Volume 5, Issue 19


29th August, 2012


Tax Alert
Supreme Court of India Rules - Goodwill eligible for Depreciation

In a business acquisition, the purchase consideration is usually more than the net assets taken over.  In accounting parlance, this excess consideration is treated as goodwill.  Under the Income-tax Act, 1961 (‘ITA’), the allowability of depreciation on goodwill has been a matter of considerable discussion and debate.  While allowing depreciation on intangible assets, the ITA uses the following expression:

“intangible assets, being know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature

The Tax Authorities would argue that since goodwill is not specifically mentioned in the above definition, it should not be eligible for depreciation.  Against this, the tax payer would contend that payment on account of goodwill is in the nature of any other business or commercial right of similar nature and hence, eligible for depreciation. 

Through certain judgments of High Courts and of the Income-tax Appellate Tribunal, the principles emerged that goodwill generated in the books of accounts is not, in itself, eligible for depreciation.  However, if the payment for goodwill is supported by acquisition of ‘business or commercial rights’, goodwill will be eligible for depreciation to the extent the amount paid for goodwill can be attributed to these business or commercial rights.  These business or commercial rights included brand, logo, trading style, customer database, distribution network, skill and know how brought by employees of the seller, business information and records, territorial and market know how, customer information etc.

The Supreme Court in a recent case1 has ruled that depreciation would be allowed on goodwill.  This case forms the subject matter of this Tax Alert.

Relevant facts of the case:

  • The tax payer, Smifs Securities Limited, took over the business of another company by way of a scheme of amalgamation sanctioned by the High Court.  The excess consideration paid over the net assets taken over was considered as goodwill and depreciation was claimed on the same.
  • The tax payer claimed that the goodwill was paid towards the reputation which the amalgamating company was enjoying in order to retain its existing clientele.
  • The tax payer in the process of amalgamation had acquired a capital right in the form of goodwill because of which the market worth of the tax payer stood increased.

Contentions of the Revenue:

  • The ITA allows depreciation on “intangible assets, being know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature
  • Goodwill is not an asset which is mentioned in the above expression.  In the instant case, no amount was actually paid on account of goodwill.  Hence, depreciation should not be allowed on goodwill.

Question before the Supreme Court:

Whether goodwill is an “intangible asset” under the ITA and whether depreciation on goodwill is allowable as a tax deduction?

Supreme Court’s judgment:

  • A reading of the expression “intangible assets, being know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature” indicates that goodwill would fall under the expression `any other business or commercial right of a similar nature'.
  • The Commissioner of Income-tax (Appeals) and Income-tax Appellate Tribunal have upheld the factual finding that the market worth of the tax payer stood increased as a result of amalgamation.  This factual finding of the lower authorities was not challenged by the Revenue before the High Court.
  • Hence, goodwill is an intangible asset under the ITA and thus, eligible to depreciation.

SKP’s comments:

This judgment of the Supreme Court can be considered as a landmark decision in relation to allowability of depreciation on goodwill.  The Supreme Court’s decision can be interpreted to say that the excess of purchase consideration over the net assets taken over in a scheme of amalgamation or slump sale would be considered as goodwill and will be eligible for depreciation in its entirety.  By implication, the tax payer will not be required to attribute the goodwill to the acquisition of any specific intangible assets.  The Supreme Court has taken into account the commercial realities behind payment of consideration over and above the net assets.  This judgment has come as a substantial relief to the tax payers expanding their operations through business acquisitions.  We hope that the Government responds to this judgment favourably and not by amending the law to deny the above benefits.

 
Notes:
1 CIT v Smifs Securities Limited [Civil Appeal No. 5961 of 2012]