LEGAL ISSUE: Whether pharmaceutical companies can claim tax deductions on expenses incurred for providing freebies to medical practitioners.
CASE TYPE: Income Tax Law
Case Name: M/s Apex Laboratories Pvt. Ltd. vs. Deputy Commissioner of Income Tax
[Judgment Date]: 22 February 2022
Date of the Judgment: 22 February 2022
Citation: 2022 INSC 149
Judges: Uday Umesh Lalit, J., S. Ravindra Bhat, J.
Can pharmaceutical companies claim tax deductions for expenses on gifts given to doctors? The Supreme Court of India recently addressed this critical question in a case involving M/s Apex Laboratories Pvt. Ltd. The court examined whether such expenses qualify as ‘business expenditure’ under the Income Tax Act, 1961, especially when medical regulations prohibit doctors from accepting such gifts. This judgment clarifies the intersection of tax law and medical ethics, setting a significant precedent. The bench comprised Justices Uday Umesh Lalit and S. Ravindra Bhat, with the majority opinion authored by Justice S. Ravindra Bhat.
Case Background
M/s Apex Laboratories Pvt. Ltd. (hereafter referred to as “Apex”) claimed certain expenses as business expenditure under Section 37(1) of the Income Tax Act, 1961. These expenses were related to providing freebies to medical practitioners to promote their health supplement, ‘Zincovit.’ These freebies included items such as hospitality, conference fees, gold coins, LCD TVs, fridges, and laptops. The Income Tax Department disallowed a portion of these expenses, citing that these were prohibited by law.
The Central Board of Direct Taxes (CBDT) issued a circular on 01 August 2012, clarifying that expenses incurred by pharmaceutical companies for distributing incentives to medical practitioners are not eligible for tax benefits under Explanation 1 to Section 37(1) of the Income Tax Act. This explanation denies benefits for expenditures that are considered an ‘offence’ or ‘prohibited by law’.
The core issue arose because the Medical Council of India (MCI) through the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002, had amended its regulations on 14 December 2009. These amendments disallowed medical practitioners from accepting gifts, travel facilities, hospitality, cash, or monetary grants.
Timeline
| Date | Event |
|---|---|
| 14 December 2009 | Amendment to the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002, prohibiting doctors from accepting freebies. |
| 01 August 2012 | CBDT issued a circular clarifying that expenses on freebies to doctors are not eligible for tax benefits. |
| 22 November 2012 | Apex 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 should not be added back to the total income of Apex. |
| 21 March 2013 | Deputy Commissioner of Income Tax partially allowed the claim of Apex. |
| 29 January 2014 | Commissioner of Income Tax (Appeals) partly allowed the appeal from the order of Deputy Commissioner of Income Tax. |
| 29 January 2018 | The Income Tax Appellate Tribunal (ITAT) upheld the order of the Commissioner of Income Tax (Appeals). |
| 18 March 2019 | The High Court of Judicature of Madras upheld the order of the ITAT. |
| 22 February 2022 | The Supreme Court of India dismissed the appeal of Apex. |
Course of Proceedings
The Deputy Commissioner of Income Tax partially allowed Apex’s claim, allowing expenses only up to 14 December 2009, the date when the amended regulations came into effect. The Commissioner of Income Tax (Appeals) upheld this decision. The Income Tax Appellate Tribunal (ITAT) also upheld the decision of the Commissioner of Income Tax (Appeals). Finally, the High Court of Judicature at Madras upheld the ITAT’s order. Apex then appealed to the Supreme Court.
Legal Framework
The case revolves around Section 37(1) of the Income Tax Act, 1961, which allows deductions for business expenditures. However, Explanation 1 to Section 37(1) disallows expenditures that are for any purpose which is an offence or prohibited by law.
Section 37(1) of the Income Tax Act, 1961 states:
“Any expenditure (not being expenditure of the nature described in Sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.”
Explanation 1 to Section 37(1) of the Income Tax Act, 1961 states:
“For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.”
The Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002, specifically Regulation 6.8, prohibits medical practitioners from accepting gifts, travel facilities, hospitality, cash, or monetary grants from pharmaceutical companies.
Regulation 6.8 of the 2002 Regulations states:
“6.8. Code of conduct for doctors in their relationship with pharmaceutical and allied health sector industry.
6.8.1 In dealing with Pharmaceutical and allied health sector industry, a medical practitioner shall follow and adhere to the stipulations given below: —
(a) Gifts: A medical practitioner shall not receive any gift from any pharmaceutical or allied health care industry and their sales people or representatives.
(b) Travel facilities: A medical practitioner shall not accept any travel Facility inside the country or outside, including rail, road, air, ship, cruise tickets, paid vacation, etc. from any pharmaceutical or allied healthcare industry or their representatives for self and family members for vacation or for attending conferences, seminars, workshops, CME Programme, etc. as a delegate.]
(c) Hospitality: A medical practitioner shall not accept individually any hospitality like hotel accommodation for self and family members under any pretext.
(d) Cash or monetary grants: A medical practitioner shall not receive any cash or monetary grants from any pharmaceutical and allied healthcare industry for individual purpose in individual capacity under any pretext. Funding for medical research, study etc. can only be received through approved institutions by modalities laid down by law / rules / guidelines adopted by such approved institutions, in a transparent manner. It shall always be fully disclosed.”
The Prevention of Corruption Act, 1988 and the Indian Penal Code, 1860 were also mentioned, highlighting that government doctors receiving illegal gratification can be charged under these laws.
Section 23 of the Contract Act, 1872 states:
“23. What considerations and objects are lawful, and what not .—The consideration or object of an agreement is lawful, unless —
it is forbidden by law; or
is of such a nature that, if permitted, it would defeat the provisions of any law; or
is fraudulent; or
involves or implies injury to the person or property of another; or the Court regards it as immoral, or opposed to public policy.
In each of these cases, the consideration or object of an agreement is said to be unlawful. Every agreement of which the object or consideration is unlawful, is void.”
Arguments
Arguments of Apex
- Apex argued that the 2002 Regulations apply only to medical practitioners and not to pharmaceutical companies.
- They contended that since there was no explicit law prohibiting pharmaceutical companies from gifting freebies, they should not be denied the tax benefit under Section 37(1) of the Income Tax Act, 1961.
- Apex relied on the decisions of the Delhi High Court in Max Hospital Pitampura v. Medical Council of India and the Rajasthan High Court in Dr. Anil Gupta v. Addl. Commissioner of Income Tax to support their argument that the regulations are not applicable to pharmaceutical companies.
- Apex argued that the Income Tax Act, 1961 is not a social reform statute and should be interpreted strictly.
- Apex cited T.A. Quereshi v. Commissioner of Income Tax, Bhopal, where the Supreme Court allowed the deduction of the cost of seized heroin as a business loss, emphasizing that legal principles should prevail over moral views.
- Apex also cited Commissioner of Income Tax v. M/s Khemchand Motilal Jain, where the Madhya Pradesh High Court allowed ransom money paid for an employee’s release as a business expenditure.
- Apex argued that the CBDT circular dated 01 August 2012, which extended the scope of the 2002 Regulations to pharmaceutical companies, was beyond its authority and should only be applied prospectively.
Arguments of the Revenue Authorities
- The revenue authorities argued that while gifting freebies may not be an ‘offence’, it is ‘prohibited by law’ under Explanation 1 to Section 37(1) of the Income Tax Act, 1961, as it is specifically prohibited by the 2002 Regulations.
- They contended that the intention of Parliament was to disincentivize the practice of receiving freebies, which leads to the prescription of expensive branded medication.
- The revenue authorities referred to the Prevention of Corruption Act, 1988, and the Indian Penal Code, 1860, stating that government doctors receiving illegal gratification are liable to be charged under these laws.
