Navigating Section 194R with respect to pharma business organisations and way forward

The Central Board of Direct taxes (CBDT), on 16th June, 2022, issued the guidelines for the effective implementation of section 194R. Although the new guidelines have been applicable from 1st July, 2022, these are applicable for the full financial year, i.e. from April 2022 onwards.

For a common man, it is important to understand and know that it is an amendment/extended version of Section 194Q and section28(iv).

As per the new guidelines, under I-T act, any person, whosoever, is providing any “benefit” or “perquisite” to the resident and if that benefit/perquisite exceeds Rs 20,000 in a year, it is liable for the Tax Deducted at Source (TDS) at the rate of 10 per cent. The value of the benefit/perquisite will be based on the fair market value. The government feels that in various business/professions, especially like FMCG/consumer durables/pharma sector, the benefits/perquisites are offered to their channel partners and customers, especially the Health Care Physicians (HCPs)/social media influencers and the amount of these benefits/perquisites now has become so high that the government feels this as a potential source of “leakage” or “evasion of taxes” and hence, it should fall under the gamut of TDS, Section 194R.

Section 194R has caught the attention from all the corners, especially from the people who are directly/indirectly involved in the business/profession where the nature of business/profession by default binds them to opt for benefit/perquisite. For instance, as per the statement of Kamlesh Varshney, Joint Secretary, Finance, the physician samples offered to the doctors are not free, and they have value (physician samples are supposed to be free and till date pharma companies claim that is free and does not attract any commercial value and also print the same on the samples –“Physician samples not to be sold.”

The circular of section 194R mentions that sales discounts/cash discounts and rebates will not come under the section 194R tax applicability.

Similarly, if the trade promotion schemes or free goods or the bonus offer, which are offfered to the stockiest/dealers (e.g. on the purchase of 10 strips, two strips free) will also be free from section 194R ruling.

However, the circular of Section 194R clarifies that if it is the case of “incentives” (earned by the dealers or channnel partners), whether it is kind or cash or may be the case of “foreign trip” earned by dealer on any business offer by the business organisation or “sponsoring of the trip” to the channnel partner or to the HCPs or may be providing any “free tickets” to any of the residents who are involved in the business/profession with payee, are eligible for the tax.

The circular has made clear, and has kept government hospitals/institutions out of the gamut of section 194R. The circular has also clearly elaborated the role of social media influencer in the section 194R.

Under section194R, if the social media influencer is accepting and retaining it with himself, any product/gadget/device, for e.g. a nutra or cosmetic product, or may, any digital app, or any electronic gadget and testing it, verifying it and then posting on the social media, its role/applicability/significance in the social/digital media platforms, then, it will attract tax. But, if the social media influencer, after testing and verification, is not retaining and returning back to the business organisation, then, it will not attract any tax liability. Here, the circular is not able to elaborate on the role of the dealer/distributor/retailer, who also receives these free products for testing, validation and consumption. It does not specify whether the tax will be applicable on this category of people too, apart from social media influencers.

The section 194R also mentions about “out-of-the-pocket expenditure” incurred by the service provider on behalf of the client/business organisation. There are many occasions when it has been observed that the company channel partners/consultants/stockiest/dealers carry out the business activity, along with company field force and then settle expenses after the event or the trip. In these types of instances, if the expenses are settled by the dealer/consultant, and they raise a claim to the business organisation, and if these expenses are settled to them by the business organisation, it will attract TDS. But, if the initial invoice/bill is raised in the name of the company, and if the dealer/consultant is settling the expenses, and after few days, if those expenses are reimbursed, then it will not attract the tax.

Section 194R has kept away the conferences/business meets which are meant for educating the dealers, especially in the case of health-apps/gadgets/medical devices. Any expenditure incurred on these trade-partners to educate them for the application and understanding of these products will not entail the tax applicability. It is exempted from this clause. On the account of these educative business conferences, if the dealers are staying after the conference or arriving before the conference, then, that particular duration, which is not part of the event, will attract tax. Similarly, if the dealer is arriving with his family members, he/she is liable for tax for their friends/family members accompanying them.

