular quantity of consumption of ingredients but that quantity of finished products reported was unreasonably lesser. The Assessing Officer was of the view that the excessive consumption of raw materials revealed that the assessee has not correctly reported the production of finished goods and accordingly concluded that the assessee had not reported the production to carry out sales outside its books. The Assessing Officer computed the excessive consumption as per below table and accordingly made addition towards suppressed sales:-
|
Sl no |
Name of the unit | Value of the unrecorded production unit wise | ||
| AY – 2010-11 | AY – 2011-12 | |||
| 1 | Jammu unit | 9,86,18,888 | ||
| 2 | Daman unit-2 | 4,55,99,871 | ||
| 3 | Daman unit-3 | 1,28,74,470 | ||
| 4 | Daman unit-4 | 4,02,97,393 | ||
| TOTAL | 19,73,90,622 | |||
4.2. Aggrieved the assessee filed an appeal before the CIT(A). The assessee submitted before the CIT(A) that the above addition was worked out on the basis of the difference between consumption of ingredients as shown in the books as against the consumption as per label. The difference is arising due to various factors such as wastage of raw material, overages vitamins, enzymes etc., additional material input for potencies and moisture consumption, salt form and wastage during production. The assessee also submitted that the addition if made would result in extraordinary margin which is not reasonable in the line of business of the assessee. The assessee further submitted that the AO has worked out the undisclosed sales by applying MRP whereas the actual selling price is lower than the MPR and therefore the addition made on MRP rate is not correct. The CIT(A) after considering the submissions of the assessee held that –
10) Based on the above discussion and analysis of the assessment order, submission and arguments of the Appellant Company, various remand reports, documentary support filed by the Appellant Company the following conclusion emerges:
(i) The AO’s basis of computation of excess raw material consumption is based on an absolutely theoretical presumption that the raw material formulation shown on the packing of the particular drug should match with the total consumption of the raw material of the drug. Such presumption has no factual or scientific basis.
(ii) It has been argued and proved that in a pharmaceutical industry the yield of the formulation is around 97 to 97 1/2 %. The DPCO order also prescribes the wastage of raw material between 1.55 – 12 %.
(iii) There are factors which affect the manufacturing process and are responsible for the excess raw material consumption. These factors includes overages, salt factor, potency, loss on drying, sampling and yield etc.
(iv)The Batch Manufacturing Record (BMR) is a crucial record maintained by the pharmaceutical companies wherein specific detail like batch size, complete formulation, actual raw material issued, date of commencement and completion of batch, production equipment used in these processes and final finished goods output are given.
(v) The Appellant Company has included the scan copy of the relevant portion of the BMR which is a crucial and conclusive document. The BMR also gives a clear picture of actual raw material input and the ultimate finished goods produced for these batches.
(vi) The sample of the Finished Goods Transfer Note (FGTN) also has been filed for each of the respective BMR submitted which give the final output of the batch which is transferred to the finished goods warehouse
(vii) The complete set of argument along with BMR were produced during the second remand proceeding. The AO has examined and analysed threadbare and has not found any infirmity in the Appellants argument.
From the above it is clear that the basis of computation of wastages and ultimate v suppression of production as concluded by the AO in the assessment order is scientifically unsustainable. In any scientific manufacturing process leading to production of various drugs it cannot be presumed or surmised that one plus one is always equal to two. The prescribed authority DPCO has prescribed a range of wastages in the process of manufacturing of pharmaceutical drugs. Thus, the theoretical The MRP of these products in the relevant year were lower than what is taken by A.O.
b) The A.O. has erred in taking MRP as the realization price of the products, whereas MRP is the price at which the retailers’ sell these products to the end consumer. The sale price of Company is NRV (Net Realizable value) which is much lower than MRP, due to margins of wholesalers, stockiest and retailers. Further due to special discounts and Bonus Schemes the Actual Realized Price is further lower than the NRV.
It may be noted that a list of correct MRP for the F.Y. 2009-10, and NRV as well as actual realized price was submitted to A.O. on 21.03.2014, however, the same is not considered.
Also, we have submitted sample copies of few invoices were submitted showing sales from company to stockiest/ CFA agents along with a NRV chart of products. .
