As the budget 2021 came up with the proposals to boost the economy and certain important proposed amendments. One of the proposed amendments was ‘No more Depreciation on Goodwill’.
The purpose of this editorial is to discuss the proposed amendment as the matter has always been debatable before the judiciary.
To start with, let’s first understand the term Goodwill-
What is Goodwill?
Goodwill is an intangible asset that arises when a buyer acquires an existing business. Goodwill represents assets that are not separately identifiable.
Goodwill does not include identifiable assets that are capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability regardless of whether the entity intends to do so.
Goodwill also does not include contractual or other legal rights regardless of whether those are transferable or separable from the entity or other rights and obligations. Goodwill is also only acquired through an acquisition; it cannot be self-created.
Section 32 of the Income Tax Act contains a provision for allowance of depreciation on tangible and intangible assets from the income computed under the heads profits and gains from business or profession.
As per explanation 3 to section 32(1), tangible assets eligible for depreciation are know-how, patents, copyrights, trademarks, licenses, franchises or any there business or commercial rights of similar nature.
The term ‘Goodwill’ of a business or a professional has not specifically been defined as an “intangible asset” in Section 32. Further goodwill is also not included in the definition of “Block of Assets” as defined by section 2(11).
Accounting Standard 14 (Accounting for amalgamation) allows amortization of Goodwill, acquired in a business acquisition, over a period not exceeding 5 years unless a longer period can be justified.
Whereas Ind AS 103 (Business Combinations) requires amortization of goodwill is over its useful life if the same is finite. But if the useful life of the goodwill is determined as indefinite, then there shall not be any amortization.
However, the income tax act does not specifically provide whether depreciation shall be allowed or disallowed on the acquired goodwill Therefore, the allowability of depreciation on goodwill has always been a matter of dispute.
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The Supreme Court’s Views:
The supreme court in the case of CIT vs Smifs Securities Ltd.  24 taxmann.com 222(SC) held that goodwill acquired on amalgamation (being difference between the cost of assets and consideration paid) was a capital right which would fall under the expression of any other business or commercial right of a similar nature and hence eligible for depreciation while computing business income.
In the recent decision, the Supreme Court in the case of PCIT vs Zydus Wellness Ltd.  113 Taxmann.com154(SC) has dismissed the Special Leave Petition (SLP) against the order wherein the High Court had upheld Tribunal’s ruling allowing the assessee’s claim for depreciation on goodwill.
Hence as per the decision of the Supreme Court, Depreciation would be allowed on the goodwill recognized as per accounting guidelines in a business combination.
Amendment Proposed by the Finance Bill 2021.
The memorandum explaining the Finance Bill 2021 stated that though the Hon’able Supreme Court has held that goodwill of a business or profession is a depreciable asset under section 32, there are other provisions that are relevant for the calculation of depreciation under section 32.
The actual calculation of depreciation on goodwill is required to be carried out in accordance with various other provision of the act, which include section 43(6)(C), Explanation 2 of Section 43(6) (c), Section 43(1), etc.
The memorandum further stated that when these provisions are applied in some situations (like that of business organization) there could be no depreciation on account of the actual cost being zero and the written down value of that assets in the hand of the predecessor /amalgamating company being zero.
Further, goodwill, in general, is not a depreciable asset and in fact, it depends upon how the business runs. GOddwilll may see appreciation or in the alternative no depreciation to its value. Therefore, there may not be a justification for depreciation on goodwill.
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The finance Bill 2021, thus proposed various amendments to provide that Goodwill will not be considered as depreciable assets and no depreciation would be allowed on it in any situation.
(a) amend clause (11) of section 2 of the Act to provide that ‘block of asset‘ shall not include the goodwill of a business or profession;
(b) amend clause (ii) of sub-section (1) of section 32 of the Act to provide that goodwill of a business or profession shall not be considered as an asset for the purpose of 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.
(c) amend section 50 of the Act to provide that in a case where the goodwill of a business or profession formed part of a block of an asset for the assessment year beginning on the 1st April 2020 and depreciation 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 the manner as may be prescribed.
(d) amend section 55 of the Act by substituting clause (a) of subsection (2) to provide that in relation to a capital asset, being goodwill of a business or profession, or a trademark or brand name associated with a business or profession, or a right to manufacture, produce or process any article or thing, or right to carry on any business or profession, or tenancy rights, or stage carriage permits, or loom hours,—
- in the case of acquisition from a previous owner– the cost of acquisition shall be the amount of the purchase price;
- in the case of acquisition as a result of the gift, amalgamation, etc. and where such asset was acquired by the previous owner by purchase, cost of acquisition shall be the amount of the purchase price for such previous owner; and
- in any other case– shall be taken to be nil
(e) Cost of acquisition of purchased goodwill shall be the purchase price as reduced by the depreciation so claimed by the assessee before the assessment year 2021-22.
The effective date of Amendments:
These amendments will take effect from 1st April 2021 and will accordingly apply to the assessment year 2021-22 and subsequent assessment years.