Disallowance u/s 37: Can Pharma Company Claim Deduction on Referral Commission?

The Income Tax Act contains sections addressing particular deductions under the head income from business or profession. Broadly, specific deductions are discussed under sections 30-36 of the act. Section 37, however, is a residual provision that covers deductions not specified under any other sections of the Act. This article will explain the general rules for claiming deductions under section 37 with an interesting case law.

Section 37 - General Deductions

Section 37 deals with general deductions. The assessee can claim a deduction under this section only when the particular deduction is not covered under other sections. Along with that, the assessee needs to satisfy the following conditions.

• It should not be an expense of a capital nature. Only revenue expenses are allowed under this section.
• Only expenses incurred exclusively for business purposes can be allowed under this section. Expenses of personal nature are disallowed.
• Only expenses that are legal in the ambit of law are allowed. Any expense prohibited by law, either in India or abroad, is disallowed under this section. 
• The above point is equally applied to expenses incurred in the nature of a direct payment of the amount or the form of a perquisite(expense in kind).
• Expenses incurred for Corporate Social Responsibility (CSR) are disallowed as they cannot be deemed expenses incurred for the purpose of business.

M/S Kap Scan & Diagnostic Centre Pvt. Ltd v/s CIT

The High Court of Punjab and Haryana passed the judgement on 3rd December 2010.

Key Questions on Eligibility of Deduction

This case law deals with the question of whether commission paid by pharmaceutical company to medical practitioners as a common business practice is an allowable expense under section 37.

Facts of the Case - Alleged Illegal Payments made 

• The assessee is involved in the diagnostic centers business, including CT scans, ultrasound, and X-rays.
• It has paid commissions to the practicing doctors for referring the diagnostic center to their patients.
• Medical practitioners are prohibited from receiving referral commissions or fees of similar nature as per Indian Medical Council Regulations.
• The assessing officer disallowed the claim, stating that the payments were illegal.
• The assessee argued that the Indian Medical Council Regulations prohibit doctors from receiving the commission.
•  Since giving commissions to doctors is not explicitly prohibited, and it is a common and prevailing business practice, the expense is allowable under section 37.

Decision of the Court on Claimable Deduction

The High Court passed judgment against the assessee. It concluded that the referral commission paid by the pharmaceutical company cannot be allowed as a deduction, citing the following reasons.

1. If receiving commissions by doctors is disallowed as per Indian Medical Council Regulations, giving commissions to doctors is also an equally illegal activity.
2. Therefore, the payment of referral commissions is considered an illegal expenditure.
3. Illegal business practices cannot be allowed only because they are common and prevailing among similar businesses.

Final Word

This case law clearly emphasizes that an illegal expenditure cannot be claimed as a deduction only because it is a common business practice. Also, To determine the legality of a transaction, it is essential to understand the legislature's intent. Playing with the structure of the words in the law could not be the correct approach in giving effect to the statute.