Goodwill is an asset eligible for depreciation U/s. 32 of I.T. Act, 1961

1. This appeal is filed by the revenue against the order of the Commissioner of Income Tax (Appeals), Rajahmundry vide ITA No. 0239/13-14/ACIT/C-1/RJY/2014-15 dated 30.03.2015 for the assessment year 2010-11.

2. All the grounds of appeal are related to the depreciation on goodwill. During the assessment proceedings, the assessing officer found that the assessee had introduced an intangible asset worth Rs. 3,73,00,000/- and claimed the depreciation of Rs. 93,25,000/-. It was explained by the assessee before the assessing officer that the company had obtained the logo of CRESA (Central for Rural Reconstruction through Social Action) Trust and it is goodwill that was acquired by the assessee which is an intangible asset. The company has acquired the entire customer base of the micro finance programme from CRESA and acquired the business. The value of software for MIS, accounting systems, internal control systems, other intellectual property rights, CRESA brand, logo and reputation in the area of operations, financial service delivery system including branch operations which is valued at Rs. 3,73,00,000/- was taken over by the assessee company which is said to be goodwill, and the intellectual property right by the company from CRESA Trust and argued that the above rights were acquired by the business transfer agreement and the difference between the value of the assets and the payment was treated as goodwill and claimed the depreciation. The assessee further argued that on intellectual property rights depreciation is allowable. However, the assessing officer was not convinced with the explanation of the assessee for to the following reasons .

“At the outset, it is mentioned that such intangible asset cannot be called at all as “goodwill” or any “intellectual property right” because the CRESA Trust where from the business transfer is said to have taken place, is not at all engaged in any activity with the advent of the so called merger or transfer of the business. Moreover, CRESA is a Trust which is assessed with Income Tax Officer, Ward-3, Rajahmundry. It is ascertained that the assessing officer has recorded some discrepancies with regard to the micro finance activity conducted under the masquerade of charity and submitted proposals to the Commissioner of Income Tax for withdrawal of registration u/s12A of the I.T. Act. First it is mentioned that it is not at all a business but a charitable organization as claimed by it, and the so called transfer, of intellectual property rights or ^,goodwill will be of no avail. The assessee company is totally engaged in banking activity and it is not at all connected to the activity of CRESA Trust in any way. It is not made clear as to how the assessee gained momentum in his business with rapid and meteoric rise by obtaining the good-will. It is only a colourable device selected by the assessee to introduce the intangible asset for the first time during the relevant year, only for the purpose of lesser incidence of tax. It is also noted that Sri Varikuti Prabhudas who is the Managing Director of the assessee company is the chief source for the CRESA Trust also. Both entities are under the total; control and management of Sri Prabhudas. All the clients either to the CRESA Trust or to the assessee are, in majority from unorganized sector and by no stretch of imagination the arguments canvassed on behalf of the assessee that because of the good-will or the Trust he can improve the business, is not convincing. There is no logical meaning in drawing a conclusion to the transaction that intellectual property right is transferred. In this case, very particularly it is noticed that in guise of intellectual property right, the intangible asset was Introduced which was purported to be from a related concern (Trust) created by the assessee itself. Both the Managing Director of the assessee and the founder of the Trust are one and the same and such transfer of intellectual property right cannot be termed as good-will and claim depreciation on it. The following points are mentioned specifically.

(1) Introduction of intangible asset in the balance sheet is not supported by any convincing reasoning. There is no basis at all for valuation of all the items grouped in the goodwill. it is only a report obtained from a professional. The items shown In the grouping were not actually reflected in the return filed by the & trust ‘CRESA’. When it is not appearing In the balance sheet as a capital asset in the hands of CRESA, it cannot take the character of a capital asset in the hands of the assessee. The assessee could not properly explain as to what was the basis for estimating the value of goodwill or Intellectual rights. It is only a transaction among the group organizations controlled and managed fully by one person. Hence, at the outset, it cannot be said that the goodwill of the other organization is purchased.

(2) Terming the intangible asset as good-will does not hold water.

(3) Claiming depredation on such intangible asset is not acceptable because dis allowance of the same is only consequential in nature when, such intangible asset itself is not recognized valid by the Assessing Officer.”

