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Clarification on Depreciation on Goodwill: Budget 2021

clarification-on-depreciation-on-goodwill-budget-2021

All the proposed amendments in the Provisions of the Income Tax Act, 1961 (“Act”) for disallowing depreciation on goodwill of a business or profession as proposed by the Finance Bill, 2021 is explained.

In order to provide certainty, it is proposed to clarify that no depreciation on Goodwill shall be allowed. However, the deduction for the amount paid for acquiring Goodwill shall be allowed on sale of Goodwill. 


Depreciation on Goodwill


Section 2 of the Act provides the definitions for the purposes of the Act. Clause (11) of the said section defines “block of assets” to mean a group of assets falling within a class of assets comprising, tangible assets, being buildings, machinery, plant or furniture and 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. 



Section 32 of the Act relates to depreciation. Sub-section (1) of the said section provides for deduction on account of depreciation on tangible assets (Building, machinery, plant and furniture) and intangible assets (know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature) acquired on or after the 1st day of April, 1998 which are owned, wholly or partly by the assessee which are used wholly and exclusively for the purpose of business and profession while computing the income under the head “Profits and gains of business or profession”.


Further, Explanation 3 to sub-section (1) provides that for the purposes of this sub-section, the expression "assets" shall mean to be tangible assets, being buildings, machinery, plant or furniture and intangible assets, being know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.


Section 50 of the Act provides for conditions for the applicability of provisions of section 48 and 49 for computation of capital gains in case of depreciable assets where the capital asset is an asset forming part of a block of asset in respect of which depreciation has been allowed under this Act.


Section 55 of the Act provides meaning of terms "adjusted", "cost of improvement" and "cost of acquisition" for the purposes of sections 48 and 49 of the Act. In relation to a capital asset, being goodwill of a business or a trademark or brand name associated with a business or a right to manufacture, produce or process any article or thing or right to carry on any business or profession, tenancy rights, stage carriage permits or loom hours, it is defined to mean the purchase price if it is acquired by purchase. In other cases, it is nil except when it is covered by sub-clauses (i) to (iv) of sub-section (1) of section 49.

  

It is seen that Goodwill of a business or a profession has not been specifically provided as an asset either in the definition under clause (11) of section 2 of the Act or in section 32 of the Act. The question whether goodwill of a business is an asset within the meaning of section 32 of the Act and whether depreciation on goodwill is allowable under the said section, is an issue which came up before Hon‘ble Supreme Court in the case  Smiff  Securities  Limited  [(2012)348  ITR  302  (SC)].  Hon‘ble Supreme Court answered the question in affirmative. Thus, as held by Hon‘ble Supreme Court, Goodwill of a business or profession is a depreciable asset under section 32 of the Act. 


However, there are other sections of the Act which are relevant for calculation of depreciation under section 32 of Act. These are as under:


Sixth proviso the section 32 of the Act mandates that in a case of succession/amalgamation/demerger during the previous year, depreciation is to be calculated as if the succession or amalgamation or demerger has not taken place during the previous year and apportioned between the predecessor and the successor, or the amalgamating company and the amalgamated company, or the demerged company and the resulting company, as the case may be, in the ratio of the number of days for which the assets were used by them.


Explanation 2 of sub-section (1) of section 32 of the Act provides that the term “written down value of the block of assets” shall have the same meaning as in clause (c) of sub-section (6) of section 43 of the Act.


Clause (c) of sub-section (6) of section 43 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.


Sub-section (1) of section 43 of the Act which defines “Actual cost” as actual cost of the assets to the assessee. Explanation 7 to this section covers a situation where in a scheme of amalgamation, any capital asset is transferred by the amalgamating company to the amalgamated company and the amalgamated company is an Indian company. It clarifies that in this situation, the actual cost of the transferred capital asset to the amalgamated company shall be taken to be the same as it would have been if the amalgamating company had continued to hold the capital asset for the purposes of its own business.


Explanation 2 of clause (c) of sub-section (6) of section 43 of the Act also covers a situation where in a scheme of amalgamation, any capital asset is transferred by the amalgamating company to the amalgamated company and the amalgamated company is an Indian company. It also clarifies that in this situation, the actual cost of the block of asset in the hand of the amalgamated company would be written down value of that block in the immediate preceding previous year in the case of amalgamating company as reduced by depreciation actually allowed in that preceding previous year.