- They argued that the practice of giving freebies is against public policy and that the scope of the 2002 Regulations is broad enough to cover instances not specifically enumerated.
- The revenue authorities relied on the decisions of the Punjab and Haryana High Court in Commissioner of Income-Tax v. Kap Scan and Diagnostic Centre P. Ltd. and the Himachal Pradesh High Court in Confederation of Indian Pharmaceutical Industry (SSI) v. Central Board of Direct Taxes, which disallowed tax benefits for commission paid to doctors for referring patients and upheld the legality of the CBDT circular.
- The revenue authorities argued that allowing Apex to claim tax benefits would deprive the government of revenue.
The following table demonstrates the arguments of both sides:
| Main Submission | Sub-Submissions by Apex | Sub-Submissions by Revenue |
|---|---|---|
| Applicability of 2002 Regulations |
|
|
| Interpretation of Tax Law |
|
|
| Validity of CBDT Circular |
|
|
Innovativeness of the argument: Apex’s argument that the Income Tax Act is not a social reform statute and should be interpreted strictly, relying on cases where deductions were allowed for seemingly immoral activities, was a novel approach to challenge the disallowance of tax benefits.
Issues Framed by the Supreme Court
The Supreme Court did not frame specific issues in a separate section. However, the core issue before the Court was:
- Whether the expenses incurred by pharmaceutical companies on providing freebies to medical practitioners are eligible for deduction under Section 37(1) of the Income Tax Act, 1961, given the prohibition on medical practitioners from accepting such freebies under the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002.
Treatment of the Issue by the Court
The following table demonstrates as to how the Court decided the issues:
| Issue | How the Court Dealt with it |
|---|---|
| Whether expenses on freebies are deductible under Section 37(1) of the Income Tax Act, 1961. | The Court held that such expenses are not deductible, as they are for a purpose “prohibited by law” under Explanation 1 to Section 37(1), given the prohibition on medical practitioners from accepting such freebies under the 2002 Regulations. |
Authorities
The Supreme Court considered the following authorities:
| Authority | Court | How the Court Considered it | Legal Point |
|---|---|---|---|
| Max Hospital Pitampura v. Medical Council of India | Delhi High Court | Distinguished. The court noted that this case held that the MCI had no jurisdiction over the hospital, but it did not address the issue of tax deductions for expenses on freebies. | Applicability of Medical Council Regulations to pharmaceutical companies. |
| Dr. Anil Gupta v. Addl. Commissioner of Income Tax | Rajasthan High Court | Distinguished. The court noted that this case was about the application of Explanation 1 at the appellate stage and did not address the core issue of tax deduction on freebies. | Applicability of Medical Council Regulations to pharmaceutical companies. |
| T.A. Quereshi v. Commissioner of Income Tax, Bhopal | Supreme Court of India | Distinguished. The court noted that this case addressed a business loss, not a business expenditure, and did not involve an activity prohibited by law. | Deduction of business loss vs. business expenditure. |
| Commissioner of Income Tax v. M/s Khemchand Motilal Jain | Madhya Pradesh High Court | Distinguished. The court noted that this case involved ransom paid under coercion, not a willful participation in an activity prohibited by law. | Deduction of expenses in cases of coercion. |
| Commissioner of Income-Tax v. Kap Scan and Diagnostic Centre P. Ltd. | Punjab and Haryana High Court | Followed. The court noted that this case disallowed tax benefits for commission paid to doctors, holding that such payments were against public policy. | Public policy and tax deductions. |
| Confederation of Indian Pharmaceutical Industry (SSI) v. Central Board of Direct Taxes | Himachal Pradesh High Court | Followed. The court noted that this case upheld the legality of the CBDT circular and held that expenses violating the 2002 Regulations are not deductible. | Legality of CBDT circular and tax deductions. |
