Why is Goowill non depreciable again?
Why the conflict over depreciation of goodwill:
To understand this from a layman’s perspective - any deduction by way of depreciation leads to reduction in profits from Business or Profession and thus Total income. What does that lead to
· For the Government – reduced tax.
· For the Buyer – reduced cost of acquiring an asset by savings in tax outflow.
For example where a person who acquired goodwill for 50 crores, will end up saving 14.80 crore(ignoring time value of money) over 15 years. This of course resu
lts in a loss to the Government.
Finance Act 2021 has amended the law and made goodwill non depreciable again. So how does it effect the people who invested in goodwill keeping the aforesaid tax savings in mind, lets discuss to find out. But first lets trace the interpretational conflict in the definition of Sec 2(11) – Block of assets
1) Treatment over the years
Before the Amendment: Sec 2(11): "block of assets" means a group of assets falling within a class of assets comprising—
a) tangible assets, being buildings, machinery, plant or furniture ;
b) intangible assets, being know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature in respect of which the same percentage of depreciation is prescribed ;
· Uptil 2012 there was confusion and a lot of litigation to claim goodwill as a part of the residual clause defining intangible assets “any other business or commercial rights of similar nature”. And uptil 2012 there was a consensus that goodwill did not fall within the parameters of these words and was hence non depreciable. The judgements led to the conclusion that acquisition of goodwill did not lead to acquisition of any rights similar to the acquisition of say a patent or trademark etc.
· However the Hon‘ble Supreme Court in the case Smiff Securities Limited [(2012)348 ITR 302 (SC)]. held that, Goodwill of a business or profession is a depreciable asset under section 32 of the Act, as by acquiring goodwill one gets the right to use the name of the business of the transferor and hence will fall within the meaning of the words “any other business or commercial rights of similar nature”.
What fascinates us is that without any change in the wordings of the Act , the reading of the words from a different view point lead to cash savings for those paying for acquiring goodwill and reduction in inflows for the Government.
2) Amendment made by Finance Act 2021
Finance Ministers Memorandum for why goodwill has been made Non Depreciable again – “It is seen that Goodwill, in general, is not a depreciable asset and in fact depending upon how the business runs; goodwill may see appreciation or in the alternative no depreciation to its value. Therefore, there may not be a justification of depreciation on goodwill in the manner there is a need to provide for depreciation in case of other intangible assets or plant & machinery. Hence there appearsto be little justification for depreciation on goodwill even in the category of cases referredto in the immediately preceding paragraph.
In view of above discussion, it has been decided to propose that goodwill of a business or profession will not be considered as a depreciable asset and there would not be any depreciation on goodwill of a business or profession in any situation. In a case where goodwillis purchased by an assessee,the purchase price of the goodwill will continue to be considered as cost of acquisition for the purpose of computation of capital gains under section 48 of the Act subject to the condition that in case depreciation was obtained by the assesseein relation to such goodwill prior to the assessment year 2021-22, then the depreciation so obtained by the assessee shall be reduced from the amount ofthe purchase price of the goodwill”
In my opinion - Buildings sometimes appreciate in value but we continue to provide for depreciation and land has seen a lot of loss in value over some years but we never provide for depreciation. So it will be right to assume that depreciation is essentially a deduction for the cost of acquiring an asset specifically allowed under the Statute. The reason for allowing or disallowing will depend upon the view point of the law makers at that specific point. We are all aware that the rules for computing depreciation are very different under the Companies Act and under the Income Tax Act and the only bone of contention being the effect on revenue.
Let us see how Goodwill is different from other Intangible Assets leading to this conflict.
While “goodwill” is essentially the difference between the value of assets and liabilities paid by the purchaser of business for the perceived gain in reputational influence for the growth in business . Whereas other “intangible assets” are actual rights acquired for something that is mostly tangibly registered , case in point being patent , copyright etc.
Thus one of the possible reasons for the amendment could also be from a view that there could be possible tax manipulation by inflating the value of goodwill for reduction in tax.
3) Some of the Amended Sections
Therefore, to give effect to the above decision,it has been proposed to amend the following sections
The definition of the Block of Assets u/s 2(11) as well as Sec 32 has been amended to provide that Goodwill of business or Profession is not an asset which can form part of the Block of assets.
(a) Sec 2(11) : block of asset‘ - shall not include goodwill of a business or profession;
(b) Sec 32(1)(ii): Depreciation – has been amended to provide that goodwill of a business or profession shall not be considered as an asset for the purposeof the said clause and therefore not eligible for depreciation. Further, it is also proposed to amend Explanation 3 to sub-section (1) of the said section to provide that goodwill of a business or profession shall not be considered as an asset for the said sub-section.
However, there are other sections of the Act which are relevant for calculation of depreciation and capital gains on Depreciable Capital Assets . These are as under:
(c) Sec 50: Capital Gains on DCA - Provides for excluding the WDV of Goodwill in case it was considered as depreciable asset prior to 1st April 21 and such WDV will be determined in the manner as may be prescribed. Thus where depreciation for goodwill was claimed before 01/04/21 then the amount of depreciation claimed will be reduced while computing Cost of Acquisition[COA].
(d) Sec 55: Now Goodwill will be a Non Depreciable Capital Asset [NDCA]
(i) The COA of purchased goodwill will be the purchase price
(ii) The COA of goodwill acquired from the previous owner will be the cost to the previous owner
(iii) The COA of Goodwill (self generated) will be Nil
(e) Sec 43(6)(c): of the Act, with respect to block of assets, inter-alia, provides that the aggregate of the written down values of all the assets falling within that block of assets at the beginning of the previous year is to be increased by the actual cost of any asset falling within that block, acquired during the previous year.
Finance Act 21 – provides that the Block of asset will be reduced by the Actual cost of Goodwill (-) any depreciation on Goodwill computed as if Goodwill was the only asset in the Block
Example: as on 01/04/2021 the Block of Intangible assets has an opening WDV of 25 lacs and has 5 assets including Goodwill acquired on 01/12/2018 for 10 lacs. Compute the opening WDV after adjustment as per Sec 43(6)
The Depreciation on Goodwill
PY 2018-19: 10,00,000 x 12.5% = 125,000
PY 2019-20: 8,75,000 x 25% = 218,750
Actual cost to be reduced from Block = 10,00,000 (-) 343,750 = 656,250
Thus Opening WDV of the Block as on 01/04/20 will be 25,00,000 (-) 656,250 = 18,43,750