• In general practice freebies although being prohibited are provided to medical professionals by pharmaceutical companies and diagnostic centers to induce them to prescribe their medicines and tests which are higher in price than their generic alternatives.
• This practice of acceptance of freebies was disallowed through a circular issued on 14.12.2009 by the Medical Council of India under Regulation 6.8. of the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulation, 2002 (for brevity hereinafter referred to as “the regulation”). This regulation also includes a penal provision against contravention of any of the regulations.
• The penal provision is upon the medical professional being the donee but not upon the donor i.e. the pharmaceutical companies. The Central Board of Direct Taxes (for brevity hereinafter referred to as “CBDT”) released a Circular bearing Circular No. 05/2012 dated 01.08.2012 w.e.f. 14.12.2009(from the date of MCI Circular) wherein expenditures incurred against gifting such freebies were disallowed for deduction under Section 37 of the Income Tax Act, 1961(for brevity hereinafter referred to as “the Act”).
• This raised various concerns among the assessees on whether freebies provided before the circular date i.e. 01.08.2012 is deductible under section 37 of the Income Tax Act, 1961. And whether such retrospective effect is valid in the eyes of law?
• This issue is now settled by a recent judgement dated 22.02.2022 by the Division Bench of Hon’ble Supreme Court presided over by Justice Uday Umesh Lalit and Justice S. Ravindra Bhat in Apex Laboratories (P.) Ltd. v. Deputy Commissioner of Income Tax LTU, Civil Appeal No. 1554 of 2022; [2022] 135 taxmann.co 286 (SC), wherein the appellant i.e. Apex Laboratories (P.) Ltd. challenged the Judgment of Hon’ble Madras High Court. Hon’ble Supreme Court upheld the rationale of Hon’ble High Court and dismissed the Civil Appeal bearing Civil Appeal No. 1554 of 2022. Before diving directly into the observation of the Hon’ble Supreme Court, let us first look at the ingredients of Section 37 of the Income Tax Act, 1961.
• Section 37 of the Income Tax Act, 1961, is a residuary provision, wherein, if a business or professional expenditure does not ordinarily fall under Section 30-36 of Income Tax Act, 1961, then upon fulfilment of the enumerated pre-requisites, a person can claim deduction under Section 37 of the Act. The following pre-requisites must be met out so that a particular expenditure may be allowed for deduction under this section:

a)      The expenditure should not be of the nature described in Sections 30 to 36.

b)     It should have been incurred in the accounting year.

c)      It should be in respect of a business which was carried on by the assessee and the profits of which are to be computed and assessed, and should be incurred after the business is set up.

d)     It should not be in the nature of personal expenses of the assessee.

e)      It should have been laid out or expended wholly and exclusively for the purpose of such business.

f)       It should not be in the nature of capital expenditure.

Thus, the crux of the current issue is whether such gifting of freebies falls within explanation 1 appended to Section 37 of the Income Tax Act, 1961.

• The counsel on behalf of the assessee contended that the Circulars by CBDT and MCI prohibited the medical practitioners from taking any incentives from pharmaceutical companies but no corresponding prohibition has been imposed upon the pharmaceutical companies. In absence of such prohibition, such expenditures against provisioning of freebies are liable to be allowed for deduction under Section 37 of the Act.
• Moreover, it was also contended that the object of the Finance (No. 2) Bill, 1998 through which Explanation 1 was inserted to Section 37 of the Act was to prohibit taxpayers from claiming “protection money, extortion, hafta, bribes, etc.” as business expenditure i.e. it was added to prohibit only expenditures against illegal acts which are offences per se. Since gifting of freebies are not illegal or an offence and therefore these activities are not hit by the Explanation appended to Section 37 of the Act.
• It was also contended that any circular favoring the assessee can be made with the retrospective effect but circulars being not favorable to the assessee can only be prospectively put into effect.