Thus, while Hon‘ble Supreme Court has held that the Goodwill of a business or profession is a depreciable asset, the actual calculation of depreciation on goodwill is required to be carried out in accordance with various other provisions of the Act, including the ones listed above. Once we apply these provisions, in some situations (like that of business reorganization) there could be no depreciation on account of actual cost being zero and the written down value of that assets in the hand of predecessor/amalgamating company being zero. 


However, in some other cases (like that of acquisition of goodwill by purchase) there could be valid claim of depreciation on goodwill in accordance with the decision of Hon‘ble Supreme Court holding goodwill of a business or profession as a depreciable asset. 


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 appears to be little justification or depreciation on goodwill even in the category of cases referred to 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 goodwill is 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 assessee in 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 of the purchase price of the goodwill. 


Therefore, to give effect to the above decision, it has been proposed to,


(a) amend clause (11) of section 2 of the Act to provide that “block of asset” shall not include 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 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 sub-section (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,-


(i) in the case of acquisition of such asset by the assessee by purchase from a previous owner, means the amount of the purchase price; and


(ii) in the case falling under sub-clause (i) to (iv) of sub-section (1) of section 49 and where such asset was acquired by the previous owner (as defined in that section) by purchase, means the amount of the purchase price for such previous owner; and 


(iii) in any other case, shall be taken to be nil


(e) provide that in case of goodwill of business or profession acquired by the assessee by way of purchase from a previous owner (either directly or through modes specified under sub-clause (i) to (iv) of sub-section (1) of section 49) and any deduction on account of depreciation under section 32 of the Act has been obtained by the assessee in any previous year preceding the previous year relevant to the assessment year commencing on or after the 1st April, 2021, then the cost of acquisition will be the purchase price as reduced by the depreciation so obtained by the assessee before the previous year relevant to the assessment year commencing on 1st April, 2021.


These amendments will take effect from 1st April, 2021 and will accordingly apply to the assessment year 2021-22 and subsequent assessment years. 


Amendment of section 2. 


3. In section 2 of the Income-tax Act,–– 


(i) in clause (11), in sub-clause (b), after the words “or commercial rights of similar nature,”, the words “not being goodwill of a business or profession,” shall be inserted; 


Amendment of section 32.


7. In section 32 of the Income-tax Act, in sub-section (1),– 


(a) in clause (ii), after the words, figures and letters, “after the 1st day of April, 1998,”, the words “not being goodwill of a business or profession,” shall be inserted; 


(b) in Explanation 3, in clause (b), after the words “or commercial rights of similar nature”, the words “, not being goodwill of a business or profession” shall be inserted. 


Amendment of section 50.


18. In section 50 of the Income-tax Act, in clause (2), the following proviso shall be inserted, namely:–– 


“Provided that in a case where goodwill of a business or profession forms part of a block of asset for the assessment year beginning on the 1st day of April, 2020 and depreciation thereon 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 such manner as may be prescribed.”


Amendment of section 55.


20. In section 55 of the Income-tax Act, in sub-section (2), for clause (a), the following clause shall be substituted, namely:––


“(a) in relation to a capital asset, being goodwill of a business or profession, or a trade mark 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,— 


(i) in the case of acquisition of such asset by the assessee by purchase from a previous owner, means the amount of the purchase price; and 


(ii) in the case falling under sub-clauses (i) to (iv) of sub-section (1) of section 49 and where such asset was acquired by the previous owner (as defined in that section) by purchase, means the amount of the purchase price for such previous owner; and 


(iii) in any other case, shall be taken to be nil: 


Provided that where the capital asset, being goodwill of a business or profession, in respect of which a deduction on account of depreciation under sub-section (1) of section 32 has been obtained by the assessee in any previous year preceding the previous year relevant to the assessment year commencing on or after the 1st day of April, 2021, the provisions of sub-clauses (i) and (ii) shall apply with the modification that the total amount of depreciation obtained by the assessee under sub-section (1) of section 32 before the assessment year commencing on the 1st day of April, 2021 shall be reduced from the amount of purchase price;”. 


