COMMISSIONER OF INCOME-TAX VS J & J DECHANE LABORATORIES (P.) LTD.
1998 P T D 2335
[2221 T R 11]
[Andhra Pradesh High Court (India)]
Before Syed Shah Muhammad Quadri and G. Bikshapathy, JJ
COMMISSIONER OF INCOME-TAX
versus
J & J DECHANE LABORATORIES (P.) LTD.
Case Referred No.70 of 1987, decided on 27/07/1995.
(a) Income-tax--
----Business expenditure---Disallowance---Company---Salary and perquisites paid to Managing Director---Section 40(c) was applicable---Indian Income Tax, 1961, Ss. 40(c) & 40-A(5).
(b) Income-tax--
----Business expenditure---Disallowance---Advertisement, publicity and-sales promotion--- Expenditure on free distribution of drugs ---Finding that distribution had been made to test efficacy of drug---Expenditure was not on advertisement, publicity or sales promotion and could not be disallowed Indian Income Tax Act, 1961, S. 37(3-A). .
In respect of payments by a company to its Managing Director section 40(c) of the Income Tax Act, 1961, is applicable and not section 40-A(5) of the Act.
The assessee claimed deduction of expenditure on distribution of free samples to Doctors. The Income-tax Officer disallowed it. However, the Commissioner of Income-tax (Appeals) and the Tribunal allowed it. On a reference:
Held, that as there was a finding by the Commissioner of income tax(Appeals) which was confirmed by the Tribunal that the expenditure .was incurred to test the efficacy of the drug, the expenditure would be within the ambit of bare minimum to carry on the business. The expenditure on physician's samples distributed to Doctors was outside the scope of section 37(3-A) of the Act. The Tribunal was right in directing the exclusion of the expenditure on free samples supplied to the doctors in working out the disallowance under section 37(3-A) of the Act.
CIT v. Ampro Food Products (1995) 215 ITR 904 (AP.); CIT v. Bata India Ltd. (1993) 201 ITR 884 (Cal.); Geoffrey Manners & Co. Ltd. v. ITO (1983) 3 SOT 40 and Smith Kline and French (India) Ltd. v. CIT (1992) 193 ITR 582 (Kar.) ref.
S.R. Ashok for the Commissioner.
Nemo for the Assessee.
JUDGMENT
G. BIKSHAPATHY, J.---The following questions have been referred to this court by the Income Tax Appellate Tribunal, Bench-B, Hyderabad, under section 256(1) of the Income Tax Act, 1961, for opinion:
"(1) Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal is correct in law in holding that in respect of payments to the managing director of the assessee- company, though an employee, section 40-A(5) could not be applied but only section 40-A(c) could be applied?
(2) Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal is correct in excluding the expenditure on free samples supplied to the doctors in working out the disallowance under section 37(3-A) of the Income Tax Act, 1961"?
Question No. 1:
The assessee is a private limited company. The assessment years in respect of the issue under reference are 1978-79, 1979-80 and 1980-81. The reference case arises out of I.T.As. Nos. 1563, 1575 and 1564 (Hyd) of 1982 on the file of the Income Tax Appellate Tribunal. For the assessment year 1978-79, the managing director received salary of Rs.48,400 besides getting perquisites amounting to Rs.21,898. The Income-tax Officer held that the assessee is entitled to only 20 percent of the salary towards perquisites by applying the provisions of section 40-A(5) and thus, deleted a sum of Rs.12,215 from the perquisites of the managing director. Similarly, in respect of the assessment years 1979-80 and 1980-81, the managing director of the firm was paid remuneration, bonus and perquisites. The Income-tax Officer while dealing with the matter under section 40-A(5) of the Act held that the computation has to be made in accordance with section 40(c) of the Act.
On appeal by the assessee before the Commissioner of Income-tax (Appeals), the Commissioner accepted the contention of the company and directed Income-tax Officer to modify the assessment by applying the provisions of section 40(c), instead of section 40-A(5) by following the decision in Geoffrey Manners & Co. Ltd. v. ITO (1983) 3 SOT 40, wherein it was held that in such circumstances, the assessment has to be made under section 40(c). Accordingly, the first question is covered by the aforesaid decision. As such we are in agreement with the view taken by the Tribunal, which is in conformity with the decision rendered in the case of Geoffrey Manners & Co. Ltd. (1983) 3 SOT 40. The question, therefore, is answered in the affirmative, that is, in favour of the assessee and against the Revenue.