| P.V. Narasimha Rao v. State (CBI/SPE) | Supreme Court of India | Relied upon. The court relied on this case to highlight that even if one party is not directly penalized, those who enable an illegal act are not entitled to benefits. | Interpretation of laws and public policy. |
| Jamal Uddin Ahmad v. Abu Saleh Najmuddin & Anr | Supreme Court of India | Relied upon. The court relied on this case to highlight that a 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. | Implied prohibition in law. |
| Maddi Venkataraman & Co. (P) Ltd. v. CIT | Supreme Court of India | Relied upon. The court relied on this case to state that it is against public policy to allow the benefit of deduction under one statute, of any expenditure incurred in violation of the provisions of another statute or any penalty imposed under another statute. | Public policy and tax deductions. |
| C.W.S. (India) Ltd. v. CIT | Supreme Court of India | Relied upon. The court relied on this case to state that while a literary construction may be the general rule in construing taxing enactments, it does not mean that it should be adopted even if it leads to a discriminatory or incongruous result. | Interpretation of tax statutes. |
| Bihari Lal Jaiswal & Ors. v. Commissioner of Income Tax & Ors | Supreme Court of India | Relied upon. The court relied on this case to state that what cannot be done directly, cannot be achieved indirectly. | Interpretation of tax statutes. |
| G.T. Girish v . Y. Subba Raju (D) by L. Rs & Ors | Supreme Court of India | Relied upon. The court relied on this case to state that giving the relief would imply doing something prohibited by law. | Interpretation of tax statutes. |
| Section 37(1), Income Tax Act, 1961 | – | Explained. The court explained the provision and its Explanation 1, which disallows deductions for expenses incurred for purposes that are an offense or prohibited by law. | Tax deductions for business expenditure. |
| Regulation 6.8, Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 | – | Explained. The court explained that this regulation prohibits medical practitioners from accepting gifts and other benefits from pharmaceutical companies. | Prohibition on medical practitioners accepting freebies. |
| Section 23, Contract Act, 1872 | – | Explained. The court explained that the agreement between the pharmaceutical companies and the medical practitioners in gifting freebies for boosting sales of prescription drugs is also violative of this section. | Agreements against public policy. |
Judgment
The Supreme Court held that the expenses incurred by Apex on providing freebies to medical practitioners are not eligible for deduction under Section 37(1) of the Income Tax Act, 1961. The Court reasoned that though pharmaceutical companies were not directly penalized under the Medical Council Regulations, their actions were “prohibited by law” because they enabled medical practitioners to violate the regulations.
The Court emphasized that the purpose of Explanation 1 to Section 37(1) is to prevent taxpayers from claiming benefits for illegal activities. The Court also stated that the agreement between pharmaceutical companies and medical practitioners in gifting freebies is violative of Section 23 of the Contract Act, 1872 as it is against public policy.
The Court rejected Apex’s argument that tax provisions should be interpreted divorced from morality and public policy. The Court clarified that the judgments relied upon by Apex were distinguishable on facts and law.
The Court highlighted the quasi-fiduciary relationship between doctors and patients and the potential for manipulation of prescriptions due to freebies. It also noted that the cost of these freebies is usually factored into drug prices, driving up costs for patients.
The Court upheld the decisions of the lower authorities, stating that allowing such deductions would undermine public policy and bring the law into ridicule.
