A brief analysis of the provisions and how it may impact:
Depreciation on Goodwill has been one long debatable issue. Even after Supreme Court Judgment in the case of Smiff Securities Limited wherein the Supreme Court of India held that goodwill of a business is a depreciable asset, taxman have been issuing notices to companies involved in Mergers & Acquisitions who tend to plan saving their tax outgo by recording value of goodwill and ultimately claiming depreciation on it. With the proposed change it will finally put a rest to prolonged non clarity on the same.
Changes proposed to be made by Finance Bill 2021:
Section 2(11) (b) that defines block of assets has been proposed to be amended to include- after the words “or commercial rights of similar nature,”, the words “not being goodwill of a business or profession,” shall be inserted; Meaning thereby– Now goodwill has been specifically excluded from definition of block of asset. Earlier corportaes used to take advantage of the words “or commercial rights of similar nature,” and argued that goodwill forms part of intangible assets of similar nature and hence was eligible for depreciation.
Section 32(1) (ii) that relates to depreciation on assets has been amended to include ”, the words “not being goodwill of a business or profession,” Meaning thereby- to make it clear that no depreciation is to be charged on goodwill.
Explanation 3 to section 32 that explains intangible assets include know how, patents or commercial rights of similar nature has been amended to include the words “, not being goodwill of a business or profession” shall be inserted., Meaning thereby- that makes it clear that Goodwill not forms part of intangible assets as explained in section 32 explanation( i..e it is a non-depreciable asset)
Section 50 that discussed capital gains on transfer of depreciable capital assets is proposed to be amended to include, “Provided that in a case where goodwill of a business or profession forms part of a block of asset for the assessment year beginning on the 1st day of April, 2020 and depreciation thereon has been obtained by the assessee under the Act, the written down value of that block of asset and short term capital gain, if any, shall be determined in such manner as may be prescribed.” Meaning thereby- That goodwill shall be transferred from block of assets and the short term capital gains if any that may arise shall be calculated .( Bill has written “in such manner as may be prescribed”, so we need to wait for more clarity on the same).
Section 55 that explains cost of acquisition of capital asset has been amended to Provided that where the capital asset, being goodwill of a business or profession, in respect of which a deduction on account of depreciation under sub-section (1) of section 32 has been obtained by the assessee in any previous year preceding the previous year relevant to the assessment year commencing on or after the 1st day of April, 2021, the provisions of sub-clauses (i) and (ii) shall apply with the modification that the total amount of depreciation obtained by the assessee under sub-section (1) of section 32 before the assessment year commencing on the 1st day of April, 2021 shall be reduced from the amount of purchase price;”. Meaning thereby- Cost of Acquisition of the goodwill which has been purchased and depreciation has been claimed if any on the same upto year ending 31.03.2020, shall be Purchase Price Less accumulated depreciation on the same upto 31.03.2020.
Intent of Legislature
Until now many companies would end up buying companies more than what the “book value” of the company is on its financial statements. This would mean that the balance amount would be considered goodwill. Most companies would claim depreciation on the goodwill over the years, resulting in lower taxation. As there was no clear regulation around this many companies would claim depreciation on the goodwill amount taking stance of the above quoted Supreme Court Judgement. This would result in lower taxation over next few years. Companies would indulge in practise of mergers to lessen their tax outgo in next years as the amalgamating co was exempt from capital gains incurred on the transfer and the amalgamated /resulting company would get additional benefit of depreciation on the amount paid for goodwill. The tax department was of the view that many companies had put together the restructuring exercise merely to escape taxes. Hundreds of companies that had undertaken restructuring or mergers within the group are under scrutiny for “artificially” creating goodwill merely to lower their tax outgo.
This regulation could also impact some of the on-going controversies around M&As, as tax department can scrutinise certain transactions retrospectively. But we will have to wait more and finally see how the Finance Act brings in these changes.
Compiled by : CA Disha Sehgal (ACA, B.COM)
Author is a practising Chartered Accountant and has been working on Direct TAX Litigations .
Author can be reached at : [email protected]