By TIOL News Service

MUMBAI, JAN 05, 2012: THE issues before the Bench are - Whether when assessee engaged in clinical trial incures expenses on trials conducted outside in-house R&D facility, such expenditure is also eligible for weighted deduction u/s 35(2AB) - Whether no addition can be made u/s 41(1) for considering the cessation of any liability, merely on the basis that the period of limitation of three years has expired. And the verdict partly goes in favour of the assessee.

Facts of the case

A) Assessee incurred expenses in respect of clinical trials, scientific information, scientific literature, analysis charges, pilot bio study expenses and consultancy charges and claimed weighted deduction u/s 35AB which allows weighted deduction for any expenditure on scientific research on in-house research and development facility as approved by the prescribed authority. The Legislature in its wisdom has used the term on ‘in-house research and development facility’ and not ‘an in-house research and development facility’ or ‘on in-house research and development’ which implies that entire expenses on scientific research conducted by the in-house facility shall be held as eligible. In order for a weighted deduction to be available under section 35(2AB) what is essential is that an assessee engaged in the business of manufacturing of drugs and pharmaceuticals has set up an in-house research facility where scientific research is carried out and expenditure is in nature of carrying out scientific research.

Clinical trial is one of the various steps involved in scientific research for new drug development. Depending on the information gathered from conducting clinical trials, an assessee may have to do further research to make drugs/formulations effective and again go for clinical trials. The Explanation to section 35(2AB) refers to availability of deduction for expenditure incurred on clinical trial, expenditure incurred on obtaining approval from any regulatory authority under any Central, State or Provincial Act and expenditure incurred on filing an application for a patent under the Patents Act, 1970. Expenditure incurred on clinical trials is nothing but expenditure incurred for procuring data which will be used in the ongoing scientific research activities carried on by the in-house research and development facility and is therefore akin to the expenditure incurred on procuring any other material used as an input in the research and development activity and, accordingly, the claim for weighted deduction is allowable.

Scientific information expenditure was incurred for purchase of paper, art work charges, etc for preparing visual aids and product literatures on drugs being researched and subscriptions to technical journals and websites and Scientific literature is subscription to scientific literature, journals, CDs, etc to enable the research personnel working in the in-house R & D facility to keep themselves updated about development in the medical field, to access available literature on the reference drug components and proposed drug. These expenses were incurred within inhouse research and development facility and should be held as eligible for weighted deduction.
Analysis charges are paid to Clinical Research Organizations (CROs) for carrying out tests on volunteers after administration of new drugs and/or innovator’s reference drug during bio equivalence studies. It is similar in nature like clinical trial expenses and hence should be held as eligible for weighted deduction. Pilot bio study expenses are part of clinical drug trials wherein newly formulated drug is initially tested along with or without innovator’s drug on small sample size of 10 to 15 human volunteers. Consultancy charges incurred for availing consultancy on patent and other procedures because a drug should match that standard for application and registration of drugs. These expenses are directly covered by the Explanation and hence the same should be held eligible for weighted deduction.

B) Addition was made by the AO on the ground that neither the assessee nor the creditor have settled the amount and more than three years have lapsed, which is the period of limitation under the Limitation Act. CIT (A) allowed the appeal of the assessee.

After hearing both the parties, the ITAT held that,

++ following the decision of Coordinate Bench in the case of Concept Pharmaceuticals Ltd. it is concluded that the assessee is entitled to only 100% deduction of these expenses in accordance with the normal provisions and that 150% deduction cannot be given. Under the provisions of section 5(2AB)(1), the expenditure incurred on scientific research on inhouse research and development facility is eligible for weighted deduction. For an expenditure to be eligible for weighted deduction it must incurred on (i) scientific research and (ii) on in-house research and development facility approved by the prescribed authority. The phraseology used is “on in-house research or development facility” and not “by in-house research and development facility” and therefore only the expenditure incurred on in-house research can be allowed under section 35(2AB) and not any expenditure incurred outside such facility. What the Explanation to section 35(2AB)(1) has clarified is that expenditure incurred on clinical trial in relation to drugs and pharmaceuticals, will be part of the expenditure on scientific research. The Explanation nowhere states that expenditure incurred on clinical trial even outside the in-house research and development facility can be allowed. The clinical trial has to be considered as a part of scientific research in relation to drugs and pharmaceuticals. For allowability of weighted deduction u/s 35(2AB), the condition that the expenditure should be incurred ‘on inhouse research and development facility is also required to be fulfilled. In case the clinical trial is not done in the in-house facility, the expenditure will not be eligible for deduction as the weighted deduction is only in relation to expenditure on inhouse research facility. The CBDT in Circular No. 763 has only explained the provisions of section 35(2AB) and has clarified that the deduction will be available to companies having in-house research and development facility approved by the prescribed authority. There is nothing in the circular to show that even the expenditure incurred outside the approved research and development facility will be eligible for weighted deduction. Circular No. 14, dated 22-11-2002 of CBDT only states the provision of law that the Explanation has been inserted which provides that “expenditure on scientific research in relation to drugs and pharmaceuticals shall include expenditure incurred on clinical trials etc. Nowhere it is provided that expenditure incurred on clinical trial outside in-house research and development facility will also be eligible.” The intention of the Legislature was clear that entire expenditure incurred on in-house research and development facility if approved has to be allowed. It was accordingly held that once the approval had been granted the assessee will be entitled for deduction in respect of the entire expenditure. There was no issue before the Tribunal as to whether expenditure incurred outside the approved in-house R & D facility can be allowed. The expenditure on clinical trial though the same is an integral part of scientific research will be eligible for weighted deduction under section 35(2AB) only if the expenditure is incurred on an in-house research and development facility. The expenditure incurred on trial conducted outside the in-house R & D facility will not be eligible for weighted deduction under section 35(2AB);

++ following the decision in the preceding year it is held that the AO made the addition on the presumption that the said ‘debts’ become time barred under the Limitation Act as no action has been taken for recovery. In our opinion, no such condition is there in section 41(1) for considering the cessation of any liability and in respect of any expenditure, even if within the period of limitation of three years, the assessee unilaterally write off the liability within one year then also the provision of section 41(1) is applicable. Thus, CIT(A) has rightly deleted the addition made by the AO u/s. 41(1).

(See 2012-TIOL-08-ITAT-MUM in 'Income Tax')