2.1. The assessing officer relied on the decision of ITAT Mumbai in the case of RG Keswani V. ACIT [308 ITR 271] and held that the depreciation is not allowable on goodwill. The AO observed that the Goodwill is a right in personam and the depreciation on goodwill is not allowable as per Section 32(1)(ii) of the I.T. Act. The AO further viewed that the Goodwill does not result into an intangible asset like know-how, patents, copyrights, trademarks, licenses and franchises. Further the assessing officer also held that the goodwill obtained by the assessee is like personal service contract which is unassignable. No third party can be roped in, in the agreement for goodwill by way of sale / assignment. Further, “business or commercial rights of similar nature” are not manufactured or produced overnight, but are brought into existence by experience and reputation. Hence, the goodwill does not result into an intangible asset. (like know-how, patents, copyright, trademarks, licenses/franchises etc.] which can be transferred/assigned/leased. Accordingly the AO disallowed the depreciation claimed by the assessee.

3. Aggrieved by the order of the assessing officer, the assessee went on appeal before the CIT(A) and the Ld.CIT(A) considered all the objections raised by the assessing officer, i.e. whether the intangible assets include goodwill, there could be any goodwill in micro finance business related to un organized activity and the issue with regard to the goodwill of the entity under the same control and management, non-disclosure of the asset in the balance sheet of the society and not falling good will within the purview of section 32 for depreciation, whether intangible asset should be eligible for depreciation or not, the intangible rights fall within the purview of sub section 32(1) and are in the nature of commercial or business rights in detail. The Ld.CIT(A) relied on the judgements of the Hon’ble Supreme Court in the case of CIT Vs. Smifs Securities Ltd. [348 ITR 302] , the decision of Hon’ble Delhi High Court in the case of Areva T&D India Ltd. & Others [345 ITR 421] and Coordinate Bench decision of Hon’ble ITAT, Hyderabad in the case of SKS Micro Finance Ltd.Vs. DCIT and allowed the appeal of the assessee.

4. Aggrieved by the order of the Ld.CIT(A), the revenue is in appeal before us. During the appeal hearing, the Ld.DR relied on the orders of the assessing officer while the Ld.AR supported the orders of the Ld.CIT(A).

5. We have heard both the parties and perused the material placed on record. The assessing officer disallowed the depreciation holding that the assessee’s Trust has not shown the asset in the balance sheet and in the business like micro finance related unorganized sector, there is no case for goodwill. Both the entities i.e. CRESA Trust and the assessee company are under the same control and management. The assessing officer held that there is no case for goodwill and the goodwill is not an asset as per section 32. The intangible assets do not fall within the purview of section 32(1) of I.T. Act. Ld.CIT(A) has considered all the objections of the assessing officer and gone through the business transfer agreement and given a clear finding placing reliance on the business transfer agreement , the valuation report of the total assets of the CRESA Trust and the consideration paid by the assessee company. The Ld.CIT(A) followed the order of Hon’ble Delhi High Court in the case of Areva T&D India Ltd. & Ors. Vs. DCIT(supra) and and the judgement of Hon’ble Apex court in the case of CIT Vs. Smifs Securities Ltd. [348 ITR 302] and decided that the goodwill is an asset and held that the depreciation is allowable on intangible assets as per sub section(1) section 32 of the Act. The Ld.CIT(A) relied on the decision of Hon’ble ITAT in the case of SKS Micro Finance Ltd. Vs. DCIT(supra) and allowed the appeal of the assessee. For the sake of clarity and convenience, we extract the relevant paragraphs of the Ld.CIT(A) order as under:

I have considered the submissions and contentions raised. I have also perused the Business Transfer Agreement and also the Valuation report filed during the appeal proceedings. The perusal of the business transfer agreement reveal that the micro finance business activity of the society, Central for Rural Reconstruction through Social Action was acquired by the assessee company with all assets and liabilities along with certain intangible rights. The intangible assets in the form of MIS, Accounting systems, Internal Control systems, financial service delivery system including branch network and infrastructure, cresa brand logo & goodwill and client acquisition rights were acquired at a value of Rs. 3,73,00,000/-. This is referred at the clause (4) relating to consideration in the Business Transfer Agreement, which is extracted as under

