Finance Bill, 2022 : Judgements overruled

The Finance Bill 2022 has sought to unsettle various settled positions of law by proposing amendments in various clauses which have an impact of overruling decisions of the Supreme Court, High Court and various other tribunal judgements.

A] Amendment’s proposed in Section 40(a)(ii) of the Act

Background

Section 40 of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’) provides various expenses which shall not be deductible in computing the income chargeable under the head ‘Profits and gains of business or profession’. Section 40(a)(ii) specifically delves into the aspect of tax payable not being eligible to be claimed as an expense. However, there is no straight jacket formula which has been provided to the definition of ‘tax’ within the contours of section 40. The term ‘tax’ has been referred to in various sections of the Act but for the purposes of section 40, the term tax is not bequeathed with any definite boundaries.

Issues

A by-product of the abovementioned ambiguity is that of extensive litigation pertaining to the legal lacuna of whether Education Cess is deemed as tax or is it eligible to be claimed as an expense under section 40(a)(ii) of the Act.

Settled position before the amendment

The Rajasthan High Court in Chambal Fertilizers and Chemicals Ltd v. JCIT [(2019) 107 taxmann.com 484] held that education cess could not be disallowed under the provisions of section 40(a)(ii) of the Act and reliance was placed on the CBDT Circular No. F. No. 91/58/66-ITJ(19) dated 18-5-1967 where the word ‘cess’ had been deleted from the section and noted that only taxes paid were to be disallowed.

The Bombay High Court in Sesa Goa Limited v. JCIT [(2020) 423 ITR 426] held that education cess and higher and secondary education cess was allowable as a deduction.

As a result of the exclusion of ‘cess’ from the ambit of section 40 of the Act, there arose a catena of litigation with respect to assessee’s claiming the deductibility of education cess whilst computing the income chargeable under the head “Profits and gains of business or profession”. Various assessee’s raised additional grounds before the CIT(A) and tribunal to claim the deductibility of education cess based on the decision of these two High Courts.

Various tribunal judgements had allowed the deduction of education cess in Sicpa India Pvt Ltd (ITA No. 704/Kol/2015), Philips India Limited (ITA No. 2612/Kol/2019), Atlas Copco India Ltd (ITA No. 736/Pun/2011), Bajaj Allianz General Insurance Company Limited (ITA No. 1111/Pun/2017), ITC Ltd (ITA No. 685/Kol/2014) and Tata Steel Limited (ITA No. 5616/Mum/2012) to name a few.

However, the Kolkata tribunal in Kanoria Chemicals & industries Ltd (ITA No. 2184/ Kol/2018) held that education cess is not deductible and held education cess to be an additional surcharge relying on the judgement of K. Srinivasan (83 ITR 346)(SC)

Proposed Amendment

The Finance Bill, 2022 proposes to amend section 40(a) of the Act by inserting Explanation 3 to clarify that for the purpose of this sub-clause, the term ‘tax’ shall include and shall always deemed to have included any surcharge or cess by whatever name called, on such tax.

As there is abundance of contrary literature on the aspect of the definition of ‘tax’ being inclusive or exclusive of cess and in order to address the ambiguity and reduce the litigation, the Government, clarified that the Bombay High Court, Rajasthan High Court and various tribunal rulings have not taken cognizance of the decision of the Supreme Court in K. Shrinivasan (supra) and are not in lines with the interpretation of the legislature. Accordingly, to avoid further misinterpretation, an Explanation is proposed to be added retrospectively to section 40(a)
(ii) of the Act clarifying that the term ‘tax’ shall be deemed to have always included any surcharge or cess, by whatever name called, on such tax.

Further, the amendment is made retrospective from April 1, 2005 to make it clear that this will apply in relation to AY 2005-06 and subsequent years irrespective of the CBDT Circular dated 18 May, 1967.

Impact

The decisions of the Rajasthan High Court, Bombay High Court and various tribunals will stand overruled by the proposed amendment.

B] Amendment and clarification on allowability of expenditure (section 37)

Background

Explanation 1 to section 37 of the Act provides that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law would not be deemed to have been incurred for the purpose of business or profession and no deduction would be allowed in respect of such expenditure.

Issues

Whether freebies given to doctors / medical practitioners was allowable as a deduction under section 37 of the Act as these payments were made in violation of MCI regulations and whether they would fall within Explanation 1 to section 37 of the Act.

