DIOSMA LIFESCIENCES PRIVATE LIMITED,MUMBAI vs. INCOME TAX OFFICER WARD 4(1) THANE, THANE

On the facts and in the circumstances of the case, the Ld. CIT(A) erred in confirming the disallowance of Rs. 30,62,507/-incurred wholly and exclusively for the purpose of the Appellant's business, without appreciating the nature of the expenses, which were reimbursements for travelling, local conveyance, accommodation, and food incurred by the Appellant's marketing staff/employees for meeting medical professionals to promote its products and not “freebies” to doctors.

On the facts and circumstances of the case and in law, the learned CIT(A) erred in confirming the action of the Assessing Officer in placing reliance on the CBDT Circular No. 5/2012 and Indian Medical Council Regulations, which are not applicable to the Appellant. On Ignoring Commercial Expediency:

On the facts and circumstances of the case and in law the Ld. CIT(A) failed to appreciate the commercial expediency of the expenditure and confirming the disallowance of the entire expenditure on the basis of a comparison with previous years, without appreciating the business context of a new and growing company, is arbitrary and against the principles of business prudence. The Appellant prays that the disallowance made be deleted. On Disallowance of Entire Expenditure without basis:

Without prejudice to above grounds, On the facts and circumstances of the case and in law the complete disallowance of Rs. 30,62,507/- is highly excessive and punitive. The learned CIT(A) failed to appreciate that the A.O. failed to examine the submitted ledgers and made a blanket disallowance without pointing out a single specific instance of an inadmissible expense. The Appellant prays that disallowing entire expenditure is against the fundamental principles of taxation and the disallowance made be deleted.

In ground nos.1 and 2, the assessee has claimed that the mandatory notice under section 143(2) of the Act was never served upon it through its registered email ID. The ld. CIT(A) also failed to adjudicate the specific ground raised that it had not received any communication from the A.O. Besides, the ld. CIT(A) in violation of principle of natural justice erred in holding that adequate opportunity was provided to the assessee without appreciating the fact that the assessment was completed during the peak of the COVID-19 pandemic under the newly introduced Faceless assessment scheme and the alleged non-compliance stemmed from a lack of proper communication due to non-receipt of notices.

1 We have gone through the records and find that prima facie the contentions of the assessee are self-contradictory and factually incorrect. Moreover, at no point, be it assessment or appellate proceedings, the assessee has raised the ground regarding non service of notice u/s 143(2) of the Act as apparent from the assessment as also the appellate order. In fact, the assessee even in the Statement of Facts submitted before the ld.CIT(A) has categorically admitted issue of impugned notice to it by the AO. Likewise, the ground on lack of adequate opportunity of hearing is also not supported from its own contentions as per SOF relevant part of which are reproduced as below:

2 Therefore, it has been admitted that the assessee was not only issued various notices u/s 143(2)/142(1) of the Act from time to time, it attended to the same and replies were submitted on several occasions. There is absolutely no basis for claiming that notices were not served on it and was denied adequate opportunity of hearing. Even during appellate proceedings, perusal of the appellate order makes it evidently clear that the ld.CIT(A) allowed adequate opportunity of hearing to it as evident from page 5 to 8 of the appellate order wherein the ld.CIT(A) has reproduced the written submissions made by the assessee before him. “Even the assessment order in para 3 refers to statutory notice u/s 143(2) was issued and served on the assessee on 28.09.2019 which was not complied with. Thereafter, notice u/s 142(1) of the Act was issued on 17.12.2019 which was also not complied with. Thereafter, notice u/s P a g e | 6 A.Y. 2018-19 Diosma Lifesciences Private Limited 142(1) of the Act was issued on 28.07.2020 which was complied with by the assessee company.” In the light of above facts, we do not find any merit in the contentions of the assessee. Consequently, both the ground nos.1 and 2 are dismissed.

