The Finance Bill 2021 has proposed that the goodwill of a business or profession will not be considered as a depreciable asset, and, accordingly, depreciation would not be allowed on goodwill of a business or profession in any situation.
It is well established in the financial world that goodwill is an asset that arises on account of consideration paid being in excess of fair value of assets and liabilities being acquired, irrespective of the fact whether consideration is discharged in cash or shares. The mode of acquisition of a business may be via a merger, demerger or business purchase.
Generally speaking, goodwill is subject to impairment under international accounting standards or is amortised in the tax books over its life. As a matter of fact, this is one of the many reasons why a buyer generally prefers a business purchase as compared to a share purchase from a seller, since the buyer would get depreciation on the value of assets that it has paid for including goodwill.
The memorandum to the Bill explains various reasons as to why depreciation should not be allowed on goodwill. The logical reasoning behind this is the impact of mergers and demergers are tax neutral in the hands of transferor company and its shareholders, and thus the transferee company should not avail depreciation on the asset value higher than the asset value that it inherits from the transferor company.
That is fair enough, but where is the logic in disallowing depreciation on goodwill of a business or profession resulting from purchase of a business by a buyer from a seller for which the seller is being taxed. If the seller is being taxed for the consideration that it receives, then the buyer must also get the depreciation benefits on the assets that it has paid for. The proposal, in fact leads to a situation of double taxation and is discriminatory and illogical.
The said situation is not that of tax avoidance or evasion. The tax department can always resort to the provisions of the General Anti Avoidance Rules to check any abuse of tax provisions on account of any business re-organisation or internal group restructuring. Further Indian Accounting Standard (Ind AS) 103 also does not allow recognition of goodwill in a “common control business combinations”.
However, the saving grace is that consideration paid for acquisition of such goodwill will continue in the tax books as a non-depreciable asset, the cost of which will be available as a deduction in computing capital gains on any subsequent sale.
Further, what is proposed to be restricted is a depreciation claim on goodwill of a business or profession. However, if the buyer allocates the purchase price that it has paid for acquiring the business, into specific and identifiable assets, whether tangible or intangible, then depreciation on such allocated value of identified asset should be available to the buyer. The buyer may consider obtaining a business valuation or a purchase price allocation report from a registered valuer or a chartered engineer to support the allocation of purchase price to specific identifiable assets like brands, licenses, customer data, know-how, patents, copyrights, trademarks, etc. Such assets are covered under the definition of intangible assets and, thus, are entitled to depreciation.
To conclude, the depreciation on goodwill is always an essential element in calculating post-tax return of an acquisition proposal and would severely impact pay-back calculations of every M&A deal, and the corresponding negotiations in the bid or offer price for an asset. The government may reconsider allowing depreciation on goodwill arising on a business purchase and may, if necessary, reduce the depreciation rate for this asset class in line with international standards.