Should Depreciation be allowed on Goodwill?

Nowadays, most of the businesses do not only rely on its tangible assets only, but on intangible assets as well simply because it creates noteworthy values for them. Many businesses survived the economic uncertainty and downturn because of their longstanding goodwill in the market. Intangibles provide higher values to the business concerns in the times of restructuring or acquisitions as compared to their tangible counterparts and undoubtedly goodwill is an inherent part of it. Therefore, tax cost and benefit associated with intangibles in restructuring or acquisitions deals are closely monitored apart from other legal and commercial considerations. It is so because the advantage of the tax incidence in the form of depreciation can be utilised to its zenith which is available on those intangible assets. So the question arises that should depreciation be allowed on goodwill?

Goodwill has never been specifically recognised by the statute for providing the depreciation in any manner. Although, the Finance (No.2) Act, 1998 provided for allowance of depreciation on ‘intangible assets’ under the Income-tax Act, 1961 (Act). Statute has earmarked the specific intangible assets for allowing the depreciation thereon. These items are Know-how, Patents, Copyrights, Trademarks, Licences, Franchises and any other business or commercial rights of a similar nature.

Depreciation can be claimed on intangible assets which are acquired for a price and on the satisfaction of the following conditions:

           I.            The intangible assets must be acquired on or after 1.4.1998,

         II.             Such assets are owned either wholly or partly by assessee; and

       III.             During the previous year such assets are used for the purposes of his business or      profession.

From the above amendment, it is crystal clear that statute did not wanted every other intangible asset (including goodwill) to be entitled for depreciation under Income-tax Act, 1961. Therefore, the only way goodwill can be indirectly considered as intangible asset is by classifying it in ‘any other business or commercial rights of a similar nature’. Now the question arises that should tax-depreciation be allowable on goodwill only on the presumption that it falls in any other business or commercial rights of similar nature? In order to dispose-off this query in view of Income-tax Act, firstly it is important to be aware of the nature of the goodwill.

Nature of the Goodwill

The goodwill can exist in a business in two manners.

a)   It can be acquired from the seller of the business in cash or for any considerations to  run that business with same name and reputation as earlier.

b)  Secondly, it can come into the existence on account of amalgamation in nature of ‘self  generated goodwill’.

Starting with the first kind of goodwill, it is often acquired in lieu of some specific consideration which can be earmarked towards the same. Now, whether tax-depreciation should be allowed or not can be understood from this legal precedent.

Raveendran Pillai vs. CIT [2011] 332 ITR 0531

Assessee purchased a hospital and under the sale deed, the value of the goodwill was declared as Rs. 2 crores which included the name of the hospital and its logo and trade mark. Subsequently, the assessee claimed the depreciation on goodwill on value shown in the sale deed. In subsequent years depreciation on goodwill was claimed on the written down value. Revenue contended that motive of providing depreciation is to take care of wear and tear in asset over a period of time. Since there can be no erosion in the value of goodwill, the claim of depreciation on goodwill is fundamentally against the scheme of depreciation.

It was held that trademarks and franchises covers name, logo etc. and the value of same were included in the Goodwill. Since, the assessee continued running the hospital in the very same building, same premises, same town and with same name, it was clear that he has acquired the enduring benefit by way of goodwill. The name of the hospital was incidental to the successful running of the hospital after it was sold to the assessee. The benefit derived by the assessee was nothing but was the retention of continued trust of the patients who were patients of the previous owner.

Depreciation on any eligible assets (whether tangible or intangible) cannot be negated on the ground that the no erosion in said asset will take place in future. Hence Goodwill was entitled to depreciation under section 32(1) of the Income-tax Act, 1961.

                                                                                           

It is very clear from the above judicial precedent, that if goodwill has been purchased in lieu of cash or some other consideration, the depreciation will be allowable on such assets under Income-tax Act. It is so because payment of consideration for goodwill, though intangible, amounts to acquisition of asset of capital nature. The benefit of the goodwill definitely accrues to the buyer of the business. So the goodwill must be eligible for tax-depreciation. Hence, the following points support the allowance of tax-depreciation.

·     Goodwill is similar to other intangibles on the basis of ‘Ejusdem Generis’ as it is akin to the assets like Patents, Copyrights, Trade-marks , etc. Ejusdem Generis means ‘of the same kind’; so goodwill is considered as intangible by many courts and forums on the basis of this principle despite not being mentioned clearly in the statute.

·    The smooth running will be halted if goodwill of the business lapsed anyhow like other tangible assets.

·    It sets the profit-generating apparatus of the business, so any expenses made thereon will be held in capital field. Hence, depreciation will also be allowed on same.

Now, we will discuss the allowance of depreciation on goodwill which generally arises in the restructuring deals. We will go through the following case-law to take a better understanding of the issue.

CIT v.  Smifs Securities Ltd. (Civil Appeal No. 5961 of 2012) Supreme Court

In the instant case, the assessee and YSN Shares and Securities Pvt. Ltd. amalgamated and all assets and liabilities Of YSN (P) Ltd. were to be transferred in the assessee-company under amalgamation. The excess consideration paid by the assessee over the value of net assets acquired of YSN (P) Ltd. was considered as goodwill arising on amalgamation by assessee. Assessee claimed the depreciation which was disallowed by revenue.

Supreme Court held that Goodwill falls under explanation 3(b) to section 32(1) of the Act by applying the principle of ejusdem generis. In the process of amalgamation the difference between actual consideration paid and cost of net assets constituted capital asset in form of Goodwill. Therefore, depreciation on such Goodwill   is allowed.

These case-laws can also be considered for same view.

·         CIT vs. Hindustan Coca Cola Beverages Pvt. Ltd. ITA Nos. 1391/2010, 1394/2010 & 1396/2010)

·         Skyline Caterers Pvt. Ltd. v. ITO 2007-TIOL-517-ITAT (Mum)

But various adverse decisions have also been given by various authorities; for which following case-laws may also be referred.

·         DCIT v. Toyo Engineering India Ltd. (ITA No. 3279/Mum/2008) Mumbai Bench of ITAT

·         R.G. Keswani v. ACIT (2009) 116 ITD 133 (Mum)

Conclusion:

Amidst varying decisions, it is pertinent from the decision of Supreme Court that tax-depreciation should be allowed on Goodwill. It is because if certain amount is paid over the value of net assets, then certainly the business which is sold has got some reputation in the market and instinct to do well in future. The difference between consideration paid and net assets rightly become goodwill as it shows that some benefit has been acquired from the previous owner for its reputation. So when benefit of enduring nature has been acquired, then certainly it tantamount to capital expenditure. Accordingly, depreciation should be allowed on it.

From the above mentioned legal precedents, it is also clear that tax-depreciation cannot be disallowed because of the following reasons:

a)       No particular fair valuation of goodwill has been carried out during the restructuring deals.

b)       Goodwill arising on account of amalgamation is not in the nature of commercial right.

c)      Depreciation is allowable on those assets only, whose value is not expected to arise in the future.      

Hence, the true base for allowing depreciation must be the real nature of intangible asset with reference to the rights which have actually accrued to acquirer.