The term ‘goodwill’ is not specifically defined in the Income Tax Act (the Act). Goodwill is typically generated during business restructuring transactions like merger, demerger, slump sale, etc. where many companies end up buying other companies (mostly internal entities) at a value that is higher than the book value. The differential amount is recorded in books of account as ‘goodwill’, as prescribed in Accounting Standards. Goodwill is basically the advantage made available to the buyer on such transactions that gives rise to commercial benefits like honesty, trade name, customer value, etc.

Goodwill generally includes other intangibles. However, under restructuring transactions, it is recommended to separately recognize specific intangibles like brand name, trademark, customer base, etc. Only the remaining amount should be considered as goodwill.

The Hon’ble Supreme Court, in the landmark Judgement of Smifs Securities, considered goodwill as a capital asset eligible for depreciation. It provided support in claiming depreciation on goodwill generated on transactions like Amalgamation, Demerger, Slump sale, etc. After the Apex Court decision, there have been many judgements on this aspect – most of them have been in favour of the assessee. Recently, the Hon’ble Supreme Court maintained this legal position in the case of Zydus Wellness Ltd.

After laps of almost 8-9 years the Ministry of Finance amended the Act to exclude Goodwill from Block of Assets.

The Act refers to multiple intangible assets like know how, patent, copyright, trademark, license, and includes wider terms like other business or commercial rights of similar nature. The reference to intangible assets is now amended to specifically exclude goodwill.

Amendments

The Finance Act, 2022 has inserted an Explanation after the proviso to Section 50 to clarify that the reduction of the amount of goodwill of a business or profession from the block of an asset in accordance with Section 43(6)(c)(ii)(B) shall be deemed to be a transfer. Earlier, the Finance Act, 2021 had not amended Section 50 for computation of deemed capital gains in a case the amount of goodwill is reduced from the block of intangible assets. Though, Rule 8AC(3) squarely covers this situation and computes the deemed capital gains.

To fill this gap, the Finance Act, 2022 has brought a consequential amendment under section 50 to provide that a reduction of the amount of goodwill of a business or profession, from the block of asset shall be deemed to be a transfer.

This amendment is applicable with retrospective effect from Assessment Year 2021-22.

The Amendment as per section 15 of Finance Act, 2022 is as follows:

Amendment of section 50

In section 50 of the Income-tax Act, after the proviso, the following Explanation shall be inserted and shall be deemed to have been inserted with effect from the 1st day of April, 2021, namely:—

“Explanation.—For the purposes of this section, reduction of the amount of goodwill of a business or profession, from the block of asset in accordance with sub-item (B) of item(ii) of sub-clause (c) of clause (6) of section 43 shall be deemed to be transfer.”.

The Memorandum explaining the proposed amendment is as follows:

Reduction of Goodwill from block of assets to be considered as ‘transfer’

From the assessment year 2021-2022, goodwill of a business or profession is not considered as a depreciable asset and there would not be any depreciation on goodwill of a business or profession in any situation. In 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.

When the amendment was carried out through the Finance Act 2021, consequential amendment was carried out in section 50 of the Act by insertion of a proviso to clause(2) of that section. A further consequential amendment required is being proposed now.

Accordingly, it is proposed to clarify that for the purposes of section 50 of the Act, reduction of the amount of goodwill of a business or profession, from the block of asset in accordance with sub item (B) of item (ii) of sub-clause (c) of clause (6) of section 43, shall be deemed to be transfer.

Since the amendment to the effect that goodwill of a business or profession is not a depreciable asset has been made applicable from assessment year 2021-2022 the above amendment will take effect retrospectively from 1st April 2021 and will accordingly apply in relation to the assessment year 2021- 22 and subsequent assessment years.

The Notes on clauses also gave insight of the legislative intent behind the present amendment

Clause 15 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 provides for certain modification in the applicability of the 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 this Act.

Proviso to the said section provides that in a case where goodwill of a business or profession forms part of a block of assets for the assessment year beginning of the 1st day of April, 2020 and depreciation thereon has been obtained by the assessee under the Income tax 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 provided by rules.