d. CRESA shall be entitled to charge and receive the following consideration of Rs. 37.30 Million for the brand associated with its Micro finance and Micro insurance business, with very high recall value, trade mark, copyrights and know-how to usher a new methodology of lending to the poor with near 100% recovery rates thorough group method applying peer pressure only without any collateral security thereby increasing the scope of lending virtually unlimited, and other business and commercial rights associated with the same and agreeing to refrain from conducting any micro finance business for the next 10 years in terms of clause 5.2 (supra) of the Memorandum of Understanding approximately divided into for the purposes of calculations :

i. One time payment towards MIS and underlying software, accounting systems, internal control and audit systems, operating system procedures and manuals.

ii. One time payment towards the cost of Brand ‘CRESA for its logo, copyrights and other intellectual Property Rights associated with the same and the business of internal controls systems and related procedure based recovery systems

iii. One time reimbursement of customer creation and transfer costs, for having identified, motivated, trained credit-checked and risk-filtered, retention value for future earning potential of approximately 44,500 customers (with no or minimal attrition rates) on May 31, 2009, since all of these customers are g€nera1ng net positive revenue for CRESA at present.

e. The above consideration as stated in 4(a) and 4(b)(i) besides the compete transfer of micro finance business of CRESA, along with Loan Portfolio as described in detail in the Schedules and the goodwill and other intangible assets described in 4b. will also include :

i. Corporate support services by CRESA to CFSPL towards including strategic planning, all technical matters of group formation, addressing recovery, issues, identification of, new markets, market surveys, change in the method and procedures of financial services, introduction of new products, impact assessment, avenues for negotiation of new loans from prospective funders, generation additional revenues through grants, fees etc., training of key human resources, establishing / upgrading the MIS and ongoing accounting, quality control and internal audit systems, until such time (not less than 3years), CFSPL, is fully in the control of the micro finance customers and the business hereby taken over through the Business Transfer Agreement, so that the business is kept in full vibrant and growing mode.

ii. The period of services will be 2 financial years commencing from June 1, 2009 or the date of agreed take over as per Business Transfer Agreement. During this period CRESA agrees that its Governing Board will be available for necessary support and strategic advice in managing and expanding the portfolio hereby being taken over and transferred.

iii. CRESA will not work in micro finance in any manner, in India, in competition with CRESA Financial Services Private Limited, for the next 10 years and will not represent or use the name CRESA with forum whatsoever. In short CRESA agree for non competing arrangement with the Purchaser in micro finance business. However, CRESA can continue to work on the social development activities which shall not be detrimental to the activities of Purchaser.

4.3.1 From the perusal of valuation report it is seen that the total assets of the activity was valued at Rs. 19,88,46,002/- (including goodwill of Rs 3,73,00,000) and liabilities ascertained at Rs. 18,20,75,025/ as at May 31, 2009. Thus consideration of Rs. 1,67,69,997/- was paid. The valuation of goodwill and of the business is given in the valuation report as under :

4.3.2. From the perusal of the above, it is evident that the intangible assets characterized ‘goodwill’ and acquired under, the Business Transfer Agreement are towards MIS, Internal Control systems, Procedure & Manual, Cresa brand logo, copyrights, client acquisition cost, certain corporate service and non-compete fee. The AO has taken the view that these would not constitute goodwill for the reasons (a) that there could not have been any good in micro finance business related to unorganized sector (b) both the entities are under same control & management (c) not shown in the balance sheet of the society (d) not falling within the purview of Sec.32.

4.3.3. In this regard, it is relevant to understand what constitutes goodwill. The Hon’ble High Court of Delhi in the case of Areva T&D India Ltd. & Ors, Vs. DCIT (345 ITR 421) has discussed the nature of goodwill and the relevant discussion is extracted as under :

In this regard, it would not be out of place to refer to the decision in CIT Vs. B.C. Srinivasa Setty [1981] 128 ITR 294 (SC) wherein the concept of goodwill has been understood in the following terms:

