Budget 2024 Expectation: Iron out enigma of tax implication for goodwill on corporate reorganization

CA Simran Keswani

Budget 2024 Corporate Expectation:  Iron out the enigma of tax implication for goodwill on corporate reorganization

Corporate reorganization as the name suggests means an action taken by the corporate entity to modify its capital structure or its operations. In India amalgamation, merger, demerger and slump sale are commonly adopted mode of undertaking the corporate restructurings.  While the corporates are free to choose their actions of undertaking the restructuring they are not free to take the flight from tax consequences arising of such.

As a result, there has been a long drawn litigation in India between the taxpayers and revenue authorities on the issue whether depreciation on goodwill (being the difference between the net worth of the entity purchased and consideration paid) arising out of business purchase or business combination is allowable or not. Agnizing the persisting debate and to put this controversy to rest, the Union Budget 2021 amended the provisions of the IT Act to disallow the depreciation on goodwill. Although the amendment have taken effect from 1 April 2021 and will apply from AY 2021-22 and subsequent years yet the revenue authorities have taken a stand that depreciation must not be allowed on goodwill in the prior years as well.  There is elongated litigation on the issue being equivocal adding to the litigation cycle of the industries.  The same is summarized below:

Section 32 of the IT Act provides for allowance of depreciation on tangible and intangible assets.  Explanation 3(b) to section 32 defines intangible asset to know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature. As the definition of the term intangible assets does not specifically includes the term “goodwill” a controversy arises whether the same qualify as intangible asset eligible for depreciation.

The revenue authorities have been denying the claim of depreciation arising during business restructuring like merger, slump sale etc. claiming no actual and allocable cost incurred during these business reorganization’s transactions with an additional argument being goodwill not specifically included in the definition of intangible asset.

In 2012, the Hon’ble Apex Court of India in case Smifs Securities (24 taxmann.com 222) however held that goodwill falls under the expression “any other business or commercial right of similar nature” and accordingly eligible for depreciation.  Though the matter seemed to be settled by the decision of the Apex court yet the controversy continued.  The key arguments taken by the revenue to disallow the claim was allowability of the claim of depreciation arising on business restructuring is subject to the other provisions of the Act.

The revenue authorities resorted to invoke Explanation 3 to section 43(1) which empowers the Assessing officer to determine the cost of the acquisition with prior approval of the specified authority if he is satisfied that main purpose of the transfer of such assets, directly or indirectly, was the reduction of a liability to income-tax (by claiming depreciation with reference to an enhanced cost).

In wake thereof, Explanation 7 to section 43(1) is invoked which provides that in a scheme of amalgamation, the actual cost of the transferred capital asset to the amalgamated company shall be taken to be the same as it would have been if the amalgamating company had continued to hold the capital asset for the purposes of its own business.

Alternatively, the revenue authorities invoked sixth proviso to section 32 of the Act which provides that the aggregate deduction, in respect of depreciation of in case of intangible assets in specified scenarios (amalgamation, demerger, succession) shall not exceed the deductions as if the succession or the amalgamation or the demerger, as the case may be, had not taken place.

By referring to the above alternate provisions the revenue authorities argue that by virtue of application of explanation 3 to section 43(1) r.w. explanation 7 to section 43(1) / sixth proviso to section 32 of the Act disallowed the claim of depreciation.  The rationale for the same being no goodwill being recorded in books of the predecessor i.e. as nothing is recorded as goodwill in books of the amalgamating / seller company, accordingly the actual cost of the asset being zero in the hands of the amalgamating / aquirer company, the claim of depreciation on goodwill is disallowed.

However, as the goodwill arising on the business combinations is acquired goodwill which is arising only pursuant to the restructuring and is accordingly recorded for the first time in the books of the amalgamated / resulting / Acquirer Company the claim of depreciation on goodwill cannot be denied even on application of the alternate provisions.

The SC decision is the law of the land which has already stated that the goodwill is an intangible asset eligible for depreciation.  By no stretch of imagination some superfluous interpretations can be imposed by the tax authorities to deny the claim of depreciation.  The amendment in law made in 2021 itself is testament to the law in place allowing the claim of depreciation. The above persistent issue has aggravated the pending litigation situation of the companies and a welcome clarification by the industry is much awaited and would be in line with the government’s intention of ease of doing business.

Epilogue

In these changing times, with BEPS Pillar 1 and Pillar 2 coming in force there are lot of other areas which are opening doors for new litigation. The future contains surprise box of various neoteric taxes and this seems to be the correct time to be prepare ourselves for the upcoming era with new tax and new disputes and ambiguities occupying the tax world and resolve the traditional issues and promote the ease of doing business.