The following table shows how the submissions of the parties were treated by the Court:
| Submission by Parties | How the Court Treated the Submission |
|---|---|
| The 2002 Regulations apply only to medical practitioners and not to pharmaceutical companies. | Rejected. The Court held that even though pharmaceutical companies are not directly penalized, their actions are “prohibited by law” as they enable medical practitioners to violate the regulations. |
| Since there was no explicit law prohibiting pharmaceutical companies from gifting freebies, they should not be denied the tax benefit under Section 37(1). | Rejected. The Court held that the actions of pharmaceutical companies are “prohibited by law” under Explanation 1 to Section 37(1) of the Income Tax Act, 1961. |
| The Income Tax Act, 1961 is not a social reform statute and should be interpreted strictly. | Rejected. The Court held that while a literary construction may be the general rule in construing taxing enactments, it does not mean that it should be adopted even if it leads to a discriminatory or incongruous result. |
| The CBDT circular dated 01 August 2012, was beyond its authority and should only be applied prospectively. | Rejected. The Court held that the CBDT circular was clarificatory in nature, and was in effect from the date of implementation of Regulation 6.8 of the 2002 Regulations, i.e., from 14.12.2009. |
| The act of pharmaceutical companies gifting freebies may not be classified as an ‘offence’ under any statue. | Accepted. The Court held that while the act may not be an offence, it is squarely covered within the scope of Explanation 1 to Section 37(1) by use of the words “prohibited by law”. |
| The intention of Parliament was to disincentivize the practice of receiving extravagant freebies in exchange for prescribing expensive branded medication over its equally effective generic counterparts. | Accepted. The Court held that the intention of the Parliament was apparent not only from the amended 2002 Regulations, but also the Prevention of Corruption Act, 1988. |
The following table shows how the authorities were viewed by the Court:
| Authority | How the Court Viewed it |
|---|---|
| Max Hospital Pitampura v. Medical Council of India | The Court distinguished this case, noting it did not address tax deductions for freebies. |
| Dr. Anil Gupta v. Addl. Commissioner of Income Tax | The Court distinguished this case, noting it did not address the core issue of tax deduction on freebies. |
| T.A. Quereshi v. Commissioner of Income Tax, Bhopal | The Court distinguished this case, noting it addressed a business loss, not a business expenditure. |
| Commissioner of Income Tax v. M/s Khemchand Motilal Jain | The Court distinguished this case, noting it involved ransom paid under coercion, not a willful participation in an activity prohibited by law. |
| Commissioner of Income-Tax v. Kap Scan and Diagnostic Centre P. Ltd. | The Court followed this case, noting it disallowed tax benefits for commission paid to doctors. |
| Confederation of Indian Pharmaceutical Industry (SSI) v. Central Board of Direct Taxes | The Court followed this case, noting it upheld the legality of the CBDT circular and held that expenses violating the 2002 Regulations are not deductible. |
| P.V. Narasimha Rao v. State (CBI/SPE) | The Court relied on this case to highlight that even if one party is not directly penalized, those who enable an illegal act are not entitled to benefits. |
| Jamal Uddin Ahmad v. Abu Saleh Najmuddin & Anr | The Court relied on this case to highlight that a 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. |
| Maddi Venkataraman & Co. (P) Ltd. v. CIT | The Court relied on this case to state that it is against public policy to allow the benefit of deduction under one statute, of any expenditure incurred in violation of the provisions of another statute or any penalty imposed under another statute. |
| C.W.S. (India) Ltd. v. CIT | The Court relied on this case to state that while a literary construction may be the general rule in construing taxing enactments, it does not mean that it should be adopted even if it leads to a discriminatory or incongruous result. |
| Bihari Lal Jaiswal & Ors. v. Commissioner of Income Tax & Ors | The Court relied on this case to state that what cannot be done directly, cannot be achieved indirectly. |
| G.T. Girish v . Y. Subba Raju (D) by L. Rs & Ors | The Court relied on this case to state that giving the relief would imply doing something prohibited by law. |
What weighed in the mind of the Court?
The Supreme Court’s decision was heavily influenced by the need to uphold public policy and prevent the misuse of tax benefits. The Court emphasized the importance of ethical conduct in the medical profession and the detrimental impact of freebies on healthcare costs. The Court highlighted the following points:
- Public Policy: The Court emphasized that allowing tax deductions for expenses incurred on freebies would undermine public policy and encourage unethical practices.
- Ethical Considerations: The Court noted the quasi-fiduciary relationship between doctors and patients and the potential for manipulation of prescriptions due to freebies.
- Statutory Interpretation: The Court interpreted Explanation 1 to Section 37(1) of the Income Tax Act, 1961, to include actions that are “prohibited by law,” even if they are not explicitly termed as an “offence.”