“Goodwill denotes the benefit arising from connection and reputation. The original definition by Lord Eldon in Cruttwell v. Lye [1810] 17 Ves 335 that goodwill was nothing more than “the probability that the old customers would resort to the old places” was expanded by Wood V.C. in Churton v. Douglas [1859] John 174 to encompass every positive advantage ‘that has been acquired by the old firm in carrying on its business, whether connected with the premises in which the business was previously carried on or with the name of the old firm, or with any other matter carrying with it the benefit of the business’. In Trego v. Hunt [1896] AC 7 (HL.) Lord Herschel] described goodwill as a connection which tended to become permanent because of habit or otherwise. The benefit to the business varies with the nature of the business and also from one business to another. No business commenced for the first time possesses goodwill from the start. It is generated as the business is carried or and may be augmented with the passage of time. Lawson in his Introduction to the Law of Property describes it as property of a highly peculiar kind. In CIT v.Chunilal Prabhudas & Co. [1970] 76 ITR 566 the Calcutta High Court reviewed the different approaches to the concept (pp.577, 578)

It has been horticulturally and botanically viewed as ¹a seed sprouting’ or an “acorn growing into the mighty oak of goodwill”. It has been geographically described by locality. It has been, historically described by locality. It has been historically explained as growing and crystallizing traditions in the business. It has been described in terms of a magnet as, the ‘attracting force:, In terms of comparative dynamics, goodwill has been described as the ‘differential return of profit”. Philosophically it has been held to be intangible. Through immaterial, it is materially valued. Physically and psychologically, it is a “habit” and sociologically it is a “custom”. Biologically, it has been described by Lord Macnaghten in Trego v. Hunt [1896] AC 7 [HL] as the “sap and life” of the business. Architecturally, it has been described as the “cement” binding together the business and its assets as a whole and a going and developing concern.

A variety of elements goes into its making and its composition varies in different trades and in different businesses in the same trade and while one element may preponderate in one business another may dominate in another business. And yet, because of its intangible nature, it remains insubstantial in form and nebulous in character. Those features prompted Lord Macnaghten to remark in IRC v. Muller & Co.’s Margarine Limited [1901]AC217[HL] that although goodwill was easy to describe, it was nonetheless difficult to define. In a progressing business goodwill tends to show progressive increase. And in a failing business it may begin to wane. Its value may fluctuate from one moment to another depending on changes in the reputation of the business. It is affected by everything relating to the business, the personality and business rectitude of the owners, the nature and character of the business, its name and reputation, its location, its impact on the contemporary market, the prevailing socio- economic ecology, introduction to old customers and agreed absence of competition. There can be no account in value of the factors producing it. It is also impossible to predicate the moment of its birth. It comes silently into the world, unheralded and unproclaimed and its impact may not be visibly felt for an undefined period. Imperceptible at birth it exists en wrapped in a concept, growing or fluctuating with the numerous imponderables pouring into, and affecting, the business.’

4.3.4. Goodwill is commonly understood as future benefits from assets that are not capable of being both individually identified and specifically recognized. Goodwill as defined in Lexis Nex in Tax Law. Dictionary is as under (discussed by the Hon’ble ITAT, Delhi in the case of Cyber India Online Ltd Vs ACIT)

“should be recorded in the boos only when some consideration in money or money’s worth has been paid for it Whenever business is acquired for a price (payable in cash or in shares or otherwise) which is in excess of the value of the net assets of the business taken over the excess should be termed as ‘goodwill’

4.3.5. Any excess of cost over the fair value of the net assets acquired is recorded as goodwill. In Eric Koblers : A dictionary for Accountants, the term Goodwill has been defined as:.

“The current value of expected future income in excess of a normal return on the investment in net tangible assets not as a recorded or reported amount unless paid for. The excess of the price paid for a business as a while over its book value or over the computed or agreed value of all tangible net assets purchased.

4.3.6. In the light of the above discussion it can be said goodwill is generated with the business. That the business was conducted in an unorganized sector would be of no relevance. Similarly, that the impugned transaction was between two related entities cannot be reason, against the existence or transfer of goodwill. And goodwill need not be reflected in the balance sheet unless paid for,

4.3.7. The next issue arises whether the impugned intangible rights acquired under the Business Transfer Agreement would be eligible for depreciation under section 3 2(1). In this regard, it is relevant to refer to the discussion of the Hon’ble Apex Court on the issue whether goodwill is an asset within the meaning of Sec.32 of the I.T.Act. The Hon’ble Apex Court in the case of CIT Vs. Smifs Securities 348 ITR 302 discussed as under :