In ground nos. 3 to 7 the assessee has contested the disallowance of Rs. 30,62,507/- debited under head Sales promotion including publicity (other than advertisement).Briefly stated, it was noticed by the AO that the assessee had debited the above sum as Sales promotion expenses. Before him, it was contented that the assessee is a manufacturer of pharmaceutical formulations and marketing expenses were major expenses of the industry. Apart from salaries, it had to make payment for daily of marketing staff like travelling accommodation and food etc. every month. The expenses were reimbursed to the marketing staff on the basis of their statement of expenses. After taking relevant detail of such expenses and the list of 15 persons to whom payment with regard to Sales Promotion were made, the AO examined and it was noticed that some of person left the organisation and PAN details and other details were not submitted. So, it was very difficult to ascertain with from the bank statements about nature of such payment as to whether the same were for their salary or other re-imbursement as the assessee had already debited salary expense separately. Such persons to P a g e | 7 A.Y. 2018-19 Diosma Lifesciences Private Limited whom notice u/s 133(6) of the Act were issued were asked to verify whether the company had made any payment other than salary which was being claimed by the assessee under head ‘sales promotion’. No response from any of the persons was received by the AO. It was submitted by the assessee that there was a substantial increase of Rs.38,06,126/- in the turnover of the company in the AY 2018-19 as compared to the turnover in the AY 2017-18 and the management of the company could foresee an increase in the subsequent years as well. The sales promotion expense incurred was to create a base for the company in the future years and promote business expansion.

1 However, subsequently, the assessee changed its stand submitting that these expenses debited under head ‘sales promotion’ amounting to Rs. 30,62,507/- were amounts / gifts given to Doctors. In justification of allowablity of the same, the assessee company cited case laws of M/s Aishika Pharma Pvt Ltd Vs The ITO (ITAT Delhi) (Appeal No. ITA No. 732/Del/2019 dt 29.04.2019).

The AO observed that as per CBDT vide Circular No. 5/ 2012 dated 01.08.2012 expenses incurred on freebies to doctors are inadmissible under section 37(1) of the Act. Circular No. 5/2012 dt 01.08.2012 is reproduced below:

Section 37(1) of Income Tax Act provides for deduction of any revenue expenditure (other than those failing under sections 30 to 36) from the business Income if such expense is laid out/expended wholly or exclusively for the purpose of business or profession. However, the explanation appended to this subsection denies claim of any such expense, if the same has been incurred for a purpose which is either an offence or prohibited by law. Thus, the claim of any expense incurred in providing above mentioned or similar freebees in violation of the provisions of Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 shall be inadmissible under section 37(1) of the Income Tax Act being an expense prohibited by the law. This disallowance shall be made in the hands of such pharmaceutical or allied health sector Industries or other assessee which has provided aforesaid freebees and claimed it as a deductable expense in its accounts against income.

It is also clarified that the sum equivalent to value of freebees enjoyed by the aforesaid medical practitioner or professional associations is also taxable as business income or income from other sources as the case may be depending on the facts of each case. The Assessing Officers of such medical practitioner or professional associations should examine the same and take an appropriate action. This may be brought to the notice of all the officers of the charge for necessary action. “

1 It was also stated even Indian Medical Association (IMA) has imposed prohibition on acceptance of gift, travel facility, hospitality,

2 In view of above facts, the AO concluded that genuineness of claim of expenses could not be established though the onus was on the assessee to prove the same and establish that expenses were laid out or expended wholly and exclusively for the purpose of the business as per the provisions of section u/s 37(1) of the Act. However, assessee could not prove its claim during the assessment proceedings and kept on changing its version. Thus, he concluded that the nature of the expenditure under head “Sales Promotion” amounting to Rs. 30,62,507/- was not proved by the assessee and even the names of the recipients of such expenses were not disclosed. Accordingly, claim was disallowed for deduction u/s 37(1) of the Act holding that the same was not genuine and added back to the income of the assessee.

In the subsequent appeal, the ld.CIT(A) observed that initially the appellant had claimed that the said expenses were incurred on some employees whose list was provided to the AO by it. However, during the assessment proceedings, it changed its justification with regard to claim of sales promotion and stated that these expenses the amount debited under head 'sales promotion' amounting to Rs.30,62,507/- were amounts/gifts/freebies given to doctors. The appellant had stated that they had provided gifts to doctors’ staff during Diwali festival but the gifts were not those as prohibited by section 37 and were based purely on the grounds of humanity and relations and as token of gratitude. The ld.CIT(A) observed that the appellant has itself had accepted that it had provided gifts to the doctors/staff and for the same it had debited Rs.30,62,507/- under head Sales promotion including publicity (other than advertisement) which was quite high. The appellant is in the business of medical profession and has to follow rules and regulations that are necessary for ethical medical profession. The appellant has given the list of 15 persons to whom it has made the payments as reimbursement of expenses. Even during the assessment proceedings, the appellant failed to provide such details. Moreover, giving gifts to doctors/staff is considered an unethical/illegal business practice in business profession. According to him, the CBDT has clear cut

In the course of hearing before us, the ld.AR has contested the conclusion drawn by the authorities below on the ground that case of the assessee was not hit by the provisions of Explanation 1 to section 37(1) of the Act in as much the expenditure incurred could not be considered as prohibited by CBDT Circular and MCI Guidelines. Pre contra, the ld.DR placed reliance on the order of the lower authorities and the provisions of the Act in this respect.

