What is Depreciation?
Section 32 of the Income Tax Act outlines depreciation, which can be understood as a deduction allowed from an asset owned and used by a taxpayer or assessee for the reduction in the real value of such assets, whether tangible or intangible. Tangible assets are those that can be physically touched or seen, whereas intangible assets cannot be physically touched or seen.
The cost of an asset is written off over its useful life and is a mandatory deduction made by every business from its income to derive the net profit earned. The Income Tax Act provides two methods for computing and deducting depreciation: the Straight Line Method (SLM) and the Written Down Value (WDV) Method. Out of these, the WDV method is most widely used by taxpayers.
Section 32 states certain intangible assets on which the assessee can claim the depreciation, and this includes know-how, patents, copyrights, trademarks, licenses, franchises, or “any other business or commercial rights of similar nature”. And in this, there is no such term as Goodwill Listed under intangible assets.
What is Goodwill?
Goodwill can be understood as an intangible asset that is associated primarily with the purchase of one company by the other. This will be affected by the value of the company’s brand name, customer base held by the company, the employee relations maintained by the company along with the customer relations in a good manner, and the proprietary technology which is used by the company, altogether.
Hence, many business entities claimed that it would come under the definition of “any other business or commercial rights of similar nature”, which is nothing but the residual category given under the definition for intangible assets.
As per section 2(11) regarding the block of assets, also, there is no word ‘goodwill’ included, making it apparent that the same is not specifically included in the meaning or definition of intangible assets. But to date, we can see that taking advantage of the decision made by the Hon’ble Supreme Court of India in CIT Vs. Smifs Securities Ltd, whereby it held, “that goodwill arising on account of excess consideration paid over the value of assets acquired on amalgamation is an intangible asset. It would fall in the category of ‘any other business or commercial rights of similar nature.” Thus, the court held that goodwill is a depreciable asset applying the principle ejusdem generis (meaning the same kind)”, this was adopted by many of the tribunals.
The Amendment Proposed
The Finance Bill 2021 proposed an amendment to section 2(11) of the Income Tax to exclude goodwill of a business or profession from the ‘block of assets’ along with an amendment of section 32(1) clause (ii) to provide that goodwill of a business or profession shall not be eligible for depreciation. Furthermore, an amendment was also introduced to Explanation 3 to Section 32(1), stipulating that the goodwill arising from a business or profession shall not be treated as an intangible asset for the purposes of Section 32(1) of the Income Tax Act.
Consequentially there was also an amendment brought to section 50 of the Income Tax Act where the Central Board of Direct Taxes (CBDT), prescribed a manner for determining the WDV of the block of assets and short-term capital gains, along with the amendments made to section 55 of the Income Tax Act.
Section 50 states that if a person sells an asset that is forming a part of the block of assets owned by the business or profession, on which depreciation has been allowed as per the provisions of the Income Tax Act, then such sales shall be treated as a capital gain.
While section 55 defines the cost of acquisition and cost of improvement for the Income Tax Act. Section 55 was amended to provide that the cost of acquisition of purchased goodwill of a business or profession should be calculated after reducing the depreciation amount that was allowed for AY prior to AY 2021-22. And in case of cost of improvement, the same section was amended as, “in relation to a capital asset being goodwill of a business or a right to manufacture, produce or process any article or thing or right to carry on any business or profession shall be taken to be nil”
The reason given by the authority for such an amendment was that “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 the 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, we can now conclude that, with this amendment made to Section 32 and such other allied sections, such as Section 50 and Section 55, the confusion regarding goodwill and whether it is depreciable has been clarified, making it easier for direct reference. But there might be some other issues that might arise in the future that will give way to more litigation.