Further, the CBDT vide Circular No. 5/2012 dated 1-8-2012, sought to clarify that providing the abovementioned benefits to medical practitioners and associates is deemed to be illegal and therefore, would attract the provisions of Explanation 1 to Section 37(1) of the Act. Thus, disallowance was directed to be made in the hands of such pharmaceutical companies or allied health sector industries or other assessee which have provided the aforesaid benefits to the doctors / medical practitioner and claimed the same as a deductible expense.

This circular was challenged in Himachal Pradesh High Court in the case of Confederation of Indian Pharmaceutical Industry Vs Central Board of Direct Taxes [(2013) 335 ITR 388 (HP)], in which the Hon’ble High Court rejected the petition and held that –

“The regulation of the Medical Council prohibiting medical practitioners from availing of freebies is a very salutary regulation which is in the interest of the patients and the public. This Court is not oblivious to the increasing complaints that the medical practitioners do not prescribe generic medicines and prescribe branded medicines only in lieu of the gifts and other freebies granted to them by some particular pharmaceutical industries. Once this has been prohibited by the Medical Council under the powers vested in it, s. 37(1) comes into play. The Petitioner’s contention that the circular goes beyond the section is not acceptable. In case the assessing authorities are not properly understanding the circular then the remedy lies for each individual assessee to file an appeal but the circular which is totally in line with s. 37(1) cannot be said to be illegal. If the assessee satisfies the assessing authority that the expenditure is not in violation of the regulations framed by the medical council then it may legitimately claim a deduction, but it is for the assessee to satisfy the AO that the expense is not in violation of the Medical Council Regulations.”

Settled position before the amendment

The Mumbai, Delhi and Chennai Tribunal in a series of judgements had allowed a deduction under section 37 in respect of freebies given to doctors. The Tribunal held that MCI Regulations, 2002 provided limitation / curbs / prohibition only for medical practitioners and not for pharmaceutical companies. Further, the CBDT Circular which created a burden or liability or imposed a new kind of imparity could not be reckoned retrospectively. Hence, expenses in the nature of sales and business promotion, advertisements and free samples given were allowed as a deduction.

The decisions where these payments were allowed as a deduction under section 37 of the Act are as under:-

  • Eli Lily & Co (India) Pvt. Ltd. (Del trib)

  • Dupen Laboratories Pvt Ltd. (Mum trib)

  • UCB India Pvt. Ltd. (Mum trib)

  • PHL Pharma P. Ltd. (163 ITD 10)(Mum trib)

  • Aristo Pharmaceuticals Pvt. Ltd. (Mum trib)

  • Solvey Pharma India Ltd. (Mum trib)

  • Pfizer Limited (Mum trib)

  • ICARUS Health Care Pvt. Ltd. (Chennai trib)

  • Cipla Limited (Mum trib)

  • Medley Pharmaceuticals Ltd (118 taxmann.com 44)(Mum trib)

In light of the proposed amendment, all these rulings will be overruled and reference to the Special Bench in Macleods Pharmaceuticals Ltd (192 ITD 513)(Mum trib) may not be necessary.

The position adopted in Kap Scan and Diagnostic Centre Pvt. Ltd. (344 ITR 476) (P&H), Liva Healthcare Limited (ITA No. 4791 of 2014)(Mum trib) and Ochao laboratories Ltd where the deduction under section 37 of the Act has been denied for expenses will be confirmed by the proposed amendment.

Proposed Amendment

Finance Bill, 2022 proposes to amend section 37 by inserting Explanation 3 to clarify that the expression “expenditure incurred by an assessee for any purpose which is an offence, or which is prohibited by law” under Explanation 1 to section 37. As per clause (i) to Explanation 3, the aforementioned expression shall include an expenditure for any purpose which is an offence under, or which is prohibited by, any law for the time being in force, in India or outside India.

This amendment is proposed to come into effect from April 1, 2022 and will accordingly apply in relation to AY 2022-23 and subsequent AYs.

As per clause (ii) to Explanation 3, the aforementioned expression shall include and shall be deemed to have always included the expenditure incurred by an assessee to provide any benefit or perquisite, in whatever form, to a person, whether or not carrying on a business or exercising a profession, and acceptance of such benefit or perquisite by such person is in violation of any law or rule or regulation or guideline, as the case may be, for the time being in force, governing the conduct of such person.