In the 1st remand report dated 13th January 2015, the AO has accepted our contention that MRP is not our selling price and hence MRP cannot be considered. Further, assessment orders from AY 2012-13 have also been considering our selling price and not the MRP. Also, some of the products are only for exports and hence it is not even possible to sell these in the Indian market as the packs are in different language and also it is not permissible to market these in India as the pharmacopeia specifications are different and also MRP is not printed on these packs.
As requested in the course of hearing, we have submitted a statement based on NRV and adjusted WIP (Annexure II). The adjustment of WIP which was not considered in the original order has been accepted in the remand report dated 3rd July 2017. This statement is without prejudice to our 1st Ground of Appeal regarding deletion of entire addition of Rs. 19,73,90,622/- and this may not be construed as our consent to the said addition @ NRV.”
4.3. The CIT(A) also directed the AO to verify the selling price of the assessee on net realizable value and accordingly consider the addition.
4.4 Before us the Ld.AR submitted that a similar addition has been made in the AY 2012-13 and therefore submitted that the issue is covered by the decision of the co-ordinate bench in assessee ’ s own case for A.Y. 2012-13 (ITA No.2344/Mum2018) dated 22/07/2020 wherein it is held that –
“28. We have given a thoughtful consideration to the view taken by the CIT(A), and to the extent he had observed that the wastage up to the limits prescribed by the DPCO norms was to be accepted, we concur with him. At the same time, we are unable to persuade ourselves to subscribe to his view that the excess wastage of raw material would ipso facto lead to an inference of suppressed/unaccounted production carried out by the assessee. In our considered view, the aforesaid observation of the CIT(A) de hors any material evidencing the factum of suppressed/unaccounted production carried out by the assessee, cannot be accepted. Unexplained wastage of raw material, in our understanding can only lead to a consequential addition/disallowance of the cost of such raw material as had been debited by the assessee in its „books of accounts‟ for the year under consideration. Accordingly, we modify the order of the CIT(A) and therein direct the A.O to restrict the disallowance in respect of the excess raw material wastage in terms of our aforesaid observations. Ground of appeal No. 1 is partly allowed.”
4.5 The Ld.AR submitted that the facts are identical for the years under consideration also and accordingly prayed that the above decision of the coordinate bench be followed.
4.6 The Ld.DR relied on the order of the lower authorities.
5. We heard the parties and perused the materials available on record. We notice that for the years under consideration the basis on which the disallowance is made by the Assessing Officer and the decision of the CIT(A) modifying the addition is similar to A.Y. 2012-13 and, therefore, respectfully following the above decision of the co-ordinate bench, we modify the order of the CIT(A) wherein the A.O is directed to restrict the disallowance in respect of the excess raw material wastage in terms of the aforesaid observations of the Hon’ble Tribunal.
6. Allowing 80IB Deduction in respect of increased income due to addition on account of alleged concealed production.
6.1 The CIT(A) did not allow this claim of the assessee for the reason that the additional income is not supported by the amount mentioned in Form 10CCB basis which the deduction u/s.80IB is allowed. The CIT(A) also relied on the decision of the Hon’ble Supreme Court in the case of Commissioner of Customs vs Dilip Kumar to state that the while interpreting benevolent provisions when there is ambiguity the decision should be in favour of the assessee. Accordingly the CIT(A) did not accept the claim of the assessee.
6.2. The Ld.AR during the course of hearing submitted that this issue is held against the assessee in assessee’ s own case by the co-ordinate bench of the Tribunal for A.Y. 2012-13. Respectfully following the said decision of the coordinate bench, we see no reason to interfere with the decision of the CIT(A) in rejecting the claim of the assessee that 80IB deduction be allowed in respect of increase in the business income due to addition on account of concealed production. This ground is dismissed.
7. Sales promotion expenses
7.1 The CIT(A), during the appellate proceedings, sent a notice of enhancement under section 251(2) and the assessee has filed a reply stating that–
Merit of issue of Enhancement.
(i) The Appellant company has submitted the entire expenditure in a tabular form. The expenditure has been bifurcated into two groups one is taxable and the other in non-taxable meaning by taxable one are expenses which are disallowable u/s section 37(1) of the Act. Non-taxable items are those expenditure which according to the Company are not in the nature of freebees and also has not been incurred in violation of any public policy disallowable under Explanation to sec 37(1) of the Act.
