The Finance Act, 1998 introduced the concept of depreciation on intangible assets. As per section 32 (1)(ii) of the act, depreciation would be allowable on intangibles such as know-how, patents, copyrights, trademarks, licenses, and franchises. It would also be allowable on any other business or commercial rights of similar nature, acquired on or after April 1, 1998. The above definition does not specifically include goodwill. Also, the term goodwill has not been defined under the Income Tax Act, 1961.

For accounting purposes, acquired goodwill is amortisable over the best estimate of its useful life (not exceeding 10 years). However, whether such goodwill would fall within the meaning of the expression ‘any other business or commercial rights of similar nature’, and hence amortisable for tax purposes, has been the subject of debate.

Internationally, the tax deductibility of amortised goodwill varies across jurisdictions. In certain jurisdictions (such as the US, UK, Germany, and Netherlands), amortisation of goodwill is tax deductible. Some others (such as Australia, France, Ireland, and Romania) do not allow tax deduction on amortised goodwill.

In India, there have been various court decisions, which upheld the position that where goodwill represents identifiable intangibles or specific business or commercial rights that may enable the tax payer to carry on his business effectively, the goodwill should fall within ‘other business rights’ — and, hence, be eligible for depreciation. However, where goodwill is self-generated, or does not represent a specific benefit or asset, it would be based on general rights of business, and therefore, not be eligible for depreciation.

This issue seems to have been laid to rest by the recent Supreme Court ruling in the case of Smifs Securities. In this case, goodwill has been held to be an intangible asset, eligible for depreciation under section 32 of the Income Tax Act. The ruling reaffirmed the position that the principle of ejusdem generis (‘of the same kind’) should strictly apply while interpreting the expression ‘any other business or commercial right of a similar nature’. Accordingly, goodwill would be covered within this expression.

The Supreme Court ruling has also laid down the position that goodwill could arise as a result of amalgamation of two companies, if the consideration paid exceeds the net book value of assets taken over. However, the issue of availability of depreciation on goodwill when a subsidiary amalgamates into the parent is still a subject of debate.

In a recent ruling, the Mumbai Tribunal held that no depreciation was allowable on goodwill (difference between the net book value of assets acquired and the investment cost in the books of the parent) created due to amalgamation of a subsidiary company into its parent. The Tribunal held that the goodwill disclosed was on account of a mere book entry. Since fair valuation of assets and liabilities were not carried out and value was not ascribed to goodwill, it did not represent any commercial right. Accordingly, such goodwill would not be eligible for depreciation.

In most situations, the investment value in the books of the parent (on the acquisition of shares of the subsidiary) would include consideration paid towards intangibles — such as reputation built over a period of time, or customer base. The tax payer should ascribe an appropriate value to the goodwill to contend that the consideration paid was in the nature of a commercial right.

While the Supreme Court ruling in the Smifs Securities case held that goodwill was an intangible asset eligible for depreciation, it did not delve into the issue of valuation of goodwill. Tax payers may need to wait a while longer for certainty on this issue.

Madhukar Dhakappa is Associate Director – Tax & Regulatory Services, PwC India

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