Goodwill by its very nature is an intangible asset and always considered as ‘Good’ in the Books. However, claiming depreciation on the goodwill has been debated issue and specifically in the deal scenario, has been litigated for several times whenever, depreciation has been claimed on same.
The tax litigation on whether depreciation on goodwill generated at the time of acquisition of business either through slump sale or amalgamation or demerger would qualify as tax deductible expenditure has been answered in affirmative in the past, by the Apex Court in the case of Smiff Securities Limited[1] whereby it was held that goodwill of a business or profession is a depreciable asset under section 32 of the Income Tax Act, 1961 (‘ITA’). Although there have been contrary views[2] as well whenever claiming depreciation on Goodwill have been questioned by various tax officials. In most cases, based on the affirmative pronouncement of Supreme Court, practice of claiming depreciation on Goodwill have been prevalent, specifically in cases of acquisitions of business.
The amendment made in the Finance Act 2021 with an underlying rationale state in the Memorandum to Finance Bill, 2021 that Goodwill, in general, is not a depreciable asset and in fact depending upon how the business runs, goodwill may see appreciation or in the alternative no depreciation to its value. Therefore, there may not be a justification of depreciation on goodwill in the manner there is a need to provide for depreciation in case of other intangible assets or plant & machinery.
Finance Act, 2021, puts to rest much debated issue on allowability of depreciation on Goodwill by excluding it from the definition of written down value under section 43(6) of the ITA. Accordingly, the relevant provisions were amended, in line with amendment proposed in Section 32 of the ITA. Accordingly, amendment proposes as under:
- The WDV of the block not to be increased by the cost of acquisition of goodwill of a business or profession; and
- The WDV of the block to be reduced by the WDV of the goodwill falling within the said block
The extant provisions of section 32 of the ITA provide for depreciation on tangible as well as intangible assets used for business or profession. Intangible assets included know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature. However, goodwill of a business or profession, was not specifically included in the definition of intangible assets.
Now, section 2(11) of the ITA is amended, which defines block of assets and section 32 of the ITA to categorically provide that goodwill should neither be included in “block of asset” nor should it be considered as an asset for the purposes of section 32 of the ITA. The overall impact of the above would be that such goodwill would not be eligible for depreciation. This amendment shall be effective from AY 2021-22 (i.e. from April 1, 2020 itself).
As a corresponding effect of above amendment, section 50(2) of the ITA is also amended to prescribe manner of determining tax WDV and STCG, if any, upon cessation of block of assets, where goodwill formed part of said block as on April 1, 2020 and depreciation thereon was claimed.
Also, considering that goodwill would continue to be categorized as capital assets (not eligible for depreciation claim), cost of acquisition for goodwill would be determined as per section 55(2)(a) of the ITA. The said section is amended to provide the following:
- Where goodwill (or trademark, brand, right to manufacture, etc.) has been acquired by way of purchase, the cost thereof should be the purchase price paid (adjusted for the depreciation claimed upto March 31, 2020);
- where the goodwill has been acquired by way of transactions covered under section 49(1) of the ITA (gift, distribution upon dissolution of firm, distribution upon liquidation of company, amalgamation, etc.), the cost should be the purchase price paid by the previous owner (adjusted for the depreciation claimed upto 31 March 2020); and
- in all other cases, cost should be nil.
Effects of amendment in treatment of Goodwill:
- With this amendment, the effect of Supreme Court’s decision is nullified and any transaction taken place during FY 2020-21, would also need to be given effect for the amendment in treatment of Goodwill.
- Further, the amendment could adversely affect the business transactions with non-related entities where seller’s negotiating power is reduced while valuing the business intended to be sold. As such, there is no such restriction on claiming depreciation on other forms of intangible assets developed by any company over a period of time, viz. know-how, patent, copyrights, licenses, franchise and other forms of commercial rights of similar nature. Practically, in a deal scenario, in case where consideration in excess of book value of a company is discharged, based on a valuation report, where possibility such excess consideration is discharged in lieu of intangible assets other than goodwill. In such case, controversy still prevails and could have an impact on deal negotiation.
- Although the amendment proposed is prospective, effect of same would be retrospective, in a sense that, while calculating capital gains tax on sale of goodwill, past depreciation claim would need to be adjusted to be reduced. Further, provisions in relation to deferred tax asset / liability would also need to be readjusted in the books of accounts. In the absence of any sale of Goodwill, no adverse effect would be imposed on treatment of goodwill.
- Also, another clarification that needs to be brought in would be in relation to treatment of depreciation on goodwill claimed for accounting purposes, for determining ‘Book Profit’ for MAT purposes (for companies on which MAT is still applicable under old regime).
For the detailed discussion on the above subject, please feel free to connect at contact@devadhaantu.in
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[1] Smiff Securities Limited [(2012)348 ITR 302 (SC)]
[2] United Breweries Ltd [TS-553-ITAT- 2016(Bang)]