Question No. 2:
For the year 1979-80, the assessee distributed samples produced by it worth Rs.1,59,996 among various doctors with a view to afford facilities of testing the genuineness of the drugs. The Income-tax Officer held that the value of the samples are to be treated as part of advertisement expenditure incurred by the assessee under section 37(3-A) of the Act, as the samples are treated as advertisement media for pushing up the sales. Similarly, for the assessment year 1980-81, free samples of medicines manufactured by the assessee-company worth of Rs.1,68,822 were distributed among the doctors. The Income-tax Officer applied the same principle and refused to grant disallowance. Aggrieved by the order of the Income-tax Officer for the assessment years 1979-80 and 1980-81, the assessee-company preferred an appeal before the Commissioner of Income-tax (Appeals). The learned Commissioner held that the samples given to the doctors by the assessee from out of its manufactured medicines should not be considered as falling under the term advertisement. Therefore, he directed the Income-tax Officer to exclude the value of the samples for the assessment years 1979-80- and 1980 81 in working our disallowance under section 37(3-A) of the Act. The Department filed second appeal before the Tribunal. The Tribunal after considering the respective contentions held that the view taken by the appellate authority was quite reasonable in view of the fact that the samples of medicine distributed for the purpose of testing the efficacy of the drugs and hence the direction of the appellate authority for exclusion of the sums in making disallowance under section 37(3-A) of the Act was found to be in order.
As against the said order of the Tribunal, the Revenue sought reference of question of law, which was accepted by the Tribunal and thus the questions referred to above have been referred to this Court for opinion.
In this issue, the question relating to the exclusion of expenditure of free samples supplied to the doctors while working out the disallowance under section 37(3-A) of the Act is considered.
Mr. S.R. Ashok, learned standing counsel for the Revenue, contends that the lower authorities did not consider the matter in the proper perspective. Samples are distributed to the Doctors for the main purpose of sales promotion and, therefore, the value of the samples should be treated as expenditure on advertisement under section 37(3-A) of the Act. He relied on the decision of the Kainataka High Court in Smith Kline and French (India) Ltd. v. CIT (1992) 193 ITR 582, wherein a similar case arose in respect of samples manufactured by a pharmaceutical company. In the said case, the assessee-company claimed the expenditure on distribution of physicians' samples as expenditure under section 37 of the Income Tax Act, 1961. While the Revenue treated this expenditure as an expenditure incurred towards advertisement publicity or sales promotion and, consequently, the restrictive clause of section 37(3-A) was applied resulting in the disallowance of part of the expenditure, the High Court held that before the drug gets circulated, its reputation will have to be confirmed by the medical practitioners and that is why free samples are supplied to them. If the object of supplying free samples is only to find out the reaction of the medical practitioner about the efficacy or curative value of the drug, the supply of free samples would have been confined to the initial stages of production of the new drug. The assessee had not contended that the free samples were distributed only when a drug was introduced for the first time. Moreover, in its original return, the assessee had shown these sums under the head "Advertisement". Therefore, on the facts and in the circumstances of that case, the court held that the expenditure incurred on physicians' samples amounts to an expenditure on advertisement, publicity or sales promotion falling within the restrictive provisions of section 37(3-A).
A somewhat similar issue came up for consideration before this Court (one of us Syed Shah Muhammad Quadri, J., is a party) in R.C. No.48 of 1985---CIT v. Ampro Food Products (1995) 215 ITR 904. In the said case the issue was "Whether the expenditure incurred by the assessee towards the free distribution of notebooks and placing gift coupons in the assessee's products is not covered by section 37(3-A) of the Act". This Court by its orders, dated February 21, 1995, after referring to the Karnataka High Court decision in Smith Kline and French (India) Ltd. v. CIT (1992) 193 ITR 582 and also the judgment of the Calcutta High Court in CIT v. Bata India Ltd. (1993) 201 ITR 884 held as follows (page 912 of 215 ITR):
"From the above discussion what follows is that expenditure of the nature which is essential to the running of the business---a bare minimum to carry on the trade---would not fall within the meaning of the three expressions, i.e., advertisement, publicity and sales promotion. The other expenditure, incurred under any of the three heads, would be within the mischief of the provisions of subsection (3-A) of section 37 of the Act and, therefore, will have to be scaled down."
In the instant case, the assessee claimed expenditure on distribution of physicians' samples under section 37 general head. In view of the principles settled by this Court in the aforesaid decision, if the expenditure falls within the bare minimum it will not be caught by subsection (3-A) of section 37 but if it is of the nature which is not essential to the carrying of the business, it will be within the net of subsection (3-A). Physicians' samples are necessary to ascertain the efficacy of the medicine and to introduce it in the market for circulation and it is only by this method the purpose is achieved. In such cases giving physicians' samples for a reasonable period is essential to the business of manufacture and sales of the medicine. But if a particular medicine has been introduced into the market and its uses are established, giving of free samples could only be as a measure of sales promotion and advertisement and would, thus, be hit by subsection (3-A). As in this case there is a finding of the Commissioner (Appeals) and confirmed by the Tribunal that the expenditure was incurred to test the efficacy of the drug, the expenditure would be within the ambit of bare minimum to carry on the business. For these reasons, it has to be held that the expenditure on physician' samples distributed to Doctors is outside the scope of subsection (3-A) of section 37 of the Act. Therefore, the appellate authority, as well as the Tribunal are right in directing the exclusion of the expenditure on free samples supplied to the doctors in working out disallowance under section 37(3-A) of the Act.
Accordingly, the reference is answered in the affirmative, i.e., in favour of the assessee and against the Revenue.
The reference is answered accordingly. No costs.
M.B.A./1505/FCReference answered.