2013 (3) TMI 539 - HC - Income Tax

Expenditure on Clinical Trials and Patent Filings Qualifies for Weighted Deduction Under Section 35(2AB)

Commissioner of Income-tax – I Versus Cadila Healthcare Ltd.

The HC upheld that expenditure on scientific research incurred outside the approved in-house R&D facility, such as clinical trials, regulatory ... Deduction u/s 35(2AB) - Expenses incurred outside the approved R&D facility - whether would get weighted deduction based on the word under 'on in house' - Whether the assessee who has incurred expenditure for scientific research, which was not in the in-house facility, could be covered for deduction under section 35(2AB)? Held that:- The assessee carried out scientific research in its facility approved by the prescribed authority. It incurred various expenditure including on clinical trials for developing its pharmaceutical products. These clinical trials were conducted outside the approved laboratory facility. The Tribunal observed that the term 'in-house' used in section 35(2AB) must be viewed in the context of which it has been used. If by utilizing the staff or resources of an organization, research is conducted within the organization rather than through utilization of external use of resources or staff, it can be stated to be an in-house research. The Tribunal committed no error. The Explanation to section 35(2AB)(1) provides that for the purpose of said clause, i.e. clause (1) of section 35(2AB), expenditure on scientific research in relation to drugs and pharmaceuticals shall include expenditure incurred on clinical drug trial, obtaining approval from any regulatory authority and filing an application for a patent under the Patents Act, 1970. The whole idea thus appears to be to give encouragement to scientific research. By the very nature of things, clinical trials may not always be possible to be conducted in closed laboratory or in similar in-house facility provided by the assessee and approved by the prescribed authority. It cannot be imagined that such clinical trial can be carried out only in the laboratory of the pharmaceutical company. The activities of obtaining approval of the authority and filing of an application for patent necessarily shall have to be outside the in-house research facility. Thus the restricted meaning suggested by the Revenue would completely make the explanation quite meaningless. Merely because the prescribed authority segregated the expenditure into two parts, namely, those incurred within the in-house facility and those can were incurred outside by itself would not be sufficient to deny the benefit to the assessee under section 35(2AB) of the Act. In favour of assessee. ISSUES: Whether legal and professional expenses incurred for expert opinion on manufacturing different pharmaceutical products constitute capital expenditure or revenue expenditure.Whether product registration expenses paid to Drug Regulatory Authorities, which provide enduring benefits, should be treated as capital expenditure or revenue expenditure.Whether trademark registration fee and patent fee constitute capital expenditure as intangible assets under section 32(1)(ii) of the Income Tax Act.Whether expenses incurred outside the approved in-house R&D facility qualify for weighted deduction under section 35(2AB) of the Income Tax Act.Whether the Assessing Officer has the right to determine the fair market value of goods in absence of inter-corporate transfer, under section 80IA(8).Whether the entire profit including profit already earned from marketing same products is eligible for deduction under section 80IC.Whether disallowance of expenditure under section 14A can be deleted despite clause (f) of Explanation-I to section 115JB. RULINGS / HOLDINGS: The Appellate Tribunal did not err in holding that legal and professional expenses incurred for expert opinion on manufacturing different pharmaceutical products were revenue in nature, as the expenditure enabled the assessee to run existing business smoothly and did not result in acquisition of any tangible or intangible asset.The Appellate Tribunal correctly held that product registration expenses are revenue expenses since no new asset was acquired and such registration is essential for marketing existing products; enduring benefit alone is not sufficient to classify expenditure as capital.Trademark registration fee and patent fee are revenue expenses, not capital expenditure, as registration does not create a new asset but merely provides procedural advantages; the Supreme Court held that such expenditure is akin to maintenance and not acquisition of capital asset.The Tribunal rightly interpreted 'in-house' in section 35(2AB) to include research utilizing the organization's staff or resources even if some activities (e.g., clinical trials) were conducted outside the approved facility; therefore, expenses incurred outside the approved R&D facility qualify for weighted deduction.The Assessing Officer's lack of right to determine fair market value of goods in absence of inter-corporate transfer under section 80IA(8) was upheld as per the Tribunal's finding.The Tribunal erred in allowing deduction under section 80IC on the entire profit including the amount already earned from marketing same products, as increase in profit was only incremental after manufacturing commenced.The deletion of disallowance under section 14A despite clause (f) of Explanation-I to section 115JB was found to be erroneous. RATIONALE: The Court applied the principle that expenditure enabling continuation or smooth operation of existing business without acquisition of new asset is revenue expenditure; enduring benefit must be coupled with acquisition of asset to qualify as capital expenditure.Reliance was placed on precedent holding that registration under Trade Marks Act confers procedural advantages but does not create a new asset; expenditure on defending title or registration is maintenance and classified as revenue expenditure.The Court referred to section 35(2AB) and its Explanation introduced by Finance Act 2001, which includes clinical trials and regulatory approvals as part of scientific research expenditure eligible for weighted deduction; a restrictive interpretation of 'in-house' would undermine legislative intent to encourage pharmaceutical research.The Court noted that the certificate issued by the prescribed authority segregating expenditure does not preclude weighted deduction under section 35(2AB), as the authority's certification is for listing expenditure, not for determining deduction eligibility.The Court distinguished between inter-corporate and non-inter-corporate transfers under section 80IA(8), affirming the Assessing Officer's lack of jurisdiction to determine fair market value absent inter-corporate transfer.The Court emphasized that deduction under section 80IC should reflect only incremental profit attributable to manufacturing activity, not pre-existing profit from marketing.The Court highlighted the specific provisions of clause (f) of Explanation-I to section 115JB mandating disallowance under section 14A, indicating that deletion of such disallowance was contrary to statutory provisions.