It is proposed to amend section 50 to insert an Explanation to clarify that for the purposes of the said section 50, reduction of the amount of goodwill of a business or profession, from the block of asset in accordance with sub-item (B) of item (ii) of sub-clause (c) of clause (6) of section 43 shall be deemed to be transfer.

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

From the combined reading of the above explanations, it is seen that the amendment is curative in nature.

Earlier, vide Finance Act, 2021 the CBDT had done away with depreciation allowance on goodwill, and hence, amendments were made to various sections of the Act with effect from Assessment Year 2021-22:

• Change in the definition of ‘block of asset’ so as to remove ‘goodwill from business or profession’.
• Clause (ii) to section 32(1) was amended to provide that ‘goodwill of a business or profession’ shall not be eligible for Further, an amendment was made to Explanation to Section 32(1), which defines the expression ‘asset’. It was provided that ‘goodwill of a business or profession’ shall not be treated as an ‘intangible asset’ for Section 32(1).
• The Finance Act had amended provision of section 55 by inserting a proviso to Section 55(2)(a). The actual cost of goodwill shall be computed after reducing the depreciation claimed by the assessee up to the Assessment Year 2020-21 from the amount of purchase price of such The amount remaining after such reduction shall be treated as the actual cost of goodwill for computation of capital gain from transfer of goodwill on or after 01-04-2020.

• Clause (c) of Section 43(6) was amended to provide that the WDV of the block of intangible assets shall be reduced by the actual cost of goodwill falling within such block of assets. Before the reduction of the actual cost of goodwill from the block, it shall be first reduced by the amount of depreciation:
  1. Actually allowed to the assessee for such goodwill before the Assessment Year 1988-89, and
  2. That would have been allowable to the assessee from the Assessment Year 1988-89 as if the goodwill was the only asset in the relevant block of
• Section 50 of the Act contains provisions for computation of capital gain in case of transfer of depreciable assets. The Finance Act, 2021 inserted a new proviso to section 50(2). It provided that the CBDT may prescribe a manner to determine the WDV of the block of asset and short- term capital gain if goodwill is forming part of that block and depreciation has been claimed thereon. Thus, if a block of intangible asset contains goodwill and it ceases to exist, the capital gain on such block shall be calculated in the manner prescribed by the Board. The CBDT has accordingly notified Rule 8AC prescribing manner for computation of capital gain on such block. However, this proviso is applicable only if a block of intangible assets contains goodwill and ceases to

The effective changes can be summerised as under:

• Goodwill of a business or profession is not considered as a depreciable asset, and no depreciation is allowable on it under any situation;

• In a case where goodwill is purchased, the purchase price of the goodwill will be considered as the cost of acquisition for computing capital gains;
• If depreciation was obtained on goodwill before assessment year 2021-22, the depreciation so obtained shall be reduced from the amount of the purchase price of the goodwill. The CBDT has notified Rule 8AC to compute short-term capital gains and written down value under Section 50 where depreciation on goodwill has been

Analysis

The Finance Ministry has made various changes in the Act related to depreciation on Goodwill, which has created tumultuous wave in the industry. Changes have been made in various provisions, including the definition of the term ‘block of assets’ to specifically exclude ‘goodwill’, which has, in turn effected nullifying various decisions of the Apex Court wherein it had been held that ‘acquired Goodwill’ is a depreciable asset. The Ministry is of the view that Goodwill is not a depreciable asset and may even see appreciation. The Memorandum explaining the Finance Bill (as reproduced above) states that in general, Goodwill is not a depreciable asset and Goodwill may see appreciation or in the alternative no depreciation to its value, and therefore, there may not be a justification for allowing depreciation on goodwill. Hence, the amendment to disallow the depreciation claim on Goodwill acquired as a result of business acquisitions or reorganizations. Accordingly, going forward, businesses will have to remove Goodwill from the block of asset. The same would be chargeable to Capital Gain tax when sold in future.