Question No.[b]

“Whether goodwill is an asset within the meaning of Section 32 of the Income Tax Act, 1961 and whether depreciation on “goodwill” is allowable under the said Section:”

Answer :

In the present case, the assesse had claimed the deduction of Rs. 54,85,430/- as depreciation on goodwill. In the course of hearing, the explanation regarding origin of such goodwill was given as under:

“In accordance with Scheme of Amalgamation of YSN Shares & Securities (P) Ltd with Smifs Securities Ltd (duly sanctioned by Hon’ble High Courts of Bombay and Calcutta) with retrospective effect from 1st April, 1998, assets and liabilities of YSN Shares & Securities (P) Ltd were transferred to and vest in the company. In the process goodwill has arisen in the books of the company.”

It was further explained that excess consideration paid by the assessee over the value of net assets acquired of YSN Shares and Securities Private Limited [Amalgamating Company] should be considered as goodwill arising on amalgamation. It was claimed that the extra consideration was paid towards the reputation which the Amalgamating Company was enjoying in order to retain its existing clientele.

The Assessing Officer held that the goodwill was not an asset falling under Explanation 3 to Section 32 (1) of the Income Tax Act, 1961 [‘Act’ for short].

We quote herein below Explanation 3 to Section 32(1) of the Act: “Explanation 3… For the purposes of this sub-section, the expressions “assets” and “block of assets” shall mean –

[a] tangible assets, being buildings, machinery, plant or furniture;

[b] intangible assets, being know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature.

Explanation 3 states that the expression “asset” shall mean an intangible asset, being know-how, patents, copyrights; ‘trademarks, licenses, franchises or any other business or commercial rights of similar nature. A reading the words ‘any other business or commercial rights of similar nature in clause (b) of Explanation 3 indicates that goodwill would fall under the expression “any other business or commercial right of a similar nature; The principle of ejusdem generis would strictly apply while interpreting the said expression which finds place in

Explanation 3(b).

In the circumstances, we are of the view that “Goodwill’ is an asset under Explanation 3(b) to Section 32(1) of the Act.

One more aspect needs to be highlighted. In the present case, the Assessing Officer, as a matter of fact, came to the conclusion that no amount was actually paid on account of goodwill. This is a factual finding. The Commissioner of Income Tax (Appeals) [‘CIT(A), for short] has come to the conclusion that the authorized representatives had filed copies of the Orders of the of the High Court ordering amalgamation of the above two Companies; that the assets and liabilities of M/s. YSN Shares and Securities Private Limited were transferred to the assessee for a consideration; that the difference between the cost of an asset and the amount paid constituted goodwill and that the assessee Company in the process of amalgamation had acquired a capital right in the form of goodwill because of which the market worth of the assessee- Company stood increased. This finding has also been upheld by Income Tax Appellate Tribunal [“ITAT” , for shortȐ. We see no reason to interfere with the factual finding.

4.3.8. With reference to above discussion, it can be concluded that goodwill is an asset eligible for depreciation under section 32 of the I.T. Act and that the difference between the cost of the asset and the consideration paid would constitute goodwill. Respectfully following the Hon’ble Apex Court decision, it is held that the assessee would be eligible for depredation in regard to the consideration paid towards goodwill.

4.3.9. The AO has taken the view that the impugned intangible rights do not fall within the purview of any of the clauses of Sec.32(1) and is not in the ‘nature of commercial or business right’ so as to be eligible to claim deprecation u/s 32 In this regard, it is relevant to refer to the decision of the Hon’ble ITAT, Hyderabad bench in the case of M/s SKS Micro Finance Ltd. The facts in that case are that the assessee company acquired the micro finance business from the society Swayam krishi sangam and has paid Rs 3.97 crores towards customer costs, one time reimbursement of Rs.82 lakh towards cost of Internal control systems, computer softwares and towards corporate, services including strategic planning, market survey, introduction of new products, impact assessment etc. The AO therein took the view that the client acquisition cost of Rs. 3.97 crores would not be eligible for depreciation as it is not in the nature of intangible asset or in the nature of commercial business rights. The Ld.CIT(A ) in that case took the view that the customer base acquired by the assessee cannot be termed as know-how, patent, copyright or trademark or franchise; and it cannot be considered as license. or business or commercial, right of similar nature and relied on the decision of the Hon’ble Bombay High Court in the case of CIT Vs. Techno Shares Stocks Ltd (225 CTR 337). The Hon’ble Tribunal following the decision of the Hon’ble Delhi High Court in the case of Areva T&D India Ltd. & Others (345 ITR 421) and the Apex Court decision in the case of Smifs Securities Ltd held that the client acquisition cost would fall within the category of ‘business or commercial rights’ referred in clause (ii) of Sec.32(1) and would be eligible for depreciation.