(ii) It has also been argued that some of the expenditures are prior to 10.12.2009 when MCI guidelines came into effect. Thus it has been contended that MCI guidelines came on 10.12.2009 hence expenditure prior to this date should not be treated in violation of section 37(1) of the Act.
(iii) The appellant has also stressed upon that there are number of expenditure, though categorized under sales promotion however they are not related to the Doctors in any manner. Such expenditures have been identified as under:
|
Particular |
Total amount | Disallowed | Allowed | Details |
| Advertisement & Publicity A/C | 40,33,942 | – | 40,33,942 | Unrelated to Doctors |
| Leave Behind A/C | 78,73,279 | – | 68,73,279 | These are not gifts / freebies |
| Product reminder | 4,31,41,360 | 4,31,41,360 | – | |
| Retail Push Scheme | 3,323 | 3,323 | Unrelated to Doctors | |
| Visual aid A/C | 37,75,811 | – | 37,75,811 | These are not gifts / freebies |
| CME Expenses A/C | 1,09,23,883 | – | 1,09,23,883 | |
| Travelling (Conference) | 19,85,738 | 17,20,648 | 2,65,090 | |
| Gift and Rewards [Employee] | 3,245 | 3,245 | Unrelated to doctors | |
| Doctors Expenses | 74,32,130 | 74,32,130 | – | |
| Overseas Expenses A/C | 2,39,37,687 | 2,39,37,687 | This expenditure is no way related to doctors. It has actually been incurred on Sales Promotion in various countries. The AO has consistently allowed this expenditure upon scrutiny in other years. |
|
| Sales Promotion Exp (Others) | 36,61,773 | 36,61,773 | – | |
| Doctors Gift | 49,95,530 | 49,95,530 | – | |
| Total | 11,07,67,701 | 6,09,51,441 | 4,98,16,260 | |
| Decrease / (Increase) in PS stock | 28,90,050 | – | 28,90,050 | |
| Total | 11,36,57,751 | 6,09,51,441 | 5,27,06,310 |
“(iv) It has been submitted that MCI guideline was revised in 2009-10 and CBDT circular 5/2012 came in 2012, Thus expenditure under reference prior to these date should be allowed.
(v) It has also been argued that gifts below Rs.1000/- are allowed able under MCI guideline.
(vi) Decisions of Hon’ble ITAT in case of PHL Pharma (Supra), Syncom Formulation (Supra) which is based on PHL Pharma, and M/s Edwards Life Science (India) Pvt. Ltd, (Supra) have been relied upon.
(vii) Lastly it has been argued that CBDT circular does not have retrospective effect hence expenditure prior to 2012 can’t be disallowed.”
7.2 With regard to the submissions of the assessee that the gifts which are less than Rs.1000 should be allowed, the CIT(A) held that the assessee has not shared any details such as item, recipient doctors, their confirmation of receiving only one gift in a year etc., and therefore the said claim cannot be entertained. The Ld.CIT(A) concluded that the submissions of the assessee are not based on correct appreciation of law and the impugned expenses are clearly hit by Explanation to section 37(1) of the Act. The CIT(A) however gave partial relief to the assessee after taking into account the break-up of expenses submitted by the assessee as above and disallowed a sum of Rs.6,09,51,441. With the similar observations the CIT(A) disallowed a sum of Rs.7.00,00,520 for AY 2011-12.
7.3 The Ld. AR submitted that the coordinate bench in assessee’s own case for AY 2012-13 has considered the same issue on merits and held that the A.O on merits was not justified in disallowing the sale promotion expenses by bringing the same within the realm of the explanation to Sec. 37(1) of the Act. The ld AR further submitted that the insertion of explanation 3 to section with effect from 1/4/22 is prospective in nature and therefore cannot be applicable in assessee’s case and therefore the issue is covered by the decision of the coordinate bench.
7.4 The ld DR on the other hand vehemently argued that the MCI Guidelines are very clear with respect to what is allowable and therefore any amount paid in violation of the said guidelines would be clearly get covered under the explanation 3 to section 37(1). The ld DR further submitted that the amendment is clarificatory in nature and from the wordings used in the explanation it is evident that the amendment is retrospect and the expenses incurred by the assessee which is hit by the explanation is not allowable. The ld DR also brought to our attention the decision of the Hon’ble Apex Court in the case of M/s.Apex Laboratories Pvt. Ltd. v. DCIT [2022] 135 taxmann.com 286 (SC) where it has been held that since acceptance of freebies by medical practitioners was punishable as per Circular issued by Medical Council of India under MCI regulations, 2002, gifting of such freebies by -pharmaceutical company to medical practitioners would also be prohibited by law and thus, expenditure incurred in distribution of such freebies would not be allowed as a deduction in terms of Explanation 1 to section 37(1).
