Section 35(2AB): Examining the scope of expenditure incurred outside the 'in-house' R&D facility


Introduction

Section 35 clause (2AB) of the Income-tax Act, 1961 (hereinafter "IT Act") provides for weighted deduction on expenditure for research and development where the assessee is engaged in the business of biotechnology. It further proposes to provide that for the purpose of the said sub-section, expenditure on scientific research shall include expenditure incurred on clinical trial, regulatory approval and filing of the patent.

At the outset reference is invited to the Section 35(2AB) of the IT Act:

“35
…. 


(2AB)(1) Where a company engaged in the business of bio-technology or in any business of manufacture or production of any article or thing, not being an article or thing specified in the list of the Eleventh Schedule incurs any expenditure on scientific research (not being expenditure in the nature of cost of any land or building) on in-house research and development facility as approved by the prescribed authority, then, there shall be allowed a deduction of a sum equal to two times of the expenditure so incurred.

Explanation.—For the purposes of this clause, "expenditure on scientific research", in relation to drugs and pharmaceuticals, shall include expenditure incurred on clinical drug trial, obtaining approval from any regulatory authority under any Central, State or Provincial Act and filing an application for a patent under the Patents Act, 1970 (39 of 1970).” (Emphasis supplied)

In the present context, in view of the above provisions of the Act, it is apparent that in order to claim weighted deduction under Section 35(2AB) of the IT Act, the expenditure must be incurred on ‘scientific research’. Furthermore, it must be ‘incurred on an in-house R&D facility’. Therefore question that arises is whether expenditure referred to in Section 35(2AB) of the IT Act can be construed to mean the expenditure incurred outside R&D facility/outsourced R&D activity?

Expenditure incurred outside the Assessee's R&D Facility 

While the literal interpretation of the aforementioned provision may lead, prima facie, to the conclusion that the said expenditure would not be allowed. The other interpretation is analyzed herein below:

  • The dictionary meaning of the word "on" reveals that it may have various shades to it. It implies that its 'directed towards' or 'it's in repect thereto'. Accordingly, in CIT v. Cadila Healthcare Ltd. [2013] 31 taxmann.com 300 the Hon'ble High Court of Gujarat held that if the research is conducted within the organization through utilization of external resources or staff, it can be stated to be an in-house research.
  • The Hon'ble Court opined that for the purposes of the aforesaid section it may not always be commercially possible to have the testing in closed laboratories or in-house facilities that are maintained by the assessee. A pharmaceutical drug requires extensive testing to meet the strict standards on all possible effects of the said drug. 
  • On the argument advanced by the Revenue that the scheme of the provision allows only those expenditures that are spent on 'in-house' facility, the said argument was negated by the Court stating that the certificate issued by DSIR in this regard states only total expenditure and has no bearing on the treatment of the said expenditure for the purposes of this clause. 
There are however contrary decisions on the aforementioned subject. While interpreting such provisions, it should be kept in mind that, they cannot be interpreted in a void. Where the Legislature confers a benefit through a statute, it needs to be read in favor of the assessee. These provisions need to be read schematically and in the true import of their meaning needs to be assigned to the words employed. Therefore, following Cadila Healthcare (supra) and the facts and circumstances of the case at hand, a view may be reasonably taken that 'in-house' facility includes using external labs for limited purposes for the purposes of Section 35(2AB).  


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