The issued circular for the section 194R mentions the threshold of Rs 20,000 for the benefit/perquisite. Although the circular is operationally effective from 1st July, 2022 onwards, the threshold limit is applicable for tax computation from 1st April, 2022 onwards.

Marketing expenditures –Snapshot

The marketing expenditure incurred by the pharma companies has always been under the scanner by the government authorities, media and common public and the litigation between the pharma companies and the government has always received due attention by all the people.

The recent 2022 case of Apex Laboratories (Chennai) turned against them by the Supreme Court (SC) where it gave directives to the company that expenses incurred on the medical promotion on HCPs will be covered under the tax.

This further motivated the government authorities to go all out and review the marketing expenditure of Micro Labs (makers of Dolo 650, Bengaluru) and disallowed their entire marketing expenditure worth few hundred crores. The pharma industry experts believe that these types of actions will lead to cascading effects and probably will engulf other pharma business organisations.

The marketing expenditure incurred by pharma companies in the past 30 years or so has gone up, and, as per industry experts, it shot up to more than 20 per cent in the bottom line, eventually leading to high medicine cost, and, thus, making medicines costlier for the common masses.

The “freebies,” as labelled by the trade pundits, listed various gifts and articles, including computers, holidays to exotic locations, home utensils, mobiles, scientific journals, costlier medical books, refrigerators, TVs/LEDs, sponsoring to the Key Opinion Leaders (KOLs) to the hi-tech scientific sessions and conferences, etc. The list is endless. This is over and above the physician samples and various different forms of attractive high-value/low-value brand reminders.

This all started way back in early 1980s with small prescription pads and common gift items, especially those which used to be placed on the HCPs desk/table and used to serve them as the brand reminder. However, very soon, it caught up the imagination of marketing heads, and, from these small “low-value brand reminders,” it got escalated to “high-value brand reminders.”

In 1970s, the pharma professionals, who were selling science to the HCPs through their knowledge and intellectual capital, ultimately took a back seat temporarily as the majority of pharma companies engaged themselves into “high-/low-value brand reminders” competition.

All this eventually came into limelight through the famous 2017-18 Aristo Pharma, Solvay litigation (2017-TIOL-135-ITATMUM, 2019-TIOL-2682-ITATMUM,) in which the SC passed the decisions against these business organisations and imposed tax on their marketing expenditures.

The way forward

The deductibility of these types of marketing expenditures incurred by the pharma companies has always been a bone of contention between the business organisation and government tax authorities.

The Medical Council of India (MCI) has always taken their stand, and has always issued timely guidelines as well as the code of conduct, stating clearly that HCPs/Recognised Medical Practitioners (RMPs) are not allowed to accept any gifts/favours from pharma business organisations. Even the Department of Pharmaceuticals (DoP) also issued guidelines in the form of voluntary code as Uniform Code of Pharmaceutical Marketing Practices (UCPMP, 2014) for pharma business organisations with respect to their marketing practices.

Now, since section 194R is in place, the role of marketing professionals from the pharma industry will need a paradigm shift, and they have to identify new and innovative methods of promoting science to the HCP community.

The pharma companies need to enter into strategic tie-up with the academic and research organisations and should start harnessing the new talent and should invest their resources on the new talent and develop them for the future. Today, we are in the era of digital world, a world full of new methods of analytics with plethora of software and innumerable methods to express the data in highly-customised format. It’s now high time to relook on these new resources and sharpen their business and marketing strategies with these new analytic techniques and strengthen the medical fraternity with highly-customised patient-centric approach. It’s high time to relook and re-design their business models giving due space to physical and digital applications and channels and bring out the new innovative methods of drug promotion to healthcare professionals, for which, probably, they are also eagerly waiting, as this era of science and technology is certainly going to benefit all the stakeholders.