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The Supreme Court on Tuesday held that when acceptance of freebies is punishable by the Medical Council of India (the range of penalties and sanction extending to ban imposed on the medical practitioner), pharmaceutical companies cannot be granted tax benefit for providing such freebies, and thereby (actively and with full knowledge) enabling the commission of the act which attracts such opprobrium.

The top Court also remarked that medical practitioners have a quasi-fiduciary relationship with their patients.

While delving into the role of doctor's, Court said that the doctor’s prescription is considered the final word on the medication to be availed by the patient, even if the cost of such medication is unaffordable or barely within the economic reach of the patient – "such is the level of trust reposed in doctors", court said.

Therefore,"it is matter of great public importance and concern, when it is demonstrated that a doctor’s prescription can be manipulated, and driven by the motive to avail the freebies offered to them by pharmaceutical companies, ranging from gifts such as gold coins, fridges and LCD TVs to funding international trips for vacations or to attend medical conferences," it added

"These freebies are technically not ‘free’ – the cost of supplying such freebies is usually factored into the drug, driving prices up, thus creating a perpetual publicly injurious cycle...", it further remarked.

A bench of Justices S Ravindra Bhat and UU Lalit was hearing an appeal filed by M/S Apex Laboratories filed against an order of the Madras High Court in which a division bench had upheld an order of the Income Tax Appellate Tribunal (“ITAT”), which in turn upheld an order of the Commissioner of Income Tax (Appeals) (“CIT(A)”).

The CIT(A) had partly allowed an appeal from an order of the instant respondent, i.e., Deputy Commissioner of Income Tax, which partially allowed amounts claimed by the company as ‘business expenditure’ under Section 37(1) of the Income Tax Act, 1961.

Brief Facts:

The Central Board of Direct Taxes (“CBDT”) had issued a circular in August 2012, which clarified that expenses incurred by pharmaceutical and allied health sector industries for distribution of incentives (i.e., “freebies”) to medical practitioners are ineligible for the benefit of Explanation 1 to Section 37(1).

Explanation 1 denies the application of the benefit for any purpose which is an ‘offence’ or ‘prohibited by law’.

After the circular was issued, in November, 2012, the company was issued a notice under Section 142(1) of the IT Act, to explain why the expenditure of ₹ 4,72,91,159/- incurred towards gifting freebies such as hospitality, conference fees, gold coins, LCD TVs, fridges, laptops, etc. to medical practitioners for creating awareness about the health supplement ‘Zincovit’, should not be added back to its total income.

The reason for only a partial allowance by the authorities below was that an amendment to the Medical Council Act, 1956 (now repealed) through the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002  published in the Official Gazette in December 2009, disallowed medical practitioners from accepting emoluments in the form of inter alia gifts, travel facilities, hospitality, cash or monetary grants.

Acceptance of such freebies could result in a range of sanctions against the medical practitioners, from ‘censure’ for incentives received up to ₹ 5,000/-, to removal from the Indian Medical Register or State Medical Register for periods ranging from three months to one year. Therefore, only the expenses incurred till December 14, 2009 were eligible for the benefit of Section 37(1), and not for the entirety of the Assessment Year 2010-2011, as claimed by Apex.

Analysis by Top Court:

Section 37 is a residuary provision, the bench held. It added that any business or professional expenditure which does not ordinarily fall under Sections 30-36 of the IT Act, and which are not in the nature of capital expenditure or personal expenses, can claim the benefit of this exemption.

"But the same is not absolute. Explanation 1, which was inserted in 1998 with retrospective effect from 01.04.1962, restricts the application of such exemption for “any purpose which is an offence or which is prohibited by law”, Court said.

"The IT Act does not provide a definition for these terms.....Under the IPC, Section 40 defines it as “a thing punishable by this Code”, read with Section 43 which defines ‘illegal’ as being applicable to “everything which is an offence or which is prohibited by law, or which furnishes ground for a civil action”. It is therefore clear that Explanation 1 contains within its ambit all such activities which are illegal/prohibited by law and/or punishable."...said the Court. 

It was further held that a narrow interpretation of Explanation 1 to Section 37(1) of the Income Tax Act, 1961 could not be taken as it would defeat the purpose for which it was inserted, i.e., to disallow an assessee from claiming a tax benefit for its participation in an illegal activity.

Refusing to accept Apex’s contention that it did not indulge in any illegal activity by committing an offence, as there was no corresponding penal provision in the 2002 Regulations applicable to it, it was held that there was no doubt that its actions fell within the purview of “prohibited by law” in Explanation 1 to Section 37(1).

"Furthermore, if the statutory limitations imposed by the 2002 Regulations are kept in mind, Explanation (1) to Section 37(1) of the IT Act and the insertion of Section 20A of the Medical Council Act, 195623 (which serves as parent provision for the regulations), what is discernible is that the statutory regime requiring that a thing be done in a certain manner, also implies (even in the absence of any express terms), that the other forms of doing it are impermissible..", said the Court.

Reliance was also placed on a settled principle of law that no court will lend its aid to a party that roots its cause of action in an immoral or illegal act (ex dolo malo non oritur action) meaning that none should be allowed to profit from any wrongdoing coupled with the fact that statutory regimes should be coherent and not self-defeating.

"Doctors and pharmacists being complementary and supplementary to each other in the medical profession, a comprehensive view must be adopted to regulate their conduct in view of the contemporary statutory regimes and regulations. Therefore, denial of the tax benefit cannot be construed as penalizing the assessee pharmaceutical company. Only its participation in what is plainly an action prohibited by law, precludes the assessee from claiming it as a deductible expenditure."

The Court was further of the view that an agreement between the pharmaceutical companies and the medical practitioners in gifting freebies for boosting sales of prescription drugs is also violative of Section 23 of the Contract Act, 1872.

Interpretation of Statutes:

Talking about Interpretation of law, the court said that it has two essential purposes, firstly, to clarify to the people governed by it, the meaning of the letter of the law; and the other is to shed light and give shape to the intent of the law maker.

In serving these two essential purposes, the bench added that the courts' responsibility lies in discerning the social purpose which the specific provision subserves.

"..., the cold letter of the law is not an abstract exercise in semantics which practitioners are wont to indulge in. So viewed the law has birthed various ideas such as implied conditions, unspelt but entirely logical and reasonable obligations, implied limitations etc. The process of continuing evolution, refinement and assimilation of these concepts into binding norms (within the body of law as is understood and enforced) injects vitality and dynamism to statutory provisions. Without this dynamism and contextualisation, laws become irrelevant and stale...", opined the Court.

Thus, pharmaceutical companies’ gifting freebies to doctors, etc. was held to be clearly “prohibited by law”, and not allowed to be claimed as a deduction under Section 37(1) as doing so would wholly undermine public policy.

Court's Decision:

In the present case, the incentives or “freebies” given by Apex, to the doctors, were held to have a direct result of exposing the recipients to the odium of sanctions, leading to a ban on their practice of medicine.

These sanctions were mandated by law, as they were embodied in the code of conduct and ethics, which are normative, and have legally binding effect.

Furthermore, the conceded participation of Apex was held to be was plainly prohibited, as far as their receipt by the medical practitioners was concerned and the medical practitioners being forbidden from accepting such gifts, or “freebies” was no less a prohibition on the part of Apex. 37. 

Accordingly, the Court was of the view that the impugned judgment cannot be faulted with, and the appeal ought to be dismissed.

Case Title: M/s Apex Laboratories Pvt. Ltd. v. Deputy Commissioner of Income Tax, Large Tax Payer Unit - II