ITAT allows Rs 3 crore deduction to Merck, says free samples to doctors recognized under UCPMP not violative of MCI Rules

The assessee Merck Limited, a subsidiary of Merk Group, Germany moved the Tribunal against the disallowance confirmed by Dispute Resolution Panel-3, Mumbai (DRP) and made by the Learned Assessing Officer (AO).

The pharma firm had filed its return of income on 29.11.2011 declaring income of Rs 105,73,75,060/-. The return of income was picked up for scrutiny.

The AO noted that assessee entered into 8 different kind of international transactions. The AO referred the matter to the Transfer Pricing Officer (TPO) for examination of arms length price of those international transactions. The TPO noted that assessee entered into international transactions of purchase of raw materials, payment of technical know-how fees, payment of royalty, purchase of other goods, sell of finished goods, Income of commission and reimbursement of expenses paid and received. All these international transaction were benchmarked using the Transactional Net Margin Method as most appropriate method. The business of Merck is divided into 2 different business lines such as pharmaceuticals and chemicals. The margin of the assessee in pharma segment is 13.10% whereas the margin of chemical business is 19.89%.

For pharmaceutical, assessee identified 98 comparable companies whose average margin was 11.32% and 13 companies for chemical segment where the margin was 5.18%. As the margin of the assessee computed is higher than margin of comparables, in transfer pricing study report and Form No. 3CEB Merck claimed that all its international transactions are at arms length.

Accordingly, the order 92CA(3) of the of the Income Tax Act, 1961 (The Act) by the ACIT, 7(2)(1), Mumbai was passed on 12.01.2015 proposing the total adjustment at Rs 3,97,18,708/-. Based on this, the draft assessment order 143(3) was passed. The AO over and above the mentioned adjustment, allowed 50% of such expenditure and made a disallowance of Rs 03,00,62,583/ while mentioning that the assessee debited a cost of free sample and physician sample of Rs 06,01,25,166/-. He added that the assessee also incurred the conference expenditure of Rs 62,59,227/- towards travel and gift to the Doctors. Same was also disallowed by Assessing Officers.

Eventually, the income was computed at Rs 113,35,07,736/-against returned income of Rs105,73,75,060/-.

However, Merck challenged the order alleging that the TPO erred in passing the order U/s. 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 (the Act) making huge additions and disallowances on the basis of surmises, conjectures, presumptions and assumptions and without considering the papers and documents submitted as also submission jade during the course of assessment proceedings and the proceedings before the Dispute Resolution Panel.

Going through the details of the case, the panel consisting of Prashant Maharishi and Sandeep Singh Karhail learnt that free sample distributed where the AO restricted the disallowance of 50% and with respect to the sales promotion, conference expenses the disallowance of Rs 62,59,227/- was made.

The Tribunal observed;

"Regarding the issue of distribution of free sample the assessee submitted that the disallowance in support of free sample has been deleted by the co-ordinate bench in assessee's own case for past several years and therefore same should be followed."

The bench added;

"With respect to the sales promotion disallowance , AR referred to the note on sales promotion and details of such expenses stating that same should be allowed as this are expense incurred for the purpose of business of the assessee." 

The bench further took note of the submission by the Departmental Representative that both these issues are covered by the decision of Hon'ble Supreme Court in case of Apex Laboratory Private Limited Vs. DCIT in 135 taxmann.com 286.

After carefully considering the contentions, the bench said;

"With respect to free samples , we do not find that same is covered against the assessee by the decision of Honourable SC or it is prohibited by MCI Guidelines. Free sample of medicines supplied to doctors is for promotion of the product of the pharmaceutical company. When a new product is launched, the doctors through the free sample provided, test marketability of new drug launched in the market, give necessary inputs regarding its acceptability etc. of the product. Provision of free samples help impart knowledge to other doctors about the new medicine/product coming into the relevant practice of their profession. Therefore, distribution of free samples is directly related to business promotion activity of the pharmaceutical company. Thus it is wholly and exclusively for the purposes of the business of the company."

"Further, providing samples of pharmaceutical products is not prohibited under either the Indian Medical Council (Professional Conduct, Etiquette and Ethics), Regulations 2002 (MCI Code) or the Uniform Code of Pharmaceutical Marketing Practices by the Department of Pharmaceuticals, 2014 (UCPMP) or 2019 Organization of Pharmaceutical Producers of India (OPPI) Code of Practice. The UCPMP prescribes guidelines under which medical samples should be dispensed which ensure that they are used strictly for clinical evaluation purposes and each sample shall be marked “free medical sample – not for sale”.

It added;

"Even the draft Uniform Code for Medical Device Marketing Practices (UCMDMP) published for stakeholder consultation on March 16, 2022 lays down guidelines to ensure that medical devices are distributed as samples for evaluation purposes only."

Subsequently, the bench noted;

"The Drugs and Cosmetics Rules, 1945 also recognizes the practice of providing drugs for distribution to medical professionals as a free sample by providing specific labelling requirements, requiring such samples to be labelled with the words, Physician's Sample – Not to be sold,” . Further assessee has submitted the complete details of such expenses therefore disallowing it to the extent of 50 % is not justified when the same issue is covered in favour of the assessee by the decision of the coordinate bench in earlier years. Thus, we direct lower authorities to delete the disallowance of expenses on free samples. Ground no 4 is allowed."

To view the original order, click on the link below: