Section 37(1) disallowance and foreign tax credit principles: pharma expenses and matching of credit to corresponding income.

Marketing and sales promotion expenses of a pharmaceutical company were held not disallowable under section 37(1) merely because they were said to conflict with Medical Council of India regulations or CBDT Circular No. 5/2012, since those regulations govern medical practitioners and not pharma companies, and the prohibition in section 37(1) applies only where the assessee's own expenditure is for an offence or prohibited by law applicable to it. Foreign tax credit on interest income was also allowed in the year the corresponding income was offered to tax, on the footing that relief against double taxation follows the taxed income and may be matched or apportioned under the applicable credit rules.

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Issues: (i) whether marketing and sales promotion expenses incurred by a pharmaceutical company were disallowable under section 37(1) on the ground of alleged violation of Medical Council of India regulations and CBDT Circular No. 5/2012; (ii) whether credit for foreign tax deducted at source on interest income could be allowed in the year in which the corresponding income was offered to tax.

Issue (i): whether marketing and sales promotion expenses incurred by a pharmaceutical company were disallowable under section 37(1) on the ground of alleged violation of Medical Council of India regulations and CBDT Circular No. 5/2012.

Analysis: The disallowance depended on whether the Medical Council of India regulations, which regulate the conduct of medical practitioners, applied to pharmaceutical companies. The Tribunal followed its earlier view that those regulations were not meant for pharma companies and that the embargo in the Explanation to section 37(1) applies only where the assessee's expenditure is for an offence or is prohibited by law applicable to that assessee. It also noted that the CBDT circular could not enlarge the scope of the Medical Council of India regulations so as to create a new burden on pharmaceutical companies.

Conclusion: The disallowance was not sustainable and the issue was decided in favour of the assessee.

Issue (ii): whether credit for foreign tax deducted at source on interest income could be allowed in the year in which the corresponding income was offered to tax.

Analysis: The Tribunal relied on the settled position that relief from double taxation is linked to the income on which tax is paid abroad and is not defeated merely because the foreign tax was deducted or paid in a later year. It also referred to the scheme reflected in section 91(1), Rule 128 and Rule 37BA, under which credit is to follow the corresponding income and may be apportioned where income is taxed over more than one year. On that basis, and following the principle of consistency, the foreign tax credit claim was held to be allowable.

Conclusion: The foreign tax credit claim was allowed and the issue was decided in favour of the assessee.

Final Conclusion: The appeal succeeded in full, with both disputed additions and the denial of foreign tax credit set aside in favour of the assessee.

Ratio Decidendi: An expenditure is disallowable under section 37(1) only when the assessee's own expenditure is for an offence or is prohibited by a law applicable to that assessee, and foreign tax credit must be linked to the corresponding income so as to prevent double taxation.

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