Surprisingly the Ministry has taken more than nine years to notify that Goodwill is not a depreciable asset and amended the law, the only positivity could be considered that it has not taxed the presumed appreciation in Goodwill till now, which could be major relief to the assessee.

Though it’s observed throughout the years it’s a practice to overturn the decisions of the Hon’ble Supreme Court, by bringing in the parliamentary veto, the above amendment comes as a surprise. These changes may have a significant negative impact not only on proposed mergers and restructuring transactions, but also on past transactions.

If Goodwill is considered to be not an appreciable asset then it, not necessarily, has to be a non-depreciable asset. The value of Goodwill may change depending on many factors like, performance, customer satisfaction, financial stability or even due to technological changes. An example could be taken of Nokia which used to make best cell phones in past, but it had to shut down as the technology advanced & they could not keep up with the change in technology.

This amendment will have a far-reaching negative impact on business acquisitions and restructuring transactions. It could be enthralling to observe that how sellers and buyers negotiates and agree on valuations in coming years.

It is pertinent to note that ‘retrospective amendment’ takes effect from a date in the past. Though the current amendment has not been made applicable retrospectively, it has severely affected entities having acquired Goodwill in recent past years. It’s nearly ten years since the legal position related to depreciation on Goodwill was settled after the judgment of the Apex Court in the year 2012. Thereafter, many mergers, demergers, business acquisitions, restructuring has taken place. The sudden change in the law, after such a lapse, would probably result in higher tax outflow on account of disallowance of depreciation on Goodwill, which would naturally increase the cost to the business. Where the Goodwill is part of the block of assets consisting of other intangible assets, which if disposed-off, then there is also a possibility that depreciation already claimed in preceding years may now result in Short- Term Capital Gain adding insult to injury. The impact will be two edged sword as there could be additional tax burden & it would also impact the valuation of the Business or the going concern status of an entity depending on the size of business acquisitions or reorganizations and Goodwill acquired.

Going Forward, Goodwill will not be taxed under S. 50, but will be taxed under S. 45, in case of any transfer.

In case of block of assets consisting of Goodwill, the quantum of Goodwill within the block of intangible assets could be unascertained and the CBDT guidelines should address this aspect.

It is well known international practice of allowing Depreciation on Purchased Goodwill for taxation purpose. The intent of such allowance is that the assessee had incurred a cost for the purpose of his business, and hence, should be given the benefit of depreciation or amortization over a period of time. Incidentally, the memorandum to Finance Bill of 2021 states as:

“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.”

Even in spite of this After this, the Memorandum also has a contradictory explanation that the need of allowing depreciation on goodwill is not as justified as that allowable on other intangible assets or tangible assets, as Goodwill in general, is not a depreciable asset and may see appreciation or otherwise depending upon how a business runs. I would believe that depreciation on Purchased Goodwill should be allowable, irrespective of the way Business runs. This is because such a claim by the acquiror can’t be the basis for the way business goes on subsequently, but as there is a cost which has been incurred to acquire that business, which as per settled principles, should qualify for a claim of deduction.

It is a need of time, that the Finance Ministry recognizes this and gives further clarifications for better business environment and avoid controversies. Without which, the Business Acquisitions will become more expensive, and that’s not welcome for our economy, which has an ambitious growth agenda where mergers and acquisitions is one of the commonly-followed strategy by organizations to pursue business growth.

To conclude with, in future, any retroactive amendment to levy taxes (like the one discussed above) would only bring additional tax burden on the assessee, which in turn would impact ‘Ease of doing business’ (a pledge taken by our Government). Especially when global economy is staring at recession & Slow down & our economy and businesses are trying to expand with M&A.

As per the Current Scenario:

• Acquirors will need to rework their advance tax computations and pay additional taxes with interest where they had, in earlier years, had claimed depreciation on Goodwill acquired through M&A Transactions closed during the previous year; and
• For open transactions, the entities will need to renegotiate the transaction that were planned to be closed assuming availability of depreciation on

It is desired that the Ministry of Finance should pay due attention to this aspect while making further enactments.