Under the India Income Tax Act, 1961 (IT Act), there are prescribed depreciation rates for different categories of assets, called the ‘block of assets’ – which contain both tangible and intangible assets. The rates are applicable on the written down value (WDV) of the block of assets. As regards intangible assets, the IT Act provides for a list of such intangible assets on which depreciation can be claimed. These are know-how, patents, copyrights, trademarks, licences, franchises or “any other business or commercial rights of similar nature,” i.e., the residual category of intangibles. The ‘goodwill’ is not explicitly covered in this list.
In order to remove any ambiguity on the issue of claiming any depreciation on goodwill, the Finance Act, 2021 contains significant amends in this regard. The amendments lay down that there will be no depreciation of goodwill allowed from April 1, 2020, i.e., financial year 2020-21. The amendments specifically state that goodwill does not form part of the block of assets and thus are excluded from the list of intangible assets. This primarily flows from the fact that the goodwill in general terms cannot be classified as a depreciating asset. It may see an appreciation or no change in its value depending upon how the business performs during the relevant assessment year. Hence, it does not seem to be the right approach to claim depreciation for goodwill even when in actual terms there is no depreciation which has occurred. Rather it may have appreciated over a relevant period of time which, of course, can be gauged by analyzing the business revenue figures over the same period in the previous year.
Interestingly, in the past, taxpayers have argued that goodwill is part of ‘any other business or commercial rights of similar nature’. Hence, depreciation should be available on goodwill. The revenue department, on the other hand, supported the view that it is not covered in the list of intangibles eligible for depreciation.
In the year 2012, the issue of classification of goodwill as an intangible asset came up before the Hon’ble Supreme Court of India in the case of Smifs Securities Ltd. The court, in this case, had come to the conclusion that the goodwill arising on account of excess consideration paid over value of assets acquired on amalgamation is an intangible asset. Thus, it is a depreciable asset as it would fall in the category of ‘any other business or commercial rights of similar nature’. Resultantly, this judgement led to the several other judicial decisions which allowed depreciation on goodwill both in case of tax-neutral restructuring e.g. amalgamations/ mergers and those acquisition transactions which are not tax-neutral, e.g. slump sale – which means the transfer of one or more undertaking, by any means, for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales.
It is important to note that in case of slump sale, the seller is required to pay tax on the capital gains made on sale of the business undertaking and there is no specific value ascribed to the goodwill which, in any case, forms part of this business. Capital gains in this case is computed as the excess of sales consideration over the net worth of the business undertaking. In the past, buyers used to claim deprecation on this excess amount.
Post these amendments in the Income tax laws, the provisions now do not differentiate between goodwill recognized during tax-neutral transactions (such as amalgamation, demerger) and non-tax neutral transactions such as slump sale. While the seller will continue to be liable to pay capital gains tax, the buyer will not be eligible to claim depreciation.
Hence, considering the aforementioned amendment/s, the taxpayers may now need to assess and assign specific values to all the intangibles where depreciation may still be available. This aspect will have to be carefully evaluated so as to provide clear explanation to the tax authorities, if any such need arises, especially in case of those items which are not specifically mentioned in the list of intangibles such as the goodwill – even though it is now outside the purview of claiming depreciation on it. Thus, now, it is apparent that the stakeholders would need to factor in these changes while formalizing any mergers and acquisition transactions or structuring any future deals.