The Finance Bill 2021 has proposed that goodwill of a business or profession will not be considered as a depreciable asset. Depreciation would therefore, not be allowed on goodwill of a business or profession in any situation. Accordingly, goodwill of a business or profession has been excluded from the meaning of intangible assets under section 32 of the Income Tax Act, 1961 (IT Act) and corresponding changes under various other provisions are proposed to be amended.
Though a subject matter of litigation during assessments, it has been well settled by various judicial pronouncements, including the decision of Hon'ble Supreme Court in the case of Smif Securities Limited [(2012) 348 ITR 302 (SC)], that goodwill is an asset that arises on account of consideration paid being in excess of fair value of assets and liabilities being acquired, irrespective of the fact whether consideration is discharged in cash or shares. The mode of acquisition of business may be via a merger, demerger or business purchase.
THE CASE OF INTANGIBLE ASSETS
Further there are a plethora of various judgements which have held that goodwill arising on a purchase of business is included under the definition of intangible asset and therefore is a depreciable asset in the hands of the buyer. As a matter of fact, this is one of the many reasons why a buyer generally prefers a business purchase as compared to a share purchase from a seller since the buyer would get enhanced depreciation on the value of assets that it has paid for.
The memorandum to the Finance Bill 2021 explains various provisions of the IT Act and the reasons as to why depreciation should not be allowed on goodwill. However, all such provisions pertain to a merger or a demerger situation where the depreciated asset block of the transferor company continues in the hands of the transferee company without any "step-up" in value. The logical reasoning behind this is the impact of mergers and demergers are tax neutral in the hands of transferor company and its shareholders and thus the transferee company should not avail depreciation on the asset value higher than the asset value that it inherits from the transferor company.
A DEBATABLE ISSUE
It is important question the logic in disallowing depreciation on goodwill of a business or profession resulting from purchase of a business by a buyer from a seller for which the seller is being taxed on the capital gains – this being the difference between the consideration received and the tax value of net assets of its business. If the seller is being taxed for the consideration that it receives, then the buyer must also get the depreciation benefits on the assets that it has paid for. This certainly is not tax abuse or evasion that ought to be disallowed.
The proposal, in fact leads to a situation of double taxation where the seller is taxed but the buyer is not being allowed to depreciate the asset that it has paid for. Reasons to disallow allowability of depreciation on goodwill in all situations without making any distinction, including that of a business purchase is discriminatory and illogical.
Goodwill, by definition, is a residual asset, the value of which cannot be attributed to a specific tangible asset or intangible asset. But nonetheless, the buyer has paid value for this asset and there is no reason why depreciation benefit should be denied unless it has been abused by way of an internal restructuring which otherwise can be curbed under the provisions of General Anti Avoidance Rules. Further IND AS 103 also does not allow recognition of goodwill in a "common control business combinations".
THE SAVING GRACE
The saving grace is that consideration paid for acquisition of such goodwill will continue in the tax books as non-depreciable asset, the cost of which will be available as a deduction in computing capital gains on any subsequent sale.
Further, what is proposed to be restricted is a depreciation claim on goodwill of a business or profession. However, if the buyer allocates the purchase price that it has paid for acquiring the business, into specific and identifiable assets, whether tangible or intangible, then depreciation on such allocated value of identified asset should be available to the buyer. The buyer may consider obtaining a business valuation or a purchase price allocation report from a registered valuer or a chartered engineer to support the allocation of purchase price to specific identifiable assets like brands, licenses, customer data, know-how, patents, copyrights, trademarks, etc. Such assets are covered under the definition of intangible assets and thus are entitled to depreciation.
To conclude, depreciation on goodwill is always an essential element in calculating post tax return of an acquisition proposal and would severely impact pay-back calculations of every M&A deal and the corresponding negotiations in the bid or offer price for an asset. With the advent of pre-pack solutions of stressed assets and InvITs leading to monetisation of infrastructure assets such as highways, airports, railway infrastructure etc. depreciation on goodwill would perform an important part in increasing the yield to the buyers. The government may reconsider allowing depreciation on goodwill arising on a business purchase and may if necessary, reduce the depreciation rate for this asset class in line with international standards.
This article has been printed in Money Control
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