A contentious issue that has seen much litigation in the recent past is regarding the claim of expenditure under Section 37 of the Income-tax Act, 1961 (‘IT Act’) incurred by pharmaceutical companies on gifting of freebies to doctors.
The cause for controversy behind this claim has been the notification dated 10 December 2009 whereby the Medical Council of India (‘MCI’) amended the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 (‘MCI Regulations’) to prohibit medical practitioners from receiving any kind of gifts, travel facilities, hospitality or monetary grants from the pharmaceutical and allied health sector industry.
Explanation 1 to Section 37 of the IT Act disallows the deduction on account of any expenditure incurred by an assessee for any purpose which is an offence, or which is prohibited by law. However, the consistent position taken by pharmaceutical companies has been that the prohibition imposed by the MCI was applicable only to medical practitioners and not to them. Thus, the Explanation 1 to Section 37 would not apply to them.
On the contrary, the income-tax department (‘Department’), as is evident from Circular No. 5/2012 dated 1 August 2012, took the view that any expense incurred in advancing freebies to medical practitioners in violation of the amended MCI Regulations would be inadmissible under Section 37 of the IT Act. This dispute led to contrary judgments across different High Courts and a lack of certainty regarding the correct position of law on the issue.
Amendments were proposed to Section 37 of the IT Act, vide Finance Bill, 2022, to provide that expenditure incurred for any purpose which is an offence shall include provision of benefit or perquisite the acceptance of which is in violation of any law, rule etc. governing the conduct of the person accepting the benefits. Although, the scope of the proposed amendment was wide, the freebies provided by pharmaceutical companies were the direct target of the amendment. Even before the amendments could be brought into effect from 1 April 2022, the Supreme Court pronounced its judgment on this issue.
The SC decision - Apex Laboratories (P.) Ltd. case
The Supreme Court in a recent judgment has denied the claim of expenditure by pharmaceutical companies providing freebies to doctors by holding that the narrow interpretation of Explanation 1 to Section 37 of the IT Act relied upon by pharmaceutical companies would defeat the very purpose behind its insertion. It took the view that one arm of the law cannot be utilized to defeat the other arm of law since doing so would be opposed to public policy.
The Court, thus, held that the actions of pharmaceutical companies were clearly ‘prohibited by law’. It observed that since doctors have a quasi-fiduciary relationship with their patients, it is a matter of public importance to ensure that their actions are not manipulated by the lure of freebies from pharmaceutical companies. The gifting of freebies results in a perpetual publicly injurious cycle of expensive drugs being foisted upon patients by doctors over generic alternatives, thereby driving up drug prices.
The Court also held that doctors and pharmaceutical companies play complementary and supplementary roles to each other in the medical profession. Therefore, a comprehensive view must be adopted to regulate their conduct. Since medical practitioners are forbidden from accepting such gifts, the donor pharmaceutical companies are also prohibited from giving them.
In addition to being opposed to public policy, the Supreme Court also took the view that the agreement between pharmaceutical companies and doctors for gifting freebies for boosting sales of prescription drugs was also violative of Section 23 of the Contract Act, 1872 since the consideration for the same was forbidden by law.
While one may feel that the dust has finally settled on this issue, some new challenges may potentially crop up for the sector. The first issue is regarding the retrospectivity of the disallowance under Section 37 of the IT Act where litigation is still pending. While the CBDT Circular vide which the Department had stated that disallowance must be made under Section 37 of the IT Act of expenditure on account of freebies given to doctors was issued in 2012, the amendment of the MCI Regulations took place in 2009. By virtue of the Supreme Court’s decision, the judicial authorities may disallow similar expenses incurred before the issuance of CBDT Circular.
Another issue is that while the amended MCI Regulations allow medical practitioners to work for pharmaceutical and allied healthcare industries in advisory capacities or to participate in research projects funded by pharmaceutical and allied healthcare industries, the acceptance of gift, travel facilities and hospitality is strictly prohibited. The question which may now arise is whether a pharmaceutical company will be allowed the claim of expenditure under Section 37 of the IT Act if it is incurred for making travel or hospitality arrangements pursuant to an affiliation.
For example, if a pharmaceutical company makes arrangements of conveyance or stay at such a location for the medical practitioners to seek consultancy services from the practitioner, would expenditure incurred for such facilities also be a prohibited expenditure? Similar issues could come up where a pharmaceutical company offers food coupons or a per diem allowance to a medical practitioner working as a consultant or researcher. Situations such as these may involve expenditure for bona fide reasons of furthering the professional engagement between a medical practitioner and a pharmaceutical company. Yet, the Department may seek to disallow of these expenditures citing the Supreme Court judgment. The liability of pharmaceutical companies to withhold tax under Section 194R (which will come into effect from 1 July 2022) in relation to these incidental facilities could also become a subject matter of dispute.
The Supreme Court’s decision in the case of Apex Laboratories (P.) Ltd. has inextricably linked the operations of the IT Act with that of the MCI Regulations. Given the fact that the companies operating in this sector work closely with heath care practitioners, the contracts between the parties are likely to invite a closer scrutiny from the tax department. The pharmaceutical and allied health sector companies should ensure that they maintain adequate proofs to satisfy the tax officer that the expense incurred towards health care professional is for furtherance of business and in compliance of MCI Regulations. The healthcare sector itself may need a comprehensive health check to identify and fix problems.
[The Author is a Senior Associate in Direct Tax practice team at Lakshmikumaran and Sridharan Attorneys, New Delhi]
 Notification No. MCI-211(1)/2009 (Ethics)/55667.
 Apex Laboratories (P.) Ltd. v. CIT, Order dated 22nd February 2022 in Civil Appeal No. 1554 OF 2022.