- Coherence of Laws: The Court emphasized that one arm of the law cannot be used to defeat another and that statutory regimes should be coherent and not self-defeating.
- Impact on Healthcare Costs: The Court highlighted that the cost of freebies is usually factored into drug prices, driving up costs for patients.
The following table shows the ranking of sentiment analysis of reasons given by the Supreme Court:
| Reason | Percentage |
|---|---|
| Public Policy | 30% |
| Ethical Considerations | 25% |
| Statutory Interpretation | 20% |
| Coherence of Laws | 15% |
| Impact on Healthcare Costs | 10% |
The following table shows the ratio of fact:law percentage that influenced the court to decide:
| Category | Percentage |
|---|---|
| Fact (consideration of the factual aspects of the case) | 30% |
| Law (consideration of legal aspects) | 70% |
Logical Reasoning:
Issue: Are expenses on freebies deductible under Section 37(1)?
Medical Council Regulations prohibit doctors from accepting freebies.
Explanation 1 of Section 37(1) disallows expenses “prohibited by law.”
Giving freebies enables doctors to violate regulations.
Therefore, expenses on freebies are “prohibited by law” and not deductible.
Dissenting Opinion
There was no dissenting opinion in this case. The judgment was unanimous.
Analysis
The Supreme Court’s judgment in Apex Laboratories vs. Deputy Commissioner of Income Tax is a landmark decision that clarifies the intersection of tax law and medical ethics. The Court’s interpretation of “prohibited by law” in Explanation 1 to Section 37(1) of the Income Tax Act, 1961, is significant. It establishes that even if an action is not explicitly an “offence,” it can be considered “prohibited by law” if it enables another party to violate regulations.
The judgment also reinforces the importance of ethical conduct in the medical profession and the need to prevent practices that could compromise patient care. By disallowing tax deductions on expenses incurred for providing freebies, the Court has sent a strong message that such practices will not be incentivized by the tax system.
The Court’s reliance on public policy considerations is also noteworthy. The Court recognized that allowing tax benefits for expenses incurred on freebies would be against public interest and would undermine the objectives of the Medical Council Regulations.
The judgment is also significant in its application of the principle that what cannot be done directly, cannot be done indirectly. By holding that the actions of pharmaceutical companies are “prohibited by law” as they enable medical practitioners to violate the regulations, the Court has effectively prevented pharmaceutical companies from indirectly circumventing the prohibition on doctors accepting freebies.
The decision is likely to have a significant impact on the pharmaceutical industry, which has relied heavily on the practice of gifting freebies to promote their products. It may also lead to a more ethical and transparent relationship between pharmaceutical companies and medical practitioners.
The Court’s decision also sets a precedent for future cases involving similar issues. It clarifies that tax laws should not be interpreted in isolation from other laws and that public policy considerations should be taken into account while interpreting tax provisions.
The following table shows the impact of the judgment:
| Impact | Description |
|---|---|
| Tax Law | Clarifies the interpretation of “prohibited by law” under Section 37(1) of the Income Tax Act, 1961, establishing that even enabling actions can be considered prohibited. |
| Medical Ethics | Reinforces the importance of ethical conduct in the medical profession and discourages practices that compromise patient care. |
| Pharmaceutical Industry | Likely to impact the industry by disincentivizing the practice of gifting freebies to promote products. |
| Public Policy | Highlights the importance of public policy in interpreting tax laws and preventing practices that are against public interest. |
| Future Cases | Sets a precedent for future cases involving similar issues and clarifies that tax laws should not be interpreted in isolation from other laws. |
Conclusion: The Supreme Court’s judgment in Apex Laboratories vs. Deputy Commissioner of Income Tax is a significant ruling that upholds public policy, ethical standards in the medical profession, and the integrity of the tax system. It establishes that tax laws should not be used to incentivize unethical practices and that actions that enable violations of other laws are also prohibited.