Amended Provisions disallowing depreciation on goodwill explained


Clause 3 of the Bill seeks to amend section 2 of the Income-tax Act relating to definitions. 


Clause (11) of the said section, inter alia, defines “block of assets” to  mean a group of assets falling within a class of assets comprising tangible assets, being buildings, machinery, plant or furniture and intangible assets, being know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.  


It is proposed to amend the said clause so as to exclude goodwill of a business or profession from the purview of “block of asset”. 


Clause 7 of the Bill seeks to amend section 32 of the Income-tax Act relating to depreciation. 


Sub-section (1) of the said section provides for deduction on account of depreciation on tangible assets (building, machinery, plant and furniture) and intangible assets (know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature) acquired on or after the 1st day of April, 1998, and are owned, wholly or partly by the assessee and are used wholly and exclusively for the purpose of business and profession while computing the income under the head ‘Profits and gains of business or profession’. 


It is proposed to amend clause (ii) of the said sub-section (1) so as to provide that goodwill of a business or profession shall not be considered as an asset for the purpose of the said clause and, hence, not eligible for depreciation. 


Explanation 3 to the said sub-section defines the expression “assets” to mean tangible assets, being buildings, machinery, plant or furniture; and intangible assets, being know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature. 


It is proposed to amend the said Explanation 3 so as to provide that goodwill of a business or profession shall not be considered as an asset for that purposes of the said sub-section. 


These amendments will take effect from 1st April, 2021 and will, accordingly, apply in relation to the assessment year 2021-2022 and subsequent assessment years. 


Clause 18 of the Bill seeks to amend section 50 of the Income–tax Act relating to special provision for computation of capital gains in case of depreciable assets. 


The said section, inter alia, provides for certain conditions for the applicability of provisions of sections 48 and 49 for computation of capital gains in case of depreciable assets, where the capital asset is an asset forming part of a block of asset in respect of which depreciation has been allowed under the said Act. 


It is proposed to insert a proviso in the said section so as to provide that in a case where goodwill of a business or profession forms part of a block of asset for the assessment year beginning on the 1st day of April, 2020 and depreciation thereon 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 such manner as may be prescribed. 


This amendment will take effect from 1st April, 2021 and will, accordingly, apply in relation to the assessment year 2021-2022 and subsequent assessment years. 


Clause 20 of the Bill seeks to amend section 55 of the Income-tax Act relating to the meaning of “adjusted”, “cost of improvement” and “cost of acquisition”. 


Clause (a) of sub-section (2) of the said section provides that for the purposes of sections 48 and 49, "cost of acquisition" in relation to a capital asset, being goodwill of a business or a trademark or brand name associated with a business or a right to manufacture, produce or process any article or thing or right to carry on any business or profession, tenancy rights, stage carriage permits or loom hours,— 


(i) in the case of acquisition of such asset by the assessee by purchase from a previous owner, means the amount of the purchase price; and 


(ii) in any other case [not being a case falling under sub-clauses (i) to (iv) of sub-section (1) of section 49], shall be taken to be nil ; 


It is proposed to substitute the said clause so as 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,— 


(i) in the case of acquisition of such asset by the assessee by purchase from a previous owner, means the amount of the purchase price; and 


(ii) in the case falling under sub-clause (i) to (iv) of sub-section (1) of section 49 and where such asset was acquired by the previous owner (as defined in that section) by purchase, means the amount of the purchase price for such previous owner; and 


(iii) in any other case, shall be taken to be nil.


It is also proposed to provide therein that in case of goodwill of business or profession acquired by the assessee by way of purchase from a previous owner (either directly or through modes specified under sub-clause (i) to (iv) of sub-section (1) of section 49) and any deduction on account of depreciation under section 32 of the said Act has been obtained by the assessee in any previous year preceding the previous year relevant to the assessment year commencing on or after the 1st day of April, 2021, then the cost of acquisition will be the purchase price as reduced by the depreciation so obtained by the assessee before the previous year relevant to the assessment year commencing on the 1st day of April, 2021. 


These amendments will take effect from 1st April, 2021 and will, accordingly, apply in relation to the assessment year 2021-2022 and subsequent assessment years. 



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