7.5 The Ld.AR to counter submitted that the expenses incurred by the assessee have not been examined from the perspective of what is prohibited as per the MCI regulations, 2002 by the lower authorities in assessee’s case in order to apply the ratio laid down by the Hon’ble Supreme Court in the case of ApexLaboratories (P.) Ltd (supra). The ld AR therefore without prejudice submitted that the expenses need to be examined thoroughly as per the MCI regulations and the disallowance to be decided accordingly. In this regard the ld AR submitted before us complete break-up of expenses segregating expenses between what is paid to others (non doctors), paid towards gifts below Rs.1,000/- and what is paid to doctors for both AY 2010-11 and AY 2011-12.
7.6 We have heard rival submissions and perused the material on record. The contentions of the ld AR on merits is that though the assessee had submitted the break-up of expenses before the lower authorities the details were not segregated under various heads in order to be examined in the light of MCI guidelines to apply the ratio laid down by the Apex Court. In this regard it is pertinent to note that prior to the judgment of the Hon’ble Apex Court in the case of M/s.Apex Laboratories Pvt. Ltd. v. DCIT (supra), many of the judicial pronouncements had held that MCI Regulations are not applicable on pharmaceutical companies and expenses incurred by such companies are not violative of CBDT Circular based on summary evaluation of expenditure. Even the coordinate bench in assessee’s own case for AY 2012-13 has also taken a similar view basis the overall examination of expenses to hold that explanation to section 37(1) is not applicable to the sales promotion expenses. For the year under consideration there is no critical evaluation of the expenses and post the Hon’ble Supreme Court judgment, the dictum laid down, same needs to be followed and each of the expenditure needs to be evaluated to see if the disallowance is justified. In the present case, the A.O. had primarily made disallowance by referring the CBDT Circular No.5/2012 dated 01.08.2012. The A.O. has not critically examined the nature of expenditure incurred by the assessee. In the larger interest of justice, in view of the latest judgment of the Hon’ble Apex Court, which has examined the very same issue, it becomes necessary to examine the exact nature of expenses incurred by the assessee for Doctors from all angles. Therefore, for substantial question and cause, necessarily, the matter needs fresh verification by the A.O, especially in the light of the recent judgment of the Hon’ble Supreme Court in the case of M/s.Apex Laboratories Pvt. Ltd. v. DCIT (supra). For the aforesaid purpose, the issues for both AY 2010-11 and 2011-12 is remitted back to the AO with a direction to examine the details of expenses submitted from MCI guidelines perspective in the light of the decision of the Apex Court after giving an opportunity of being heard to the assessee. It is ordered accordingly.
8. The next ground is with respect to allowing of deduction under section 80IB in respect of the sale promotion expenses disallowed. In this regard it was submitted that as per CBDT circular No.37/2016 dated 2nd November 2016, specific disallowances related to the business activity against which the Chapter VI-A deduction has been claimed result in enhancement of profits of the eligible business and that deduction under chapter VI-A is admissible on the profits so enhanced by the disallowance. Accordingly the ld AR prayed that the expenses if any disallowed based on the verification of expenses in the light of the decision of the Apex Court the same may be considered for the purpose of deduction u/s.80IB.
9. The ld DR on the other hand objected to the said contention for the reason the Form 10CCB does not include the expenses disallowed and therefore the deduction u/s.80IB cannot be allowed.
10. We heard the parties and perused the material on record. In view of the CBDT circular No.37/2016 dated 2nd November 2016, we direct the AO to consider enhanced profits due to the disallowance if any of sales promotion while computing the revised deduction u/s.80IB for AY 2010-11 and 2011-12 Needless to say that the assessee be given a reasonable opportunity of being heard.
11. In result the appeals of the assessee for AY 2010-11 and 2011-12 are allowed.
Order pronounced in the open court on 23/05/2023.
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