The Hon’ble Tribunal followed the principle laid down by the Hon’ble Delhi High Court in Areva T&D India Ltd and concluded that the specified intangible assets are in the nature of ‘business or commercial, rights of similar nature’. The relevant discussion is as under

“In the present case, applying the principle ejusdem generis, which provides that where there are general words following particular and specific words, the meaning of the latter words shall be confined to things of the same kind, as specified for interpreting the expression “business or commercial rights of similar nature” specified in section 32(1)(ii) of the Act. It is seen that such rights need not answer the description of “know-how, patents, trade marks, licenses or franchise” but must be of similar nature as the specified assets. On a perusal of the meaning of the categories of specific intangible assets referred to in section 32(1)(ii) of the Act preceding the term “business or commercial rights of similar nature”, it is seen that the aforesaid intangible assets are not of the same kind and are clearly distinct from one another. The fact that after the specified intangible assets the words “business or commercial rights of similar nature” have been additionally used, clearly demonstrates that the Legislature did not intend to provide for depreciation only in respect of specified intangible assets but also to other categories of intangible assets, which were neither feasible nor possible to exhaustively enumerate. In the circumstances, the nature of “business or commercial rights” cannot be restricted to only the aforesaid six categories of assets, viz., know-how, patents, trademarks, copy rights, licenses or franchises. The nature of “business or commercial rights” can be of the same genus in which all the aforesaid six assets fall. All the above fall in the genus of intangible assets that form part of the tool or trade of an assessee facilitating smooth carrying on of the business. In the circumstances, is observed that in the case of the assessee, Intangible assets, viz., business, claim; business information; business records, contracts, employees; and know-how, are all assets, which are invaluable and result in carrying on the transmission an Distribution business by the assessee, which was hitherto, being carried out by the transferor, without any interruption. The aforesaid intangible assets are, thereto, comparable to a license to carry out the existing transmission and distribution business of the transferor. In the absence of the aforesaid intangible, assets, the assessee would have had to commence business from scratch and go through the gestation period whereas by acquiring the aforesaid business rights along with the tangible assets, the assesse got an up and running business. This view is fortified by the ratio of the decision of the Supreme Court in Techno Shares and Stocks Ltd. [2010] 327 ITR 323 (SC) wherein it was held that intangible assets owned by the assessee and used for the business purpose which enables the assessee to access the market and has an economic and money value is a “license” or, “akin to a license” which is one of the items failing in section 32(1)(ii) of the Act.

In view of the above discussion, we are of the view that the specified intangible assets acquired under slump sale agreement were in the nature of “business or commercial rights of similar nature” specified in section 32(1)(ii of the Act and were accordingly eligible for depreciation under that section.”

5.1. We have gone through the Ld.CIT(A)’s order and the decisions relied up on by the Ld.CIT(A). The Ld. CIT(A) followed the judgement of Hon’ble Apex court’s decision in the case of CIT Vs.Smifs Securities Ltd., Hon’ble Delhi High Court’s decision in the case of Areva T&DD, and the coordinate bench decision in the case of SKS Micro Finance Ltd cited supra. The Ld.DR did not bring any other decision to controvert the decision relied upon by the Ld.CIT(A). Therefore we hold that the difference payment made by the assessee as per the valuation report cited supra is nothing but good will and the assessee is eligible for depreciation on intangible assets acquired in the form of good will as per section 32(1) of I.T. Act and accordingly we uphold the order of the CIT(A) and dismiss the appeal of the revenue.

6. In the result, appeal of the revenue is dismissed.

The above order was pronounced in the open court on 8^th Nov 2017.