It is difficult to define goodwill. All that we can say is that it is an intangible capital asset as visualised by the Supreme Court in Srinivas Chetty's case. 128 ITR 294. It is the benefit and the advantage of the good name, reputation and connection of a business, the attractive force which brings in customers.
It is built by contributing factors like a reputation for honest dealing, quality and standard. It is the component of the total value of the undertaking which is attributable to the ability of the concern to earn profits over a course of years because of its reputation, location and other features.
Section 32(1)(ii) of the Income Tax Act, 1961 allows depreciation on know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature, being intangible assets, owned, wholly or partly, by the assessee and used for the purposes of the business or profession.
While various intangible assets are enumerated in the sub-clause, there is no mention of goodwill as being an asset entitled to depreciation.
This has led to confusion. Intangible assets as a class give rise to difficulties as we know from the different interpretations placed in respect of Stock Exchange Membership Card vis-à-vis depreciation. If goodwill is to be allowed depreciation, there should be separate valuation for the same. Valuation by accounting principles may not always lead to correct conclusion.
The Upasana Hospital Case
Upasana Hospital is a famous clinic in Kerala. It has been running in Quilon for a long period. It was sold to Ravindran Pillai 225 Taxation 282 (Kerala).
Pillai purchased the hospital with its name, logo, trademark, staff and equipment as a going concern without any break in the running of the hospital. Patients continued to be the same.
Immovable properties were mentioned in the First Schedule to the sale deed. The Second Schedule B of the sale deed mentioned the intangible assets including the Emblem or trademark of the hospital.
The sale deed gave a figure of Rs 2 crore towards the name, logo, and trademark and depreciation was claimed on this amount under the head ‘goodwill'. The Assessing Officer held that goodwill is not covered by Section 32 (1)(ii) of the Act and disallowed the claim.
The Kerala High Court considered the matter in some detail. Revenue argued that depreciation is provided for to take care of wear and tear and there can be no erosion in goodwill.
The claim of deprecation on goodwill, it was submitted, was fundamentally against the scheme of depreciation. On the other hand, Pillai contended that benefit by way of depreciation under Section 32(1)(ii) is admissible, no matter whether there is erosion in value or not on the tangible or intangible assets referred to in Section 32.
ADJUSTING INFLATION
It is common knowledge that an account of inflation, even tangible assets like building, machinery, plant or furniture will fetch higher price in later years, though in the asseessee's books the value got eroded on account of depreciation written off.
One has only to look into the provisions of Section 41(2) and Section 50 to understand that the Act takes into account the possibility of appreciation or at least retention of value of depreciable assets on which depreciation is allowed. The High Court accepted this argument. It ruled that the entitlement for depreciation on assets including intangible assets cannot be negated on the ground that no erosion in value takes place on account of use of the asset in business or profession.
The High Court also considered the question whether goodwill is covered by the residuary clause in Section 32 (1)(ii). Trademark and logo include the value for goodwill. The hospital was run in the same building, in the same town, in the same name for several years and became a successful hospital.
It is the reputation that brings patents to the hospital and this involves the quality of the doctor, staff, equipment and other facilities available in the hospital.
The purpose of paying a very huge amount for goodwill is for maintenance of the continued reputation of the hospital which was run in the same name for years. If the previous owner of the hospital had wanted, he could have retained the trade name, logo etc., without transferring it to Pillai.
By transferring the right to use the name of the hospital itself, the previous owner has transferred the goodwill to the purchaser.
When goodwill is paid for ensuring retention and continued business in the hospital, it becomes a business or commercial right comparable with trademark, franchise and copyrights etc., Goodwill was thus found eligible for depreciation.
Any doubts regarding the entitlement of goodwill to depreciation can be taken as resolved by the Kerala Ruling. Henceforth, mergers, acquisitions and takeovers must assign separate value for goodwill to take advantage of the benevolent ruling of the Kerala High Court.
(The author is a former Chief Commissioner of Income-Tax.)