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No Depreciation On Corporate ‘Goodwill’: A Bad Pill For M&As

As per the amendments proposed in the Finance Bill 2021, the goodwill of a business or profession has been removed from the block of intangible assets, on which depreciation is currently calculated at the rate of 25%.

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‘Goodwill’ is the recognition a business wins for delivering high quality products or services over several years. In common parlance, it is usually recognized basis the valuation of various underlying assets such as customer base, trademark, logos, brand awareness and employee knowhow among other things. The business that generates the goodwill is not allowed to recognize it in its books of accounts, being a self-generated asset. However, any buyer of that business does recognize its value and pays consideration for the same as well. The excess of consideration paid over the net asset value of the business is usually accounted as goodwill in the books of the buyer.

Historically, a conflicting act of goodwill

While the Income Tax (IT) Act provides for depreciation of know-how, patents, copyrights, trademarks, licenses and franchises or any other business or commercial rights of similar nature, it does not specifically refer to goodwill in the list of assets eligible for depreciation. Therefore, whether or not a buyer can claim depreciation on acquiring goodwill has been a matter of debate.

In the case of Smifs Securities Limited, the Supreme Court had ruled that goodwill falls in the category of ‘any other business or commercial rights of similar nature’ and thus, would be eligible for depreciation under Section 32 of the IT Act. This judgment has been relied upon in many cases involving various aspects of depreciation on goodwill.

However, this decision addressed only the core fundamental question of whether goodwill is a depreciable asset. The Court did not make any pronouncement regarding machinery aspects (like the quantum of depreciation that will be allowed in case of amalgamation).

The IT Act has specific provisions regarding merger and amalgamation transactions, where it outlines the cost of the assets to be considered in the hands of amalgamated or resulting company.

On interpretation of these provisions, the tax authorities disallowed the claim of depreciation for the amalgamated company. This is based on the proposition that since the amalgamating company was not eligible to claim depreciation on goodwill (in view of it being self-generated and thus, not recognized in its books of accounts), depreciation should not be allowed to the amalgamated entity as well.

The issue has continued to be a matter of tremendous litigation and judicial interpretations with various tribunals holding contrary views.

Amendments to Finance Bill 2021 - a bitter pill to swallow for M&As?

As per the amendments proposed in the Finance Bill 2021, the goodwill of a business or profession has been removed from the block of intangible assets, on which depreciation is currently calculated at the rate of 25%. The rationale given is that goodwill, in general, is not a depreciable asset. The

Memorandum also states that depending upon how a business runs, goodwill may see appreciation or no appreciation to its value.

Substantial increase in tax costs

This amendment would have an impact on all recent deals as tax costs estimated would change substantially as depreciation would no longer be available as a tax break.

Contrary to business?

The rationale of this amendment, as given in the Memorandum, points to the fact that the value of goodwill cannot decline - it can never be written down. This is contrary to business and commercial perspectives. For instance, if a decision to acquire a business was taken without adequate due-diligence, or there were lapses in judgment, or in cases of adverse changes in technological, economic or market conditions in which target company operates, an impairment charge of goodwill is recorded.

A blow to internal group restructuring and strategic acquisitions

The proposal to not regard goodwill as part of the intangible assets block and consequently, deny depreciation will apply to all merger and acquisition transactions. There is no exception provided for unrelated party transactions.

This will adversely impact buyers who shell out a substantial consideration (much more than the value of the tangible assets) for transfer through the amalgamation or merger route of businesses having potential for growth and benefitting from combined synergies. This proposal is a blow to internal group restructurings and strategic acquisitions.

How the amendment will shape M&As in the future

It is likely that acquirers will now revert to the traditional practice of allocating the purchase consideration (commonly referred to as purchase price allocation) towards specific intangible assets rather than representing the entire valuation as consolidated ‘goodwill’.

Valuation reports will play a crucial role in justifying the underlying valuations of the respective intangible assets (e.g. trademark, brand name, knowhow, process rights, etc.) and the businesses will have to establish the basis of the same beyond doubt.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

Maulik Doshi

Senior Executive Director, Transfer Pricing and Transaction Advisory Services, Nexdigm (SKP)

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