Historically, in business combinations viz amalgamations, demergers, slump sale, etc., the balance consideration/residual value over and above the net tangible assets (assets minus liabilities) taken over, is recorded as ‘goodwill’ towards acquisition of a bundle of business and commercial rights. In deciding whether such goodwill is eligible for depreciation in favour of the taxpayer, SC in case of Smifs Securities observed that such excess consideration constituted a capital right acquired by the assessee company. in this backdrop, Sharath Rao (Partner, Tax, Deloitte Haskins & Sells) & Amita Jivrajani, Manager  analyse the amendments proposed in the Union Budget 2021 which in view of the authors “rains on dealmakers’ parade”. The amendments specifically exclude ‘goodwill of a business or profession’ from the definition of the term ’block of assets’ contained in section 2(11) with corresponding amendments to sections 32, 50 and 55. Highlighting that the earlier defenses in the forms of ejusdem generis besides scope for new arguments in favour of assessee’s claim for depreciation, the authors opine that “While the objective of the government to institutionalise the above amendments was to grease the squeaky wheel, these proposals may have led to opening a whole gamut of new questions and interpretational avenues.” 

“Union Budget 2021 – Not so ‘Good’(will) for potential business synergies”

The Union Budget 2021 had all the eyes of taxpayers on how the government would reset its growth agenda and strike a balance between the health and medical needs and the economic outlook. The government’s initiatives on reviving industries and boosting optimism may have found some favour from the industry on the macro level policy front. However, the proposals on the tax front, including the amendments proposed in the M&A space, have put the taxpayer’s/businessmen’s sentiments to unrest. One of the major contributors to this is the amendments proposed around the categorical exclusion of ‘Goodwill’ from the ambit of ‘intangible assets’.

Historically, in business combinations viz amalgamations, demergers, slump sale, etc., the balance consideration/residual value over and above the net tangible assets (assets minus liabilities) taken over, is recorded as ‘goodwill’ towards acquisition of a bundle of business and commercial rights such as business claims, business records, business information, contracts, employees, brand and in substance, represents the perpetual growth/going concern value or reputation of the business taken over/acquired. The Indian tax judicial space has seen considerable litigation around the depreciability of goodwill with multiple contradictory rulings that allayed with the Supreme Court ruling in Smifs Securities [TS-639-SC-2012-O].

In the aforesaid ruling, the question before the Supreme Court (SC) was whether goodwill is an asset within the meaning of Section 32 of the Income-tax Act, 1961 (IT Act), and whether depreciation on 'goodwill' is allowable. In deciding the matter in favour of the taxpayer, the SC observed that the consideration paid over the value of net assets acquired of the amalgamating company, constituted a capital right acquired by the assessee company in the process of amalgamation in the form of goodwill, for which the market worth of the assessee-company stood increased. Against this backdrop, the SC held that ‘goodwill’ would fall under the expression 'any other business or commercial rights of similar nature' contained in clause (b) of Explanation 3 to section 32(1) of the IT Act which defines the term ‘assets’ to inter alia mean ’(b) intangible assets, being know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature’. The SC held that the principle of ejusdem generis would strictly apply while interpreting the said expression which finds place in Explanation 3(b).

The above landmark ruling was relied upon by many Tribunals and High Courts (HC) across the country in deciding the issue. A few notable ones are:

• PCIT vs Zydus Wellness Ltd [TS-6160-HC-2017(Gujarat)-O];

• Triune Energy Services Private Limited vs DCIT [TS-5750-HC-2015(Delhi)-O];

• Toyo Engineering India Limited vs DCIT [TS-5946-HC-2012(Bombay)-O];

• CIT vs RFCL Ltd [TS-6173-HC-2014(ANDHRA PRADESH)-O];

• Demag Delaval Industries Turbomachinery (P.) Ltd. vs ACIT [TS-7817-ITAT-2020(Mumbai)-O]; and

• Brembo Brake India (P.) Limited [2015] vs DCIT [TS-5119-ITAT-2015(Pune)-O].

Further, Tribunals/Courts have had the occasion to examine the scope and meaning of the words ‘business or commercial right of similar nature’ in inter alia the following cases:

• CIT vs Hindustan Coca Cola Beverages (P) Limited [TS-7-HC-2011(DEL)-O];

• Areva T&D India Ltd vs DCIT [TS-189-HC-2012(DEL)-O];

• Kotak Forex Brokerage Ltd vs ACIT, [TS-5448-ITAT-2009(Mumbai)-O];

• Koch Chemical Technology Group India Private Limited vs DCIT [TS-5825-ITAT-2011(Mumbai)-O];

• Skyline Caterers (P.) Ltd. vs ITO [TS-59-ITAT-2007(Mum)-O].

The key principle inter alia emerging out of the aforesaid judicial precedence was that know-how, patents, copyrights, trademarks, licenses, franchises, etc which precede the expression ‘any other business or commercial rights of similar nature’, are assets not manufactured or produced overnight but brought in by experience and reputation. They assume importance in the commercial world as they represent a particular benefit or advantage or reputation built over a period of time and customers associated with such assets. Similarly, goodwill is nothing but positive reputation built by a person/company/business-house over a period of time. Thus, goodwill is a ‘business or commercial right of similar nature’.

Just as the issue around allowability of depreciation on goodwill was gaining certainty and was no longer considered as res integra by business houses, the Union Budget 2021 proposal rains on dealmakers’ parade. The amendments introduced vide the Finance Bill, 2021 proposes to specifically exclude ‘goodwill of a business or profession’ from the definition of the term ’block of assets’ contained in section 2(11) of the IT Act. A similar amendment is proposed in clause (ii) of section 32(1) of the IT Act which deals with depreciation on intangible assets and in clause (b) of Explanation 3 to section 32(1) of the IT Act which provides the definition of the expression ‘assets’.

It is also proposed to provide that in case where goodwill of a business or profession formed part of a block of asset for the Assessment Year (AY) 2020-21, and depreciation obtained by the assessee under the IT Act, the written down value of that block of asset and short term capital gain shall be determined as may be prescribed (amendment proposed in section 50 of the IT Act). Further, section 55 of the IT Act, which inter alia deals with the meaning of the term ‘cost of acquisition’ is proposed to be substituted to provide that where goodwill, trademark, brand name, etc are acquired, the cost of such asset shall be the purchase price or cost to the previous owner, as the case may be and in any other case, the cost of acquisition shall be considered as nil. Further, in case goodwill of business or profession is acquired by the taxpayer and depreciation is claimed in any of the year prior to AY 2021-22, the cost of acquisition shall be reduced by such depreciation claimed by the taxpayer.

As per the Memorandum explaining the provisions of the Finance Bill 2021, goodwill, in general, is not a depreciable asset and depending on how the business runs; goodwill may see appreciation or in the alternative, no depreciation to its value. Further, while the Memorandum has taken cognisance of the SC’s case of Smifs Securities, it has been clarified that the actual calculation of depreciation on goodwill is dependent upon various provisions and on application of the provisions of the Act, the depreciation in some situations (like calculation of ‘actual cost’ or ‘written down value’ in the hands of the amalgamated company in a scheme of amalgamation) would be nil.

While the objective of the government to institutionalise the above amendments was to grease the squeaky wheel, these proposals may have led to opening a whole gamut of new questions and interpretational avenues. For example, the term ‘goodwill’ itself doesn’t find a definition in the IT Act. Therefore, the scope of attributing the residual consideration to business information, business claims, business records, business information, contracts, employees, brand, etc. and bringing it within the array of ‘any other business or commercial rights of similar nature’ without nomenclating these bundle of rights as ‘goodwill’ could continue to be a bone of contention. One could argue that the principle of edjusdem generis would apply and depreciation should be allowed on these bundles of rights. As stated above, a few courts had examined the meaning and scope of ‘any other business or commercial rights of similar nature’ and had sought to include the aforesaid bundle of rights within its ambit (whether or not termed as ‘goodwill’). The proposed amendment may have the effect of going back to courts on an issue which was otherwise considered as settled with the backing of the principles upheld hitherto.

In this context, since goodwill finds its genesis in the accounting standards, it would be relevant to reflect upon Ind AS 103 which deals with accounting on Business Combinations and defines ‘goodwill’ as an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. Based on the above definition, the tax authorities may argue that goodwill (future economic benefits) is a different asset from unidentified existing assets on the date of acquisition. However, accounting standards seek to recognize and measure assets for the books of account and should not necessarily have a bearing on the identification and claim of depreciation for tax purposes.

Another aspect is the bifurcation and splitting the goodwill component, comprised within a block of intangible assets. There are no rules that are currently proposed to apply the amendment in a case where goodwill is not recognized as a separate block, but as a subset of a block.

Yet another area of tussle with the tax authorities could be on the applicability of the aforesaid amendments. These proposals are to be made effective from the AY 2021-22. Hence, ideally, the proposal should not disturb the claims made till financial year 2019-20 or rather, the amendment legitimizes the past claims of depreciation on goodwill till FY 2019-20. However, what would be the position of the tax authorities for the open assessments/appeals for previous years may be a nightmare for businesses which had factored tax savings on account of depreciation on goodwill at the time of effecting business re-organizations.

An amendment which may have been viewed by the government as a reform, axing long drawn litigations, may only, in essence, be old wine in a new bottle.