The Memorandum explaining the Finance Bill, 2022 referred to the ruling of the Mumbai tribunal in Macleods Pharmaceuticals Ltd where after discussing the provisions of the law, the tribunal recommended constitution of a larger bench to consider the issue of deduction on freebies to medical practitioners under section 37 of the Act and opined that the co-ordinate bench’s decision of PHL Pharma did not reflect the correct legal position and did not consider that the deduction was hit by Regulations, 2002 of Indian Medical Council Act, 1956.

Impact

The proposed amendments applies prospectively and hence assessee’s may place reliance on the favourable rulings where deduction had been allowed under section 37 of the Act in the past. The amendment seeks to promote healthy competition and cultivation of a market space wherein an even playing field is provided to pharmaceutical products irrespective of the behemoth companies promoting them.

C] Disallowance under section 14A of the Act

Background / Issues

Whether the disallowance under section 14A of the Act arose on non accrual / non receipt of exempt income.

Settled position before the amendment

Various decisions of the Madras High Court, Delhi High Court and Punjab High Court have held that there can be no applicability of section 14A of the Act where exempt income has not been earned during the year. Further, the Delhi High Court in Cheminvest Limited held that there could be no disallowance under section 14A of the Act in respect of interest expenditure attributable for making strategic investments absent earning any exempt income therefrom.

The decisions which held that no disallowance can be made under section 14A where no exempt income has been earned are as under:-

  • Cheminvest Limited (378 ITR 33)(Del HC)

  • Holcim India (P) Ltd (Del HC)

  • Lakhani Marketing Incl (P&H HC)

  • McDonalds India Pvt. Ltd. (Del HC)

Further, SLPs have been dismissed in the following judgements on the same proposition are as under:-

  • Chettinad Logistics (P) Ltd

  • Oil Industry Development Board

  • GVK Project and Technical Services Ltd

Proposed Amendment

The Finance Bill, 2022 proposes to amend section 14A(1) of the Act to include a non- obstante clause in respect of other provisions of the Act and provide that no deduction shall be allowed in relation to exempt income, notwithstanding anything to the contrary in the Act.

Impact

The proposed amendment would set at naught the settled principle that there can be no disallowance under section 14A of the Act where no exempt income has been earned.

However, with dividends now being taxable the scope of exempt income earned would be narrow and apply only in few circumstances.

D] Validity of proceeding against predecessor (Section 170A(2A)

Background

Section 170 of the Act governs the taxation procedure of companies which are subject to reorganization / succession. Though section 170 provides for assessment in cases of succession otherwise than by death, in practice once an entity starts the process of reorganization by filing an application with the adjudicating authority or any High Court, the period of time involved in coming to a conclusion with respect to such reorganization is found to be a long-drawn process and is not time-bound. During the pendency of the court proceedings, the income tax proceedings and assessments are carried on and often completed on the predecessor entities only.

Issues

Courts have held proceedings completed on the predecessor entity to be bad in law where the assessing officer has been intimated of the merger / reorganisation as the predecessor assessee ceases to exist in the eyes of law.

Settled position before the amendment

The decision of the Supreme Court in Maruti Suzuki India Limited (416 ITR 613) had quashed the assessment order framed in the name of a non-existing entity where the assessing officer was informed about the merger pursuant to the amalgamation and in spite of being informed a notice and order was passed on the non- existing entity. The Supreme Court held that the same is a substantive illegality and cannot be a procedural violation as contemplated in section 292B of the Act. Further, the decision went on to clarify that participation in the proceedings by the successor cannot operate as an estoppel against law.

The other decisions which upheld the same position are as under:-

  • Spice Entertainment Ltd (Del HC)

  • Dimension Apparels Pvt Ltd (Del HC)

Various tribunals have also passed orders following the above settled principle.

Proposed Amendment

The Finance Bill, 2022 with a view to clarify about the validity of assessment proceedings with regard to concluding business reorganization under the Act proposes to insert section 170(2A) which provides that the assessment or other proceedings pending or completed on the predecessor in the event of a business reorganization, shall be deemed to have been made on the successor.

The amendment will take effect from April 1, 2022

Impact

The settled judgements of the Supreme Court have been overruled by this amendment and even if an assessment is framed on a non- existent entity which does not exist in the eyes of law, the same would be deemed to be made on the successor entity. The principle laid down by the Madras High Court in Vedanta Limited which held that reassessment proceedings are valid where the notice in the name of a non-existing entity has been rectified by the revenue during the course of proceedings will be confirmed by virtue of the proposed amendment.

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