We have carefully considered the above facts and find palpable contradiction in the stand of the assessee before the lower authorities. It kept changing its stand which was initially claimed to be payment to P a g e | 12 A.Y. 2018-19 Diosma Lifesciences Private Limited employees which was later changed to freebies paid to medical professionals on the occasion of Diwali.The AO, in this backdrop, took note of the content of the CBDT circular No. 05/2012 dated 1st August 2012, the amendment in the Medical Council of India regulations vide Gazette notification dated 10thDecember, 2009, and Explanation Section 37(1) of the Act.

It is now settled law that the Board vide Circular No. 05/2012 (F.No. 225/142/2012-ITA.II), dated 01.08.2012 stated that Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002, on 10.12.2009 imposed a prohibition on medical practitioners and their professional associations from taking any Gift, Travel facility, Hospitality, Cash or monetary grant from pharmaceutical and allied health sector industries. Section 37(1) of the Act provides for deduction of any revenue expenditure (other than those failing under section 30 to 36) from business income if such expense is laid out/expended wholly or exclusively for the purpose of business or profession. However, the explanation appended to this sub-section denies claim of any such expense, if the same has been incurred for a purpose which is either an offence or prohibited by law. Thus, the claim of any expense incurred in providing freebies in violation of the P a g e | 13 A.Y. 2018-19 Diosma Lifesciences Private Limited provisions of IMC (Professional Conduct, Etiquette and Ethics) Regulations, 2002 shall not be admissible under section 37(1) of the Act being an expense prohibited by the law. Once this has been prohibited by the Medical Council under the powers vested in it, section 37(1) of the Act comes in to play.

1 Further, the Explanation inserted to the section 37(1) by the Finance Act (No.2), 1998 is with retrospective effect from 01.04.1962. Therefore, the expense of the nature specifically mentioned to be not allowable in the captioned circular of CBDT would have its applicability in respect of the cases of the earlier period years as well. The Explanation to section 37(1) is on the statute w.e.f. 1st April, 1962. The same has simply been clarified by way of a circular issued by CBDT. The MCI in exercise of powers conferred under section 20A read with section 33(m) of the Indian Medical Council Act, 1956 (MC) has framed The Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations 2002, which describes unethical acts under Chapter 6 of the said regulations. The MCI has made amendment in the above regulation vide notification dated 10-12-2009. As per said notification, a medical practitioner is not allowed to receive any gift, travel facility, hospitality, cash or monetary grants from the P a g e | 14 A.Y. 2018-19 Diosma Lifesciences Private Limited pharmaceuticals or allied health care industry and violation of these conducts are liable for punishment as per The Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002. 9.2 At this stage, it is relevant to refer to the judgment of the Hon’ble Apex Court in the case of Apex Laboratories Pvt Ltd (2022) 442 ITR 1 (SC) wherein it considered the issue as to why the expenditure incurred towards gifting freebies to medical practitioners for creating awareness about the health supplement ‘Zincovit’, should not be added back to the total income of the said Company. The Apex Court dealt with the issue and held thus: ”

It is also 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 dolomalo 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.

This Court also notices that medical practitioners have a quasi-fiduciary relationship with their patients. A 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. Therefore, it is a 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. These freebies are P a g e | 15 A.Y. 2018-19 Diosma Lifesciences Private Limited 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….”

3 While the Apex Court approved the dictum of the Punjab & Haryana High Court in Commissioner of Income-Tax v. Kap Scan and Diagnostic Centre P. Ltd.(2012) 344 ITR 476 (P&H HC) and Himachal Pradesh High Court in Confederation of Indian Pharmaceutical Industry (SSI) v. Central Board of Direct Taxes (2013) 353 ITR 388 (HP HC), it distinguished/overruled a number of earlier judgments of the High Courts, which ran contra to the dictum of Apex Laboratories (supra). In Commissioner of Income-Tax v. Kap Scan and Diagnostic Centre P. Ltd.(supra), the hon’ble Punjab & Haryana High Court held payment of commission to doctors as against public policy and held thus: