Depreciation and Short-term Capital Gain on Goodwill WEF AY 2021-22

It was well settled position, before the amendments made by Finance Act 2021, that the depreciation can be claimed on ‘Purchased Goodwill’ under the Income tax Law and it was also supported by the decision of Hon’ble Supreme Court in the case of Jogta Coal Co. Ltd. v. CIT 36 ITR 521 where the treatment given is in accordance with the Accounting Standard 14 – Accounting for Amalgamation issued by the Institute of Chartered Accountants of India (ICAI)and CIT v/s Smifs Securities Ltd [2012].

However, amendments made by Finance Act, 2021 in various sections of Income tax law have restrained the business entities from claiming deprecation on “Purchased Goodwill”. Relevant sections where amendments have been made are as under:

Section 2(11)(b) – Goodwill excluded from the definition of intangible assets;

Section 32(1)(ii) – Goodwill excluded from the block of assets relating to intangible assets on which depreciation allowed;

Explanation 3 to Section 32(1) – Goodwill excluded from the meaning of expression “assets” for the purpose section 32(1);

Section 43(6)(c)(ii) – computation of WDV as on 01^st April, 2021 i.e. adjustment on account of depreciation allowed or allowable in respect of Goodwill as if there is only Goodwill in the block of assets;

Provisio to Section 50 – 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;

Explanation 2(aa) to Section 50B – In computation of Capital Gain from slump sale value of goodwill shall be taken as NIL where such goodwill has not been acquired by purchase from a previous owner;

Section 55(2) – depreciation claimed till AY 2020-21 shall be reduced from the amount of purchase price in case of Goodwill for the purpose of calculating cost of acquisition for section 48 and 49;

And hence Rule 8AC has been inserted vide Income tax Amendment (19th Amendment), Rules, 2021 notified vide notification number 77/2021 dated 07^th July, 2021.

Rule 8AC gives guidance with regards to Computation of short term capital gains and written down value under section 50 where depreciation on goodwill has been obtained, the extract of Rule 8AC is as under:

(1) For the purposes of proviso to section 50, the written down value of the block of the asset and short term capital gains, if any, for the previous year relevant to the assessment year commencing on the 1st day of April, 2021shall be determined in accordance with this rule.

(2) Where the goodwill of the business or profession was the only asset or one of the assets in the block of asset “intangible” for which depreciation was obtained by the assessee in the assessment year beginning on the 1st day of April, 2020, the written down value of this block of asset for the previous year relevant to the assessment year commencing on the 1st day of April, 2021 shall be determined in accordance with the provisions of item (ii) of sub-clause (c) of clause (6) of section 43.

(3) Where the reduction under sub-item (B) of item (ii) of sub-clause (c) of clause (6) of section 43, for the previous year relevant to the assessment year commencing on the 1st day of April, 2021, exceeds the aggregate of the following amounts, namely:-

(i) the written down value of the block of assets at the beginning of the previous year relevant to the assessment year commencing on the 1st day of April, 2021 without giving effect to reduction under sub-item (B) of item (ii) of sub-clause (c) of clause (6) of section 43; and

(ii) the actual cost of any asset falling within the block of assets “intangible”, other than goodwill, acquired during the previous year relevant to the assessment year commencing on the 1st day of April, 2021,such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets.

(4) Without prejudice to the provisions of sub-rule (3) and section 55, where the goodwill of the business or profession was the only asset in the block of asset “intangible” for which depreciation was obtained by the assessee in the assessment year beginning on the 1st day of April, 2020, and the block of asset ceases to exist on account of there being no further asset acquired during the previous year relevant to the assessment year commencing on the 1st day of April, 2021 in that block, there will not be any capital gains or loss on account of the block of asset having ceased to exist.

(5) The capital gains or loss on transfer of goodwill, during the previous years relevant to the assessment year2021-22 or subsequent assessment years, shall be determined in accordance with the provisions of section 48,section 49 and clause (a) of sub-section (2) of section 55.”

Let us understand the above with the help of examples:

Case 1 – Goodwill is the only asset in the block of assets having WDV as on 31.03.2020 as INR 1,000.

Case 2 – WDV of block of asset as on 31.03.2020 as INR 1,000 comprising of WDV of Goodwill as INR 800 and other intangible assets as INR 200. During the FY 2020-21 A purchased one intangible asset for INR 100.

Case 3 – WDV of block of asset as on 31.03.2019 at INR 1,000 comprising of WDV of Goodwill as INR 800 and other intangible assets as INR 200. During the FY 2019-20 A sold one intangible asset for INR 900 and acquired one Intangible asset for INR 200 during the FY 2020-21. In that case WDV of block of asset as on 31.03.2020 shall be calculated as under:

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